Determining price you can pay

4 Replies

I just watched Jerry Pucketts podcast which was filled with some awesome info. 

I liked his formula for finding the price he could purchase a property which is

ARV-rehab-(your fee). I wanted to see what other wholesalers use to find that price?

Calculating Maximum Allowable Offer (MAO)

The formula we use for determining the most that you can pay for a wholesale-able or retail house is:

ARV – Rehab – B/S/H – Your Profit – Investor Buyer Profit=Maximum Allowable Offer (MAO)

After Repaired ValueMinus

Rehab Costs Minus

Buy/Sell/Hold Costs Minus

Profit EqualsMaximum Allowable Offer

**Note: if this is a house you are going to renovate and retail yourself (as opposed to wholesaling it “as-is” to another investor), then you'd simply leave out the "Investor Buyer Profit" in the above formula, since the only Investor involved is you.

ARV is determined using comparable sales or what is commonly referred to as "comps."Be sure to "drive" your comps to make sure they truly are comparable to the house you're considering.You want to make sure that the other houses are roughly similar in size, age, and style to the one that you are considering.You should use sales data that is no older than one year (the more recent, the better), nor more than one mile from the subject property. For even more accuracy, we choose to only use comps that are 1/3 mile away or less, with sales dates within the last six months.Sometimes, even the street can make a difference in the value of a property.If the only comps you have are on very nice streets, but the house you're considering is on a very "distressed" street, then you have to reduce the ARV.How much is an appropriate reduction is a judgment call on your part.You'll want to base that call on how much of a discount will be necessary to entice the final owner/occupant to buy this property over one they can get on the "better" street.

If the comparable sale that you are using is too different from the subject property, then it is of little value.If you use it in your sales marketing, you’ll lose credibility with your Investor Buyers.An example of a poor comparable is when your subject property is an old cottage fixer-upper, and you compare it to the sale of a brand new in-fill (an in-fill is a new house built on a vacant lot in an otherwise established neighborhood).

Rehab dollars vary according to level and detail of the job – everyone has a different formula.As a wholesaler, we suggest a middle-of-the-road approach for estimating enough rehab dollars to get the subject property to look like the comps.You'll need to spend more on rehab as the ARV increases.Logically,buyers like more ‘pretty-ness', higher-end fixtures, cabinets, etc. when they're paying $200,000 vs. when they're only paying $100,000 for a house.

Buy/Sell/Hold costs are all of the costs associated with:

üThe purchase (loan origination fees, title insurance, attorney fees, survey, appraisals, etc);

üThe sale (real estate agent commissions, marketing and advertising, closing costs paid by the Seller); and

üHolding the property (mortgage interest, utilities, taxes, insurance, etc.).

These costs vary greatly for each buyer, but our experience shows that a Buy/Sell/Hold cost of 15% of ARV (0.15 times the ARV) is a safe number to use.If you wholesale the property, you may never purchase the property.In this event, all of these costs are passed on to your Investor Buyer.Therefore, you can subtract your additional B/S/H costs from the MAO formula. Your Buy/Sell/Hold costs will not be 15% because you will not incur long holding times, nor pay real estate commissions, nor closing costs when you sell.You can probably use about $1,500 for your B/S/H for one of these deals, unless your cost of getting the financing was very high.

Profit is quite simply how much YOU want to make in the deal as well as how much you want to leave in the deal for an Investor Buyer.Your profit can range from $3,000 to $30,000 with a typical average in many areas of $5,000 - $15,000.You have to consider all of the costs you incur in marketing and processing all of the deals, along with the time you spend to get a deal, and determine what all that is worth to you.This will affect your MAO, so know your number before you negotiate.If you under-value your profit, it won't take long for you to realize the reward isn't worth the time and effort.If you over-value your profit, then you'll severely limit the number of deals you find.On the other hand, this profit determination is just for the MAO calculation.If you negotiate under your MAO, all that extra profit is yours to keep or to split with your Investor Buyer to make a wholesale deal more attractive.

Finally, remember to leave extra room in case you have to negotiate with your Investor Buyer and you do not get the price you anticipate.Also, sometimes title issues come up or other issues with the property that are easier for you to just pay for than to try to reconcile with all the parties.You want to have enough room to be able to handle those things.

The Investor Buyer’s Profit which we recommend that you build in (i.e. “leave on the table” for the investor) is generally $1.00 - $1.25 for every dollar of rehab, but not less than $10,000 nor much more than $30,000.For example, if your rehab estimate is $16,000, you’d leave $16,000 - $20,000 for the Investor Buyer’s profit.If the rehab estimate is $5,000, you’d leave the minimum $10,000 Investor Buyer’s profit.Finally, if your rehab estimate was $40,000, you’d leave the maximum of $30,000 for the Investor Buyer’s profit.

Once you have determined all of the numbers and do your calculation, you’ll have the Maximum Allowable Offer (MAO).This is the most you will pay for the house.It is the deal breaker.The stop point.The MAO is not where you start negotiating … it’s where you STOP negotiating.Every dollar you negotiate below the MAO is additional PROFIT in YOUR pocket.

We always say “go for the MIN-O: the Minimum Offer the Seller will accept."In other words, start negotiating well below your MAO, and work up if you have to.You can always add to the price you'll pay; but it's very hard to subtract once you've given the Seller a figure.

**Please Note:one thing that the MAO does not take into account is anything odd about the house that might make it harder to sell … things like a busy street, ugly surrounding homes, a nearby commercial property, etc.In these cases, you have to think about how much the final price will have to be reduced to get it to sell.Make sure you either reduce your ARV or increase your Investor Buyer's profit by that amount, thus appropriately reducing your offer to the Seller.

MAO Calculation Example:

Let's say that you did all of your homework, and decided that after evaluating all the comparable sales data, you've determined that the ARV for your subject property is $140,000.Based on your evaluation of the property, you determined it would take about $15,000 to get it to look like all of the comps.

To calculate the B/S/H, you take the $140,000 ARV, and multiplied it by 15% which equals $21,000 [$140,000 x .15 = $21,000].

You decided that your profit should be $10,000 as the Assignment Fee for a wholesale.The Investor Buyer’s profit is calculated by multiplying the Rehab costs by $1.25 to get $19,000 [$15,000 x $1.25 = $18,750].

Now, plug all these figures into the MAO formula and you calculate that the most you can offer on this property is $75,000.

ARV:$140,000

Rehab:$15,000

B/S/H:$21,000

Profit (you):$10,000Assignment Fee

Profit (buyer):$19,000

MAO$75,000

But you’re a great negotiator and the Seller agreed to a $71,000 purchase price. That means you just added $4,000 to YOUR profit – just by talking!

Please note:You may want to double-check your MAO formula with a much simpler, "big picture" formula:

Wholesale/Retail MAO should be:

60-70% of ARV minus Rehab Expenses

Finally, the formula we use for determining the most that you can pay for a property you are going to hold as a rental property is (in monthly figures):

Rent you will receive – Taxes/Insurance/Utilities that you will pay for tenant – Maintenance savings (6 – 10% of rent) – Vacancy savings (8% of rent) – Desired Cash Flow =

Mortgage Payment (Principal and Interest ONLY)

@John Quebedeaux 

Thanks so much for the response. This answer is so detailed that I have copied it into a word doucment to look over second. It helps a lot to have the opinion of a rehabber who buys from wholesalers and get your opinion on what is far.

That is true about repair. Investors will have different opinions on scope of work depending on their target buyer or renter.

Originally posted by @Michael Westberry :

I just watched Jerry Pucketts podcast which was filled with some awesome info. 

I liked his formula for finding the price he could purchase a property which is

ARV-rehab-(your fee). I wanted to see what other wholesalers use to find that price?

That will never work, either Jerry mis-spoke (he knows better) or you misunderstood what he said. It leaves no money for "Soft Costs" or all the hidden cost. These are things like the cost to buy, the cost hold like; taxes, high cost builders risk insurance, utilities and financing and the cost to sell. These are certainly 10-15% of the ARV and can be 20%.

 Thanks @Ned Carey that makes since. Taxes would definitely be evident because many flippers will keep the property for 3-6 months. The risk insurance, utilities, cost to financing and sell were not cost that I had previously incorporated 

Appreciate the tip

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