The seventy percent after repair value (ARV) rule-of-thumb is a widely referenced calculation in the real estate 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.
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 guidepost data point is essential because investors earn their profit when they purchase. If a buyer submits the wrong bid, that cuts into their potential profit margin. The ARV and repair costs are the operative components in this strategy. If either of them is off by a significant 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. Even more impactful is the ultra-locality specific factors underlying a given property. The % ARV an investor can purchase at will differ by zip code, subdivision, even if two properties are located in the same major market sector.
Generally, ARV and repair costs should always be fixed points premised on the given exit strategy, but keep in mind that the % ARV you purchase at less rehab may be variable. As an example, landlords will typically have the ability to pay more than an individual who wants to fix-and-flip a property because the flipper will shoulder higher expenses for repairs, plus they have to cover agent costs and other expenditures. Conversely, a landlord will be able to spend more because their exit strategy is unique, often attempting to garner short-term cash flow and long-term appreciation.
Additionally, this 70% guideline can eventually be ignored altogether as investors develop creative approaches in their real estate portfolio management techniques. For instance, if an investor intends to purchase and make a long-term hold move, relying on appreciation to sweeten the deal, they may indeed have the needed financial flexibility to pay more up front.
Another common pitfall when it comes to the 70% rule is that many investors incorrectly assume that the remaining 30% of the formula will equate to pure profit. 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.