In the dynamic world of real estate investing, fix and flip properties have garnered significant attention for their potential to generate quick profits. If you’re considering venturing this market, one critical question arises: How much should you pay for a fix and flip property?
One tried-and-true method is the 70 percent rule.
Fix and flip: Understanding the 70 Percent Rule
The 70 percent rule a handy tool for real estate investors to assess potential profitability of a house flipping venture. It helps you determine the maximum price you should pay for a property when factoring in repairs and the eventual selling price.
The rule suggests that you shouldn’t pay more than 70 percent of the after-repair value (ARV) of a property, minus the estimated repair costs.
For example, imagine you’re eyeing a house that, after it’s fixed up, will have an ARV of $200,000. According to the 70 percent rule, you wouldn’t want to pay more than 70 percent of that, which is $140,000. But not quite. You also need to consider the estimated repair costs. Let’s say those repairs will set you back $30,000. In that case, the maximum you should pay for the property is $140,000 minus $30,000, which equals $110,000.
Essentially, the 70 percent rule helps you strike a balance between the purchase price, repair costs, and the potential selling price. It ensures that you have enough room to cover expenses, make a profit, and mitigate risks.
Fix and flip: Importance of the 70 Percent Rule
Why is this rule so important for house flipping? It’s all about protecting your bottom line and making sure you don’t end up in the red.
Avoiding overpaying for a property
First and foremost, the 70 percent rule helps you avoid overpaying for a property. Paying too much upfront can seriously eat into your potential profits. By adhering to the rule, you set a maximum limit on how much you’re willing to invest in a property. This ensures you don’t get carried away by emotions or a bidding war.
Factoring in renovation costs and potential surprises
House flipping often involves renovating and fixing up a property to increase its value. However, these repairs can come with unexpected expenses, such as hidden structural issues or unforeseen repairs. The 70 percent rule reminds you to factor in repair costs and leave room for any unexpected surprises.
Considering holding and selling costs
When you flip a house, you have to consider the expenses you’ll incur while holding the property. These include property taxes, insurance, utilities, and financing costs. The 70 percent rule helps ensure you account for these expenses and still make a tidy profit when you sell.
Determining an appropriate selling price
By considering the ARV of the property, you can estimate a realistic selling price that aligns with market trends and ensures a profitable return on your investment.
Ultimately, the 70 percent rule acts as a safeguard, helping you make informed decisions and evaluate the financial viability of a house flipping project.
Fix and flip: The 70 Percent Rule in Practice
Now that you understand the ins and outs of the 70 percent rule, let’s see how you can put it into action when flipping houses. Here’s a step-by-step guide on applying the rule in practice:
1. Conduct Market Research and Analysis
Look at comparable properties in the area to get an idea of their ARV and recent selling prices. This information will help you determine the potential value of the property you’re considering.
2. Calculate the Maximum Allowable Purchase Price
Start by multiplying the ARV by 0.7 to get 70 percent of the projected value. Then subtract the estimated repair costs from this amount. The result will be your maximum allowable purchase price.
3. Estimate Repair Costs and Contingencies
Carefully assess the property and make a detailed list of repairs needed. Consult with contractors or professionals to get accurate repair cost estimates. Keep in mind that unexpected issues may arise during the renovation process, so it’s wise to include a contingency fund for such situations.
4. Assess the Projected Selling Price
Based on your market research and analysis, determine a realistic selling price for the renovated property. Consider factors such as location, property features, current market conditions, and comparable sales in the area. This projected selling price will help you gauge your potential profit.
5. Adjust the Rule Based on Market Conditions and Goals
Remember that the 70 percent rule is a guideline. You must adapt it to the specific market conditions and your investment goals. In some hot markets, you may need to adjust the percentage slightly to remain competitive. Similarly, if you have a higher risk tolerance or a particular investment strategy, you might tolerate a lower profit margin.
By following these steps, you’ll be able to apply the 70 percent rule effectively and make informed decisions when evaluating potential house flipping opportunities.
Potential Limitations of the 70% rule
Keep in mind that the 70 percent rule is not a foolproof guarantee of success. It’s a tool to help you assess a deal’s financial viability and mitigate risks. Remember to conduct thorough due diligence, work with reliable contractors, and carefully manage your renovation costs and timelines.
It’s important to be aware of the rule’s potential limitations and consider additional factors that may impact your decision-making process. Here are some key limitations and considerations to keep in mind:
1. Varying Market Conditions and Regional Factors
Real estate markets can vary greatly from one location to another. The 70 percent rule is not a one-size-fits-all solution and may need adjustments depending on the specific market conditions, such as supply and demand, economic factors, and local regulations. Take the time to understand the dynamics of the market you’re operating in to make more accurate assessments.
2. Unique Property Characteristics and Location
Not all properties are created equal. Some properties may have unique features, prime locations, or potential for higher returns. The 70 percent rule may not fully capture the true value or potential of such properties.
Evaluate additional factors like desirability, neighborhood trends, and future development plans to make a more informed decision.
3. Challenges in Estimating Repair Costs and Potential Risks
Accurately estimating repair costs can be a challenge, especially for inexperienced investors. It’s crucial to have a solid understanding of construction and renovation costs. Or at least consult with experienced contractors to ensure your estimates are realistic.
Additionally, unforeseen issues or hidden problems during the renovation process can increase costs and potentially affect your profitability. Building a contingency fund is essential to mitigate these risks.
4. Financing and Holding Costs
The 70 percent rule focuses primarily on the purchase price and repair costs but may not account for financing and holding costs.
Interest payments, property taxes, insurance, utilities, and other expenses during the holding period can eat into your potential profits. Factor these costs into your calculations to get a more accurate picture of your overall expenses and expected returns.
5. Evolving Market Trends and Future Selling Prices
Real estate markets are dynamic, and trends can change over time. The projected selling price you determine at the beginning of your project may not align with the actual market conditions at the time of sale.
Stay updated with market trends and be prepared to adjust your selling price and strategy accordingly.
Conclusion
Remember that the 70 percent rule is a tool to guide your decision-making process, but it shouldn’t be the sole factor in determining the profitability of a house flipping project. Conducting thorough market research, evaluating property specifics, and carefully analyzing financial aspects beyond the rule itself will help you make well-informed investment decisions.
When you’re ready to start investing in residential real estate, contact us at Black Brook Capital. We’re focused on hard money lending in Milwaukee, with years of experience in the local construction industry. We are your perfect partner to turn your vision into reality.
