The 70% Rule and How It Impacts Hard Money Financing

It is no secret that real estate investors depend on hard money to acquire new properties. Hard money offers a lot of advantages conventional funding just cannot match. But even with hard money, investors need to be careful about how much they spend on a new acquisition. That’s where the 70% rule comes into play.

A Basic Formula

In its purest form, the 70% rule applies mainly to fix-and-flip projects. It is designed to ensure that investors don’t pay too much to acquire and rehab properties. By nature, it builds in a buffer that protects an investor against heavy losses in the event things don’t go as planned.

The 70% rule is also based on a mathematical formula: Maximum Allowable Offer (MAO) = (ARV}x 0.70) – ERC. Of course, now you need to know what the terms mean.

• MAO – This is the investor’s offer ceiling. It is the most he will pay for the property.
• ARV (After Repair Value) – This is the anticipated value of the property after all renovations have been completed.
• ERC (Estimated Repair Costs) – This is the anticipated cost of all renovations and repairs.

By plugging all the numbers into the formula, an investor can come up with a maximum offer amount. If the seller takes the offer and the transaction goes through, the investor still has a 30% buffer to cover profit, closing costs, origination fees, agent commissions, etc.

How It Impacts Hard Money Financing

As for how the 70% rule impacts hard money financing, there are different ways to look at it depending on the deal an investor is trying to get done. When fix-and-flip is the name of the game, investors must understand that lenders will base loan amounts on ARV.

Let’s say a lender’s LTV dictates lending only 65%. That is 65% of the ARV. Given that ARV is likely higher than the current value of the property, the loan amount could cover a considerable portion of the borrower’s rehab and renovation costs. That’s a good deal.

However, let us say an investor isn’t into fix-and-flip. He buys commercial properties as long-term rentals, instead. His hard money lender isn’t interested in ARV. The lender is interested in what the property is worth right now. Any loan offered will cover acquisition costs only. Any additional costs will be borne by the borrower out-of-pocket.

Here, the 70% rule is less rigid because the investor must deal with real property values rather than projected values. On a distressed property, he could probably still offer 70% and get away with it. But on a property that is not distressed, the 70% rule goes out the window.

Not Exactly Set in Stone

Actium Lending is a hard money firm located in Salt Lake City, Utah. Most of their loans go to commercial real estate investors adopting a long-hold approach. They don’t do fix-and-flip loans.

At any rate, they explain that the 70% rule isn’t exactly set in stone. Fix-and-flip investors adhere to it more closely, but even they will flex when circumstances warrant. As for long-hold investors, the 70% rule is more of a guide than anything else.

Regardless of whether an investor employs the rule, one thing is clear: spending too much on acquisition puts a real dent in an investor’s profit. And taken to the extreme, paying too much could turn what might have been a modest profit into a significant loss. It is in an investor’s best interests to find a way to avoid paying too much, even if that means using the 70% rule.