What Exactly Is the 70% Rule?
The 70 percent rule states that the buying price of a home should be 70% of its after-repair value, less restoration and repair costs. This prevents you from splurging on a home that will provide minimal return on investment. This is how it appears:
Assume you estimate the after-repair worth of a residence to be $300,000. Begin by multiplying $300,000 by 70%, or 0.7.
$300,000 multiplied by 0.7 equals $210,000
Assume it need $50,000 in repairs. Subtract $50,000 from $210,000 to get the maximum price you should spend for the house.
$210,000 minus $50,000 is $160,000
That implies the home’s purchase price must be no more than $160,000 in cash—more on that later. And if you didn’t catch it, you’ll make $90,000 when you sell the house for its after-repair worth of $300,000.
Remember to account for your two favorite things: time and taxes. Using the previous scenario, let’s imagine it takes two years to complete and sell the house flip. That equates to $45,000 per year of labor. When long-term capital gains taxes are included, house flipping is unlikely to be profitable.
However, if you finish the fix and flip in six months, you’ve made $90,000 in half a year. Because you owned the residence for less than a year, the profit is considered a short-term capital gain and is taxed at your regular personal income tax rate, which is higher than the long-term capital gains rate. However, this flip is still a steal.
In 5 Easy Steps, Learn How to Flip a House
1. Use cash to fund the house flip.
Flipping properties may be a risky business, especially if you don’t have any money. It’s easy to understand how adding debt to the mix simply makes matters worse. Here’s why we always propose flipping a house for cash:
There are no interest charges. House flippers who borrow money may have to pay interest for months, increasing the amount they must sell the house for just to break even.
There is no rush to sell. When you utilize debt to finance a flip, you may act in desperation. If you can’t sell the house, you’ll most likely drop the price and lose money. Cash-only house flippers can ride out a weak market because they don’t have interest payments piling up against them every day the property isn’t sold.
There will be no debt to hold you back. Most importantly, any type of “investment” using debt is a bad idea. Period. Even with cash, trying to sell a flipped house for more money than you invested in it is a risk. Using debt in the process increases your chances of losing money if your plans go through.
Let’s look at an example to demonstrate why borrowing money to flip a house isn’t a good idea: You take out a loan to buy a house to flip, and everything appears to be going swimmingly until renovations take six months instead of four. When you advertise your home, it sits on the market for a month before you’re forced to lower the price and sell it for far less than you expected.
You close a month later and receive your payment. However, a large portion of your reward is used to repay the money you borrowed plus eight months of interest! This is in addition to the standard selling charges such as agent commissions, taxes, and title fees.
Desperation would not have compelled you to sell low if you had flipped the house with cash. With no interest payments to worry about, you might have waited until the market warmed up and the price was perfect before selling.
The financial risk of property flipping is simply not worth it unless you can pay cash.
