The 70% Rule: Determine The Profitability Of A Real Estate Investment
By Paul Esajian on June 2, 2014
There are a lot of numbers associated with real estate investing. Between the 70% rule, the 50% rule and the 2% rule, it is easy to get overwhelmed. However, these numbers and “rules” should be viewed as guidelines instead of an iron clad way to conduct your business. The most popular rule associated with determining what to offer on a distressed property is the 70% rule. It’s math is rather simple and it is only as good as the numbers you plug in. These are entirely dependent on your expertise and familiarity of the market.
With the 70% rule, you look at two important factors: the after repair value and the estimated repair costs. There are plenty of arguments and discussions among investors as to if you make your money on the buy or the sell side of the transaction, but both of them are equally important. If you get your property at too high a number, the rest of the process will be an uphill battle. If you follow the 70% rule, you need to make sure your after repair value is based on real comparable listings and sales and not a number that is convenient for you to make money with. The more accurate you are with your value, the higher chance you have at making a profit on the deal.
The second key factor is to determine the repair costs. The more deals you close and houses you rehab, the better you will be with these costs. In the interim, you should bring a contractor or handyman with you to every property you want to make an offer on. Obviously, your costs have a direct impact on your bottom line. If you fail to recognize a potential cost or omit it from your calculation, you will quickly fall under budget and throw your calculations for a loop.
Once you know both of these items, you can plug them into your equation. To find your number, take the after repair value (ARV) and multiply that number by 7 and subtract it from your estimated repair costs (ERC). On a property with an ARV of $100,000 and an ERC of $20,000, the maximum amount you should offer is $50,000 ($100,000 x.7-$20,000). Again, this should be looked at as a guideline and not an iron clad rule. Too many investors will strictly adhere to this and lose deals over a couple of thousand dollars. The market the property is in, the degree of repair work and the time-frame to get the property back on the market should all be reviewed. Always leave some buffer to play with, but use this as one of many guides used to determine your offer.
The 70% rule is a very good starting point for investors to determine their offer amount, but only if the numbers put in are accurate. It takes time, experience and a feel for the local market to come up with a price that the seller will accept and still be profitable for you. Use the 70% rule as a guide rather than gospel.