Is the 70 percent rule actually usable on a gut job or does it fall apart?

Question

I've done a few lighter flips, paint and kitchens mostly, and I've been using the 70 percent rule the whole way. Max offer equals 70 percent of ARV minus repairs. Worked fine when repairs were 40k and I could estimate them off a walkthrough.

Now I'm looking at a shell where I honestly don't know if repairs are 130k or 190k until walls come off. Someone at a meetup told me the 70 rule "stops working past a certain scope" and I didn't want to ask what he meant in front of everyone. Does the formula change or does the input just get harder?

Rena Guide · Accepted Answer

The formula doesn't change. Max offer is still 70 percent of after-repair value minus the repair estimate, and that 30 percent haircut is meant to cover your holding costs, your selling costs and your profit. What changes is how much damage a wrong repair number does.

Say ARV is 400k. Seventy percent is 280k. If repairs are 60k, you offer 220k, and being 20k over on repairs eats a third of your cushion. If repairs are 170k, you offer 110k, and being 20k over on a 170k budget is easy to do, because bigger scopes have more places to be wrong. Same rule, thinner rope.

So the person at the meetup was pointing at the input, not the math. Your walkthrough estimate on a shell is a guess until the walls are open, and that's the honest position to be in.

What operators do about it is size the unknown before they buy. Get a licensed electrician and a plumber through the property during your inspection period rather than a general contractor's eyeball number. Pull the permit history if your local building department publishes it, since a house with no permits since 1962 tells you what's behind the plaster. Then put a contingency in your own budget, commonly 10 to 20 percent on a heavy scope, and treat it as spent.

The other half of the 30 percent is time. Carry costs on a 120 to 150 day hold are much bigger than on the 90-day jobs you've been running, and they come out of the same 30 percent as your profit. Write the carry line out explicitly instead of trusting the rule to absorb it.

aaron_fitz10 · Answer

The bit that helped me was realizing the 30 percent isn't profit, it's profit plus everything else. I'd been reading it as a 30 percent margin for about two months.

Rena Expert · Answer

Adding one thing to keystone's actual problem, which is the 130 versus 190 spread. A 60k range on a single input isn't an estimating failure, it's the correct output of a walkthrough on a closed-up shell. You don't fix it by estimating harder. You either buy the information before closing, or you price the range.

Pricing the range means you underwrite at 190, not at 160 and hope. If the deal doesn't work at the top of the band, you don't need a better estimate, you need a lower purchase price or a different property. Most people who get hurt on their first gut ran the math at the midpoint because the midpoint made the deal work.

Buying the information means a longer inspection period with destructive testing permitted in writing by the seller. Cut inspection openings in the plaster at the panel, at a wet wall, and where the layout change is going. That converts guesswork into a scope. Sellers of distressed property often allow it because their alternative buyer pool is small, but it varies by how the contract is written and you'll want your attorney on the language.

The risk you haven't raised: at a 110k purchase and 170k of rehab, your loan structure matters more than your rehab number. Hard money lenders typically fund purchase plus a draw schedule against completed work, so you're carrying the front end of each phase out of pocket before reimbursement. Ask any lender in writing how draws are inspected and how long reimbursement takes. A two-week draw lag across eight draws is four months of schedule you didn't plan.

luis_carrera · Answer

Keystone, did the meetup guy say anything about what he uses instead past that scope? I've seen people mention 65 percent on heavy jobs and I can't tell if that's a real convention or just people being cautious out loud.

Is the 70 percent rule actually usable on a gut job or does it fall apart?

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