I probably answer this question for investors 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 the formula I use for single family homes:
The Maximum Offer (MO) is calculated by first determining what the house will be worth after renovation which is referred to as the After Repaired Value (ARV); less the rehab dollars required; less the Buy/Sell/Hold (B/S/H) costs; less profit amount desired
MO = ARV – Rehab – B/S/H – Profit
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 ˝ 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, use less expensive sub-contractors, 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). I do not attempt to obtain all of the various contractor bids when I am making offers. All the real deals would be sold before I could ever have an offer together! Instead I have 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 MO. Your negotiations should lead you as far below the MO as possible. The difference in amounts is additional profit in your pocket. What you SHOULD pay is the minimum price below the MO that the seller will accept.
I call this the MIN-O.
Best of Success & Abundance,
Lou Castillo
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Lou Castillo has been successfully investing in real estate since the early ‘90’s, and now shares his vast experience with investors around the country. Unlike many of the speakers and mentors in real estate, Lou has both an undergraduate and a Master's Degree in Business and Marketing, and for 12 years he worked managing a 50 million dollar business for American Express.
He was on his way up the corporate ladder until he recognized that real estate offered a greater opportunity for financial freedom, and for the lifestyle he desired. Using his powerful formulas Lou was able to retire from his corporate job at age 37 and follow his passion - his first love - which is investing in real estate.
Lou has developed proven systems that create massive wealth through real estate investing. He has authored more than 7 books and courses on the subject focusing on the implementation of his techniques. His latest development 'The Investor Riches System' has been helping investors world wide achieve financial freedom through real estate. For more information, go to http://www.freerealestatestrategies.com If you wish to talk to Lou you can e-mail him at Lou@InvestorRiches.com
