If you are new to house flipping or only have a few flips under your belt, you probably have heard of the 70% rule, but do you fully understand it?
The 70% rule, which is more of a guideline than a hard and fast rule, guides many experienced flippers in determining how much they are willing to pay for a house.
The 70% rule itself is pretty basic, but you want to understand all the factors that go into your calculation if you want to apply the rule to become a successful house flipper.
The Basic Calculation
The basics of the calculation are that you want your costs involved in the house to total 70% of what you estimate you can sell the house for at the end of the project. That means your purchase price, your rehab budget and your soft money costs should total 70% of your after rehab value (ARV).
A simple example: the house you consider buying has an estimated ARV of $100,000, so you want your total cost to be $70,000. Your contractor tells you the rehab will cost $15,000. You might budget another $5,000 for soft money costs (we'll talk more about this later). That means you don't want to pay more than $50,000 for the house. (100,000 x .7 = 70,000 - 15,000 = 55,000 - 5,000 = 50,000). This leaves you a profit of $30,000 on your flip.
The bigger issue is how do you ensure all the numbers you put into your 70% formula are good. Let's start at the top:
Understanding Your Comps
The first piece of the equation is the ARV (your selling price). To get the most accurate figure, you need to know how the homes are selling in the neighborhood where you will be flipping. In real estate terms, these are your "comps," or comparable value homes that have sold recently.
When we say recently, the best figures you can get are homes that have sold in the past 90 days. If you are in a neighborhood or community where home values are less volatile, you can look at comps up to a year old. It's always better to look at homes that have sold, rather than homes that are just on the market. If a house has been sitting on the market for 6 months at a certain price, you don't want to base your comp on that.
The key factors that determine what homes are considered comparable to yours are square footage, number of bedrooms and bathrooms. Some other factors can come into play such as basement, finished vs. unfinished, crawl space or slab. Also the lot size can be a factor.
Finding other rehabbed homes can benefit your pricing as they will have many of the new amenities and features you will be putting into your rehab. If not, at least consider the age of such costly items as roofs, heating-air units, sewer lines, etc.
Having good comps is the most important information you need as a flipper, so if you're not a real estate agent, it would be a good idea to put one on your team so you are getting the latest information. You don't want to set your selling price too low or too high as either can destroy your flipping business.
Setting Your Rehab Costs
If you're not in the construction business, you need a reliable contractor to give you the estimate on your rehab costs. You'll want to understand which improvements pay off and which ones don't. When your contractor gives you the bid, adding a contingency fund (usually 10%) is a good idea to cover unforeseen costs, and there are always unforeseen costs on a flip.
Knowing Your Soft Costs
The final piece of the puzzle is knowing what your soft costs are going to entail. This will include interest on money you may need to borrow to purchase the house or for the rehab costs. You also will be paying property taxes and insurance on the home the entire time you own it, plus utilities during the rehab. Finally, you will have the closing costs when you sell the house. Your real estate agent friend will help you understand what these will be.
Now that you understand the 70% rule and all the factors that go into setting it, you can determine for yourself how closely you want to stick to it for your flipping projects. When flipping lower-cost houses, sticking close is a great idea, but if you go higher end, maybe you'd be happy making $200,000 on a $1 million house, so you can flex a little on the 70% rule.
Whatever your target goals for your house flipping business, contact us about competitive rates for your house purchase and rehab loans.
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