Yikes. That’s going to meet some resistance...
But that’s ok because I’m here to educate and inspire you, not placate you.
I’m going to lay out some very real issues with the 70% Rule and give you an even smarter, always current way to calculate your offers.
What is the 70% Rule?
In case you haven’t heard of the so-called Golden Rule in house flipping, the 70% Rule states that your offer on a property should be no greater than 70% of the After Repair Value (ARV) minus the estimated repairs.
For example, let’s say you’ve got a property with the following:
ARV = $350,000
Repairs = $60,000
According to the 70% Rule, your max offer should be:
70% of $350,000 = $245,000
Minus $60,000 = $185,000
Let me quickly define some important variables before we get too far ahead of ourselves:
- After Repair Value (ARV) – what the house will be worth once it’s renovated
- Title Closing Costs on Purchase – any and all fees charged by the title company/closing attorney/escrow company to handle the purchase transaction
- Loan Closing Costs – any and all fees and points charged by the lender to fund the deal
- Loan Holding Costs – loan payments per lender’s terms
- Carrying Costs – property taxes, builder’s risk insurance, electricity, water, sewer, trash, HOA dues, any other ongoing costs (based on the length of the project)
- Title Closing Costs on Sale – any and all fees charged by the title company/closing attorney/escrow company to handle the sale transaction
- Real Estate Agent Commissions – on the sale, this varies and is not set in stone, so this is one of the questions you have to ask your agent
- Net Profit– what goes into your pocket after the sale once all expenses are accounted for
In the 70% Rule, that 30% margin (the difference between 100% and 70%), is intended to cover all of those factors above: title closing costs on the purchase, lender points and fees, loan payments, carrying costs, title closing costs on the sale, real estate agent commissions, and a profit.
Now, let’s get into why this Golden Rule is way past its prime.
1. The 70% Rule is lazy.
Let me explain. In house flipping, it is crucial to know your numbers. It’s your #1 job. Lead generation is #2, because if your numbers are crap, you’ll be out of business and there wouldn’t be any need for lead gen.
If you are simply lumping all of those variables from the above definitions into 30%, you aren’t breaking them out individually, leaving you with no real understanding or control of your specific numbers.
What’s the potential net profit? What kind of impact do your lender’s terms have on your net profit? How does your net profit vary depending upon the project timeline, or property taxes, or insurance premium, or any of the other variables?
You don’t know, and you can’t know if you’re solely using the 70% Rule.
I often hear people say, “Oh, I’m terrible at math,” or, “Numbers aren’t my thing.”
Please stop saying these things. If you can’t be bothered to take the time to understand the numbers in your business, you don’t need to be in business for yourself.
If you want different results in your life, you have to show up differently.
2. The 70% Rule will make you lose money.
Hear me out.
This is the same example we used earlier that follows the 70% Rule formula:
ARV = $350,000
Repairs = $60,000
According to the 70% Rule, your maximum offer should be:
70% of $350,000 or (.7 X 350000) = $245,000
$245,000 Minus $60,000 =$185,000 Maximum Offer
Let’s see what the maximum offer would be my way, which I call the Profit Rule:
[Timeframe = 4 months]
ARV = $350,000
Minus Repairs $60,000
Minus Title and Loan Closing/Holding Costs $20,900
Minus Carrying Costs $1,400
Minus Selling Costs $15,750
Minus Buffer (Oh Crap Contingency) $7,000 (at least 2% of ARV)
Minus Minimum Net Profit $40,000
= $204,950 Maximum Offer
If you’re the seller, which offer would you take? An offer of $185,000 or $204,950. Yeah, I thought so. Frankly, the higher offer is way fairer, too.
You don’t have to be greedy; there is plenty of profit to go around, y’all.
When you miss out on the opportunity to flip this house because the 70% Rule says you’ve got to stay under $185,000, you’re losing that oh-so sweet profit of $40,000 - $47,000 (if you don’t dip into your Buffer).
That’s just bad business, because while you’re waiting for the needle in the haystack property that meets the antiquated 70% Rule,others are flipping houses hand over fist and racking up some big profits using a far more current formula.
Is there a certain ARV to use as a guideline?
In my Profit Rule example above, we arrived at a maximum offer of $204,950, which comes out to roughly 75.5% of the ARV minus repairs. [(.755 X 350,000) – 60,000 = 204,250]
I’ve gone as high as 82% multiple times, and still made roughly $70,000 in net profit, but that was at a much higher end price point. The higher the ARV, the more room there is to ooch up that percentage. But please reserve these types of deals for when you have at least 20 profitable fix and flips under your belt.
I would strongly encourage you to stay under 78%, and use very conservative/firm numbers if you go that high.
In my current market, and in most metro areas, you’re going to see 72-78% of ARV minus repairs, as the norm.
Back in the day, the 70% Rule worked perfectly.
When the Golden Rule first started getting floated around by the good ol’ boys, it worked swimmingly. Of course, that was 40 plus years ago. And, it even worked when I first started flipping houses in Austin, Texas, around 2008. Of course, you were still able to find sub-100k properties in emerging neighborhoods back then.
And the Golden Rule does still apply in lower priced markets, think sub-100k ARV. (Okay okay, so maybe it's not 100% outdated, but it is at least 92%. 😉)However, the vast majority of flips are happening in urban, metro areas where prices are way north of 100k. Again, the higher the ARV, the potentially higher the percentage of it that can be offered.
This is what I mean...
Using the gross profit margin of 30% (from the 70% Rule), you will see that:
30% of $90,000 = $27,000
30% of $350,000 = $105,000 <<< higher ARVs allow more room for a substantial profit
So, if the 70% Rule is outdated, then what should you use to calculate a smart offer?
Use my Profit Rule
This Rule forces you to account for the little fees, the big expenses, your desired minimum profit, plus an “oh crap, I didn’t account for that” buffer.
It gives you far more control over and understanding of your specific numbers.
I know you're scared.
- You don't want to screw up
- You don't want to lose money
- You don't want to make costly mistakes
- You don't want to look like a fool
However, overanalyzing properties so that none of them ever meet whatever incredibly high standards you’ve declared to be necessary, so that you don’t actually ever have to move forward on anything (because that’s super scary), will not get you where you want to go.
There’s a fine line between being smart and talking yourself out of a solid deal because you’re scared.
As you prepare to find and complete your first flip, remember that the whole point is to do your first flip in a way that makes you want to do a second flip, then a third, and so on. But you have to actually DO A FLIP.
Flip smart out there.
Over to You
I hope this post leaves you feeling more confident in your ability to calculate smart offers that will make you money AND actually get accepted. If this makes perfect sense to you, or if you have any questions or encounter difficulties when trying to implement this strategy, let me know by scrolling down and leaving a comment!
