We probably answer this question for someone a couple times every week. The problem is that they don’t have a good formula for determining the most they can pay and still make a profit – so they’re scared to make any offer. Here’s what we use for single family homes:
The (MAO) Maximum Allowable Offer is calculated by first determining what the house will be worth after renovation – the ARV (After Repaired Value); less the rehab dollars required; less the Buy/Sell/Hold (B/S/H) costs; less profit margins.
MAO = ARV – Rehab – B/S/H – Profit
So let’s break that down a little further. To determine the ARV, study comparable sales data. Comparable sales are those properties which sold in the last 6 months to 1 year, and within ½ to 1 mile from the subject house. But other factors must be considered as well. The more characteristics between the properties that are similar, the more valid the data. Make sure that the house itself is similar in square footage, bedrooms and baths, age, style, and architecture. Don’t worry about condition except as it will affect the amount of rehab dollars required. Next, look at the neighborhood and the individual street. Do they look the same? Or is the comparable property on a beautiful street while the subject property is on a street riddled with empty littered lots and boarded up houses? The point is to view the potential investment as your end homeowner occupant will. If they could buy your completed investment on the bad street, or a house on the beautiful street – either for $150,000 – which would they choose? The other house of course. Which means your house is not worth the same – it must sell for less to attract a buyer.
Rehab dollars differ from renovator to renovator depending whether they do the work themselves, or use cheap subs, or use an expensive general contractor. The scope of the work should be the same – it is whatever is required to make the investment look like the comparable houses (unless the plan is to sell well under market value). We do not attempt to obtain all of the various contractor bids when we are making offers. All the real deals would be sold before we’d ever have an offer together! Instead we’ve developed ranges of rehab dollars based on the overall condition of the home. Is it an exact science? No, but neither are the bids – there will always be something missed. So why not work with a guide that is probably 90% accurate and allows for quick offers?
Buy/Sell/Hold costs include expenses such as appraisals, attorney fees, title search & title insurance, loan origination fees, debt service, utilities, insurance, taxes, real estate commissions, and closing fees paid on behalf of the end buyer. Again, these costs vary depending on each investor’s individual situation. In the Atlanta area, 15% of the ARV seems to be a good average allocation for B/S/H costs. If you are the renovator, calculate your specific B/S/H costs, then utilize that percentage for future offers.
Profit margins are the fun part of the equation. How much do you want to make? If you’re wholesaling the property, you also want to consider how much you should leave in the deal for the investor buyer to make the deal attractive.
That’s it. That’s how you calculate the most you’ll pay for a property. But that’s not what you SHOULD pay. It is the maximum you’ll pay. It is the deal-breaker. You will not pay one penny over the MAO. Your negotiations should lead you as far below the MAO as possible. The difference in amounts is additional profit in your pocket. What you SHOULD pay is the minimum price below the MAO that the seller will accept.