How to Use the Fixed Cost Method to Determine the Maximum Allowable Offer Based on ARV
One of the more accurate methods of determining your Maximum Allowable Offer based on a property’s ARV is known as the Fixed Cost Method.
The theory behind the Fixed Cost Method is that all the extra charges, such as holding costs, utilities, and closing costs, can be combined to form one number, known as the “fixed costs.” To determine your Maximum Allowable Offer, you simply need to work backward from your ARV, subtracting out your fixed costs, the desired profit, the wholesale fee, and the rehab expenses to arrive at your offer. The formula looks like this:
ARV – Fixed Costs – Investor’s Profit – Wholesale Fee – Rehab Costs = Maximum Allowable Offer
Of course, to do this calculation, you must understand how to determine your fixed costs. The profit, fee, and rehab expenses are fairly easy to determine, but discovering the fixed costs will take a little explaining. The best explanation for fixed costs can be found in Author J Scott’s book The Book on Flipping Houses (published by BiggerPockets Publishing), which states, “Fixed costs are comprised of the various fees, commissions, and costs associated with all parts of the investment project (outside of the actual rehab costs).”
Typical Fixed Costs
The author goes on to break out these expenses into more specific detail, adding up the total of the most typical fixed costs for his business:
- Inspection Costs: $400
- Lender Fees: $1,000
- Closing Costs: $2,000
- Mortgage Payments: $2,500
- Property Taxes: $600
- Utilities: $1,000
- Insurance: $200
- Commissions: $4,000
- Selling Closing Costs: $4,000
- Home Warranty: $500
- Termite Letter: $100
- MLS Fees: $100
These costs, all added together, give an investor the fixed costs for a property. Keep in mind, these are just the rates that J Scott outlined in his book and that he has seen applied to his business—but they may not be the same for you. Every market is different, so spending some time determining what your costs would be on the listed items is important. For example, if you plan to sell to a landlord, you won’t need to worry about the sales commissions, selling closing costs, home warranty, or MLS fees, because the landlord will be holding on to the property. However, if you sell to a house flipper, you would need to include these figures, because the flipper will be selling and will need to account for these numbers.
So to determine your fixed costs, create a spreadsheet with the listed items and spend some time researching what these figures would typically be for your area. You don’t have to get them all perfect, but estimate conservatively. The nice thing is, after you do this once, you won’t need to do it again for the same kind of property, as long as that property is in the same area.
This is why we call them “fixed costs”—because we’ll use the same (fixed) number every time. For J Scott, that number was $16,400. What will yours be? Take an hour to figure it out once, and you won’t need to do it again for that same property type and area.
Let’s use the example of wholesaler Beth and the deal she’s wholesaling at 123 Main Street house. We’ll look at an example of how she used the Fixed Cost Method to determine her Maximum Allowable Offer. Earlier we determined that the home’s ARV was an estimated $147,333. We also calculated, when discussing the 70% Rule, that the rehab costs would be approximately $20,000. This time, we’ll use the Fixed Cost Method to come up with the Maximum Allowable Offer:
- Beth determines that the fixed costs would total $19,000.
- The house flipper (Jackson) that Beth is planning to sell the home to likes to make $20,000 minimum on any project, so we’ll use that number for the desired profit.
- Beth is aiming for a $10,000 wholesale fee.
- Beth estimates the rehab will cost approximately $20,000 and gets a local contractor to agree.
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– $19,000 (Fixed Costs)
– $20,000 (Profit)
– $10,000 (Wholesale Fee)
– $20,000 (Rehab Costs)
= $78,333 Maximum Allowable Offer
Beth has determined that the most she could pay for this property is $78,333 using the Fixed Cost Method.
[This article is an excerpt from Brandon Turner’s The Book on Investing in Real Estate With No (or Low) Money Down.]
Do you use the fixed cost method when wholesaling?
Let’s discuss below!