What is the 70% Rule?
The seventy percent after repair value (ARV) rule-of-thumb is a widely referenced calculation in the real estate investment industry—and for good reason. The formula is a useful indicator of potential profit when acquiring distressed properties with the end goal of reselling for a profit. The 70% “rule” expresses the maximum allowable expenditure for a given piece of real estate based on two main variables: ARV and forecasted repair expenses.
What is the 70% Rule? A formula to calculate the maximum you can pay for a fix and flip property once you input two key factors, namely the ARV and estimated repair costs.
In order to implement this tool effectively, it is essential to accurately and conservatively select ARV and repair costs. The most common stumbling block when it comes to following the 70% rule is that many investors misinterpret what is supposed to be a general guideline for an inflexible data point set in stone. The main takeaway is that the 70% rule isn’t really a “rule” in the literal sense—it’s just a useful barometer that can be used to gain a competitive edge in the marketplace. In the end, you have to be dialed in to your local market to be successful—no tips, tricks or schemes will substitute for preparation and hard work.
The 70% rule is simple enough in theory. After calculating the ARV and anticipated repair expenses, one only needs to insert the data. As an example, suppose a property has an ARV of $1,000,000 and requires $200,000 in repairs. The remaining variable is at what discount you need to purchase at. In this scenario, we’ll implement the 70% rule, so we will insert .7 into the formula, which will play out as follows:
(ARV * .7) – Repair Cost
($1,000,000 * .7) – $200,000 = $500,000
This data point is essential because most investors earn their profit when they purchase. The ARV and repair costs are the important components in this strategy and getting them wrong can eat into your profit margin. If either of them is off by even a small amount, the project could quickly turn into a bust. Because the realty industry is completely location-dependent, major market areas dictate the practical application of the 70% rule. Investors will have to adjust the generic 70% variable as high as 85% in some markets and sometimes also adjust for different property types. The final amount an investor can pay to buy the property (as a percentage of ARV) can differ by region, zip code, subdivision, even if two properties are located in the same market.
Generally, your ARV and repair costs should always be fixed based on your exit strategy, but keep in mind that your competitor’s purchase price can vary based on their exit strategy. As an example, buy and hold landlords will typically have the ability to pay more than fix and flip investors because the flipper will usually spend more money in repairs. Plus they have to cover Realtor and other closing costs on the resale.
Conversely, a landlord will be able to spend more because their exit strategy depends on cash flow and long-term appreciation. Buy and hold investors can often ignore this 70% guideline by using this creative approach to their real estate portfolio management. In other words, if an investor intends to purchase and take a long-term hold approach, they can spend more up front by trading the short term profit of flipping for the long term value of cash flow and appreciation.
A common misconception of the 70% Rule is assuming that the remaining 30% of the formula will equate to pure profit. Don’t make this mistake! This assumption couldn’t be more misguided, as the leftover capital must cover not only the profit margin but also the inherent expenditures related to acquiring, rehabbing and transacting the real estate. These costs can include a wide variety of services, including agent commissions, closing fees, title inspections and hard money lender charges.