The 70% Rule Explained: A Fast and Flexible Formula for Real Estate Investing
If you’re in the single-family real estate investing space, chances are you’ve heard of the 70% (or X%) rule. The formula applies a specified percentage to an ARV (after-renovation/repair value) and subtracts renovation/repair costs to determine an offer or purchase price.
The 70% rule is a common starting point for wholesalers, investors and/or brokers to determine a maximum offer and/or purchase price (“purchase price” for the rest of this article) for flips and, in some cases, development projects. It can be used for buying rentals, but since rental income isn’t included, we recommend using other, more relevant calculations or “rules” like cash-on-cash returns or yield on costs.
As the saying goes, “you make your money when you buy” and as with all of our max offer calculators, the goal is to help you buy right.
The formula uses a percentage to produce a margin or “spread” between ARV minus renovation/repairs and a purchase price. The resulting spread gives you an approximate project performance. This method is less accurate (but also less cumbersome) than using a formula that takes all individual costs into account.
Here’s an example of the X percent rule in action using 70%, a $100,000 renovation/repair budget, and an ARV of $1,000,000:
Solving for Purchase Price with the 70% Rule
Purchase price = (.7 x $1,000,000) - $100,000
= $700,000 - $100,000
Purchase price = $600,000
Solving for Purchase Price and Repairs (as a Percentage of ARV)
Purchase price + renovation/repairs as a percentage of ARV = ($600,000 + $100,000) / $1,000,000
= $700,000 / $1,000,000
Purchase price + renovation/repairs (as a percentage of ARV) = 70 percent
You’ll Hear 70 Percent Rule and X Percent Rule: Here’s Why
We like to use X% instead of 70% because there isn’t actually one percentage that works universally across investors, markets, project characteristics, and so on.
The X% formula is used to determine whether or not a project is likely to provide an adequate spread to meet the investors’ goals. Using a fixed percentage in the formula would be akin to using a fixed ROI hurdle or goal across two random projects, which doesn’t make much sense.
Every investment opportunity is different—different timelines, different markets or sub-markets (inferior or superior, more competitive or less competitive), different timing in the real estate/debt/macroeconomic cycle, different risks, etc. As a result of all of these differences, investment return goals are, as they should be, all over the place. The varying percentages used in this formula return resulting spreads that fluctuate exactly as investment returns do.
For example, in some highly competitive, supply-constrained markets investors may consider a property that can be purchased below 80 percent of the ARV (less renovation/repairs) as a great deal. In markets with less competition and possibly higher investment return requirements, a price below 70 percent of the ARV might be considered a great deal.
Why Everyone in Real Estate Investing Should Use the X% Rule
The 70% rule has a few primary benefits, the greatest being that it’s extremely fast and easy to use. So, not only can an investor use it to analyze past deals or set targets or ranges for future deals, but brokers and wholesalers can use renovation estimates provided by the investor based on various finish levels (e.g. lipstick job, high-end finishes, etc.) to run comp reports to assess whether a deal will work for an investor. This increases the likelihood that deals will be appropriately screened before hitting an investor’s desk, which saves valuable time for everyone involved.
Why don’t some pros like the 70% rule?
There are two common reasons some professionals don’t like using this percent rule. Some experts feel it excludes necessary variables, such as closing costs, holding costs, loan details, sale costs, and hold period. Others believe each project is so different that no one-size-fits-all rule could accurately calculate its potential.
There are plenty of other holes that can be poked in the 70 percent rule, but for the most part, all of them miss the point. The point is that the 70 percent rule is not, nor should it ever be, the sole determinant of what someone should pay. It is, instead, a quick, first-pass method to see if a deal warrants further exploration; it’s one more tool to add to your investor/broker/wholesaler analytical tool belt.
If the 70 percent rule shows you that a project isn’t going to meet your goals, you don’t have to waste valuable time completing a more detailed calculation of the property’s potential. If it does, however, then you can take that next step and execute the more detailed profitability analysis or cash flow model.
Two Things to Know Before Using the 70 Percent Rule
This rule has major potential to increase efficiency and help you make better deals—but there are a couple of pitfalls to keep in mind when incorporating the 70 percent rule into your evaluations.
First of all, never rely on someone else’s specified percentage for the 70 percent rule. It’s up to each investor to know the cost details behind each investment. Relying on others’ specified percentages can lead you to miscalculate a deal’s profitability to disastrous results.
Second, when venturing into new markets, make sure you understand the costs that aren’t included in the formula. Are property taxes much higher? Closing costs? After determining the necessary revisions to your cost estimates, run a few scenarios to see how deals that produce an adequate profit or ROI come out in terms of purchase price plus renovation/repairs, as a percent of ARV. Then adjust your percentage goal accordingly.
Ready to start calculating the profitability of your real estate values?