How To Calculate The 70% Rule In A Real Estate Transaction: An Example
The 70% rule can be an excellent guideline to ensure you take on only those flipping projects that will be worth it financially. Here’s how to run the numbers:
1. Find A Flippable Property
The first step in calculating the 70% rule is finding a property you’re interested in. A flippable property is one that is distressed or needs a lot of renovations but that you could significantly increase the value of with the right repairs.
When making this type of real estate investment, it’s important to remember the goal is to fix up the home and sell it for a large profit. If the home can’t be salvaged or, on the other hand, doesn’t actually need that much work, it may not be the right choice for a flip.
2. Estimate Renovation Costs
The next step – and perhaps the most important step – of calculating the 70% rule is estimating your renovation costs. Your costs might include:
- Home buying fees
- Payments on loans for flipping houses, plus interest
- Closing costs
- Cost of labor and materials
- Costs of selling a house
Unfortunately, this step isn’t a perfect science. It’s often the case that you don’t know with certainty how much your renovations will cost. The best you can do is make a good estimate.
3. Determine After-Repair Value
Once you’ve planned out what repairs you’ll make to the home, you can calculate its after-repair value (ARV). You can calculate the ARV of the home by adding the original purchase price and the value added from the renovations.
There’s no easy formula to help you determine the ARV. It depends largely on where you live. You can often determine an ARV by looking at comparable properties in the area (aka comps) and comparing their condition, size, number of rooms, locations and other factors.
If you don’t feel confident determining the ARV of a home yourself, consider enlisting the help of a real estate agent who can look at the comps and help you settle on a value.
Of course, the housing market can change rapidly. Depending on how long it takes you to renovate the home, the ARV might be different when you finish the project from when you started it. However, having a good estimate upfront is important to see if the property meets the 70% rule.
4. Plug Into The Formula
Once you know the cost of the property, the cost of the renovations, and the estimated ARV, you can run the numbers to see if it falls within the 70% rule.
Here’s what that formula looks like:
(After Repair Value x 0.7) - Estimated Repair Costs = Maximum Purchase Price
Let’s use an example to make the formula a bit easier to understand. Let’s say you’re considering buying a property to flip. You know you could sell the home for an ARV of about $400,000. However, you also know it needs about $75,000 of work to bring it there.
First, you would calculate 70% of the ARV of $400,000, which comes to $280,000. Next, you would subtract the estimated repair costs of $75,000, which comes to $205,000. Based on the 70% calculation, $205,000 is the most you could pay for the home and still meet the 70% rule.
If you could purchase the property for $205,000 and stick to the estimated repair costs, you would profit about $120,000.
