The 70 percent rule is usually touted as one of the ten commandments of real estate investing, and for good reason. It’s a simple, trustworthy rule that investors–especially new ones–can follow to avoid cutting their profits or losing money. But did you know that sometimes it can get in the way of a good deal more than it can help you land one? It’s true! Sometimes the best deals fall outside the 70 percent rule threshold, and if you follow the set-in-stone mentality, you’re probably missing out on deals that could net you significant profits.
So how do you know when to follow the rule and when to abandon it? It all depends on the hidden factors in the property’s after repair value (ARV).
But if that feels like a betrayal of everything your real estate coaches and mentors taught you or if it seems a bit overwhelming to figure out yourself, we’ve got you covered. Here are three critical things you should know about the 70 Percent Rule.
What is the 70 percent rule in real estate?
Before we dive into when you should break a rule, we want to make sure we’re on the same page. The 70 Percent Rule is a guideline that real estate investors use to avoid paying too much for an investment property. It states that your offer should be equal to or less than 70% of the property’s ARV when you buy an investment property. This rule ensures that investors will make a good profit even if the repairs and rehabilitation cost more than expected.
The amount an investor should pay for a home is calculated with this formula:
(ARV x 70%) – Repair Cost = Highest Offer Amount
So if the property you’re considering is worth $235,000 after repairs, and the estimated repairs cost $13,000, you shouldn’t pay more than $151,500 for the property. If the seller doesn’t accept that, you should walk. At least that’s what the rule says.
While this formula has helped many investors make great decisions and avoid bad deals, it won’t always help you maximize profit or even avoid loss. Multiple factors affect a property’s end value, and if you only look at these simple numbers, you could miss out on great deals or even end up overpaying for a property.
Numbers don’t tell the full story
Most people will tell you that math and numbers are everything you need to know about real estate investing and which properties to buy. It’s all in the formulas, right?
Not necessarily. Real estate value formulas don’t always tell you about trends in the surrounding neighborhood. They don’t tell you about upcoming city developments or population projections. Even if you’re wholesaling or looking for a quick fix and flip, a savvy cash buyer or prospective homeowner will still be aware of these factors.
If you buy a house in a declining neighborhood at what you think is 70% of its ARV, a well-informed buyer might laugh at your flip price. Or, if you walk from a deal in a neighborhood about to explode in value, you might miss out on a fantastic deal.
The best way to make informed investments is to look for hidden neighborhood growth factors when calculating ARV. And you don’t have to rely solely on your knowledge to do this. If you have friends who are experts on upcoming trends and developments, tap into your network to see what’s coming or going. Stay on top of local politics and moving trends. By doing extra work, you’ll often discover green or red flags that other investors overlook.
There’s an exception to every rule
The 70 percent rule works well for low and medium-priced houses simply because of how percentages work. At lower price points, your break-even point is much closer to your purchase price than it is at higher prices. But when dealing with more expensive houses, your break-even point is much larger, even if the percentage is identical to a similar deal on a lower-value property.
Let’s do the math. If you break the rule on a $250,000 house that needs $10,000 of repairs and buy at 80% of the ARV, you’ll have a $40,000 margin to fit unexpected hold time, repairs, and other unforeseen costs into. Depending on the state of the property and the market at the time of purchase, this could be a very thin margin. We might even lose money on this deal.
But if you buy a $600,000 house that needs $24,000 of repairs at 80% ARV, you still have a $96,000 margin to work with. In this example, you purchased at the same percentage and had the same percentage of repair costs, but the margins are very different.
One crucial factor to remember is that more expensive houses may demand more costly repairs, but this is not always the case. Sometimes walking away from a high-value home because the sale price exceeds 70% of ARV might be the wrong decision.
However, this brings us back to understanding local trends: the investor willing to put in a bit of extra work will walk away happier. Take the time upfront to accurately assess repair needs and talk to several local sources to understand the neighborhood dynamics. You’ll be more profitable than the investors who decide to take unnecessary risks or stay overly cautious.
Save time and money with a real estate license
If you’re interested in flipping houses, a real estate license can save you thousands of dollars on the resell. Because you’re already representing yourself, you won’t have to pay the typical 3-5% fee for a seller’s agent, meaning you’ll have more margin to negotiate when you’re buying.
This scenario is one of the most widely accepted circumstances for breaking the 70 percent rule, because the built-in savings mechanism gives you enough room to work with. So if you’re a real estate agent and you see a deal you can’t live without, you have an excuse to break the rule.
Rules and guidelines exist for a reason. The 70 percent rule is no different. It’s helped thousands of investors land money-making deals and avoid bad investments. But once you understand the rule, there are times when you can afford to break it.
Putting any real estate rule into practice is all about knowing your market. Sometimes you should live by the rules and best practices, but sometimes you have to bend or break them to make great investments. As long as you’re willing to put in the work and be consistent with property evaluation, it’s safe to treat the 70 percent rule as a guideline. Just don’t forget that it exists for a reason, and more often than not, the formula is your friend.