Flipping houses has become a popular investment strategy for real estate enthusiasts looking to generate substantial profits in a relatively short period. However, to succeed in this competitive market, it is crucial to understand the 70% rule and how to calculate the Maximum Allowable Offer (MAO). In this article, we will delve into the intricacies of this rule, discuss the importance of knowing your comps, reveal effective methods to find properties, and highlight the pitfalls of overrehabbing.
Understanding the 70% Rule:
The 70% rule is a fundamental principle that guides real estate investors in determining the maximum purchase price for a property they plan to flip. According to this rule, the MAO is calculated by multiplying the After Repair Value (ARV) of the property by 70% and then subtracting the estimated cost of rehab. This formula ensures that investors maintain a healthy profit margin while accounting for potential risks and unforeseen expenses.
Calculating Maximum Allowable Offer (MAO):
To calculate the MAO accurately, investors must first determine the ARV, which is the estimated value of the property after it has been fully repaired and renovated. Conducting thorough market research and analyzing recent sales of similar properties in the area will aid in establishing a realistic ARV. Once the ARV is determined, multiplying it by 70% provides a starting point for the maximum offer price.
Example: ARV x .70 – rehab = MAO or maximum allowable offer.
However, it is essential to remember that the estimated cost of rehab must be subtracted from the ARV to arrive at the final MAO. Estimating rehab costs can be challenging, especially for novice investors. Seeking advice from experienced contractors or utilizing online resources can help in accurately assessing the expenses associated with the renovation.
Here is a real life example:
Property Type: Single family home
The ARV for the property is $193,000 and the investors renovation costs are estimated at $80,000.
Using these numbers, we can now calculate the Maximum Allowable Offer.
Crunch the Numbers
Our Formula: Max Allowable Offer = (ARV x 0.70) – estimate repair costs
- Max Allowable Offer = ($193,000 x 0.70) – estimated repair costs
- Max Allowable Offer = $135,000 – estimated repair costs
- Max Allowable Offer = $135,000 – $80,000
- Max Allowable Offer = $55,100
Know Your Comps:
Knowing your comps, or comparable sales, is vital in determining the ARV and ensuring a successful house flip. Analyzing recent sales of similar properties in the neighborhood will provide valuable insights into market trends, demand, and pricing. This information will enable investors to make informed decisions and avoid overpaying for a property.
Finding Properties:
Finding suitable properties to flip is a crucial step in the house flipping process. Real estate investors employ various strategies to identify potential opportunities. Networking with other investors, attending local real estate meetings, and building relationships with real estate agents can uncover off-market deals. Additionally, online platforms, such as MLS listings, auction websites, and foreclosure databases, offer a vast array of properties for consideration.
Avoid Overrehabbing:
One common mistake made by novice investors is overrehabbing the property. While it may be tempting to add extravagant finishes and amenities, it is crucial to remember that the goal is to generate a profit. Overrehabbing can lead to increased expenses and extended holding periods, ultimately reducing the potential return on investment. Striking a balance between necessary repairs and cosmetic upgrades is key to maximizing profits.
Mastering the 70% rule is essential for real estate investors looking to succeed in the competitive world of house flipping. By understanding how to calculate the Maximum Allowable Offer (MAO), analyzing comps, effectively finding properties, and avoiding overrehabbing, investors can increase their chances of achieving substantial profits. Remember, success in house flipping comes with experience, knowledge, and careful planning. So, start implementing these strategies and watch your house flipping business flourish.