As a new real estate investor interested in fix and flipping, you often find yourself asking, "How much can I offer on a property?”.
You want to submit the “best offer” without going too high or overspending. However, if you aren't savvy at number crunching, or factoring in the costs and potential gains, you may be setting yourself up for losses.
That’s where the 70 percent rule helps. The 70 percent rule is a way to determine what price to pay for a fix and flip to make money.
Let’s read more to understand this better.
This rule is more of a formula to use to calculate what you can offer for a distressed property.
It can be treated as a guideline to make sure unexpected losses do not hit you and make a good profit on your flip.
Religiously sticking to the 70% rule will keep you in the safe zone.
Two factors that determine the final value of the property are:
"With 70% Rule, you can make a good profit on your flip."
While calculating the maximum amount to spend on a property, the best deal according to the 70% rule says to pay not more than 70% of the ARV, minus the ERC value.
The estimated repair costs, as the name suggests, is the expenses allocated to have the property renovated. These may include:
To come up with an accurate value, you'd need to spend on renovations; it's the best to visit home improvement stores to get estimates.
Alternatively, you can get in touch with other investors and real estate professionals for a better understanding of these costs.
The After Repair Value (ARV) is the estimated future sale value of your distressed property after the renovation. It includes both the purchase price, as well as the price of repairs.
Before you flip, it is essential you have an accurate number in mind for the property's ARV. This will help measure the profitability of your flip.
The formula for after repair value (ARV) is:
The Property’s Purchase Price + The Value of Renovations or Repairs
"It is essential to have accurate numbers to calculate a property's ARV and ERC."
Once you have your ARV and ERC, calculating the price to offer for the property is a piece of cake:
70% of the ARV – Your ERC = The Maximum price you can pay for the property.
ARV x 7.0 – ERC = The Maximum price you can pay for the property.
EXAMPLE 1:
Let’s say you’re planning on buying a house offered at $2,00,000.
After having a thorough look at the property, you know your ERC to be $30,000, and the ARV to be $2,50,000.
Then, the maximum amount you can pay for this property according to the 70% rule would be $2,15,000.
EXAMPLE 2:
Now let’s consider you’re buying a house offered at $350,000. After having a thorough look at the property, you know your ERC to be $79,000, and the ARV to be $475,000.
Then, the maximum amount you can pay for this property according to the 70% rule would be $253,000. As you can see, this isn't a good deal, unless you're able to bring the cost down considerably. Alternatively, if you're ready to find $96,500 in the renovation, it's safe to close the deal. If neither of the two factors clicks, it's best to walk away from the agreement.
The answer to this question would be a “no.” This is because, in a thorough, detailed analysis of return on investments, investors will also take into consideration other expenses such as financing costs, settlement costs, carrying costs, and soft costs including the budget for hidden repair costs.
Therefore, there are times when the 70% rule might fall short of the mark.
In other cases, you may want to only offer 60% of the After Repair Value, minus the ERC. Or, in other cases, you might consider offering 75-80%.
It is therefore essential to note that this 70% golden rule works best as a guideline for newer investors looking to find funding for flipping.
"The 70% rule works best for the new investors who need a fix and flip loan to invest in a property."
Here are the factors that also influence what you can offer for a property:
The 70% Rule works best for coming up with a quick approximate figure. But, before making an offer, it's best to analyze the possible expenses in a more detailed manner and includes all hidden costs.
The most important criteria that govern the final value is the accuracy of ARV and ERC. So, be doubly sure with these numbers before setting an offer.
If you’d like to know more about the 70% Rule, speak to the hard money lending experts at Gauntlet Funding. We offer competitive rates with any prepayment warranties for prime borrowers. Contact Gauntlet Funding today at (631) 465-2161.
What is the 70% rule in fix and flipping? | Gauntlet Funding – Melville, NY.
