The 70% rule is a guideline commonly used by real estate investors to estimate the maximum price they should pay for an income-producing property. The rule states that the purchase price of a property should not exceed 70% of its after-repair value (ARV) minus the estimated cost of repairs.
The 70% rule is based on the idea that an investor should aim to achieve a positive cash flow from a rental property, where the monthly rental income covers the monthly expenses, including mortgage payments, property taxes, insurance, and maintenance costs. By estimating the ARV and the cost of repairs, the 70% rule helps investors determine the maximum purchase price that will allow them to achieve a positive cash flow and still leave room for a reasonable profit.
To use the 70% rule, an investor must first estimate the ARV of the property, which is the estimated market value of the property after any necessary repairs or renovations have been made. The cost of repairs can then be estimated based on a thorough inspection of the property and a comparison of similar properties in the area.
Once the ARV and cost of repairs have been estimated, the investor can use the following formula to calculate the maximum purchase price:
Maximum purchase price = (ARV x 70%) – cost of repairs
For example, if the ARV of a property is $100,000 and the estimated cost of repairs is $20,000, the maximum purchase price would be $50,000 ($100,000 x 70% – $20,000).
It is important to note that the 70% rule is not a hard and fast rule and should be used as a guideline rather than a strict rule. Real estate markets can vary greatly, and the actual maximum purchase price may be higher or lower depending on a variety of factors, such as competition for properties, the local housing market, and the investor’s personal financial situation.
In conclusion, the 70% rule is a useful tool for real estate investors to estimate the maximum price they should pay for an income-producing property. While it should not be relied upon as a strict rule, it can provide a starting point for determining the maximum purchase price and help investors make informed investment decisions.