How To Determine Your Maximum Offer
If you are going to be assigning your contracts, you need to ensure a good margin for your AS IS Cash Wholesale Buyer to Buy! 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
(MOP) or MAO = ARV – Rehab – B/S/H – Profit
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, 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.
The most important wholesaling formula for you to remember:
WHOLESALE REAL ESTATE ARV X 65% LESS REPAIR ESTIMATE = MAXIMUM OFFER PRICE
Example:
A house is worth $100,000 once it has been fixed up.
The after repair value (ARV) is $100,000.
The house requires paint and new carpet which you estimate would cost $5,000.
65% of the ARV is $65,000.
Less the $5,000 repairs results in a maximum offer price of $60,000.
This is also approximately the amount of money that a hard money lender would loan although they would require you to put up some skin (money). If you were to ask a hard money lender for a loan they may fund you $55,000 if you put up $5,000. This would assume of course that they agreed with you on the after repair value and also on the repair estimate. If their ARV was lower or their repair estimate was higher then they would offer to loan less.
If you look at the formula above you will notice that there are really only two components to the formula:
1. ARV (after repair value)
2. Repair estimate
Naturally if there are only two components then those components values are very critical to getting the correct outcome. In this case the outcome is the maximum offer price (MOP) which is the highest amount you would pay to buy this house. Since these two components are so critical we will go through them each separately.
After Repair Value
The after repair value (ARV) is the estimate of what you think the house is worth. Calculating what a house is worth is an art not a science. One house may have a granite countertop and another may have a pool. One house may have a really nice back yard and another might be on a busy road. Appraisal is an art form since it is subjective to the opinion of the individual doing the appraisal. And appraisers can be influenced or persuaded by what they are told. For example if you told an appraiser that you spend $35,000 to upgrade a kitchen and it looked believable they would probably add a little on to the value of the house because of the remodeled kitchen. Appraisals may work in retail real estate but they are not going to work in wholesale real estate.
What you need to establish for the purposes of ARV is the following. What is the least amount that the house is worth? Or expressed differently, if I were to list this house for sale on the MLS, what is the amount that I could definitely get for it within a few days. Naturally you would need to use conservative numbers to come to this conclusion.
For example assume the following scenario:
900 sq foot house sold for $99,000 ($110 per sq foot)
1000 sq foot house sold for $105,000 ($105 per sq foot)
1200 sq foot house sold for $120,000 ($100 per sq foot)
1500 sq foot house sold for $135,000 ($ 90 per sq foot)
These four houses above would be considered comparable sales comps or just comps in real estate lingo. Assume that all of the houses were constructed of the same material and were identical in every aspect other than square footage. Assume also that they all had the same number of bedrooms and bathrooms and were all situated on the same street and that all sales occurred last week. This would mean the comps would be very consistent and reliable as well as recent. If we look at the prices we can see that the houses sell for between $99,000 (lowest) and $135,000 (highest). We can also see that the houses sell for as low as $90 per sq foot and as high as $110 per sq foot.
Now using this information, assume that you get a phone call from a desperate seller that has a 1300 sq foot house on this same street. Assume that the house is in exactly the same condition as the four comparable sales (comps) above. Obviously this is not very likely but I am doing this exercise to illustrate how to do a conservative comp. This 1300 square foot house could have any of the following values which would all be justified and supported by the comps from the four houses. This 1300 square foot house could be worth:
Value of 1,300 sq foot house
$117,000 ($90 per sq foot)
$130,000 ($100 per sq foot)
$136,500 ($105 per sq foot)
$143,000 ($110 per sq foot)
Now considering that based on the four sold comps from the other four houses nothing sold above $135,000. Therefore if a 1,500 sq foot house sold for $135,000 then there is no reason that a 1,300 sq foot house should sell for more than this number. You could also argue that if someone paid $135,000 for 1,500 sq feet why would someone else pay the same price for 1,300 sq feet which is 200 sq feet less? Based on this information you can probably figure that the house is worth around $120,000 to $125,000 because a 1,200 sq foot house sold for $120,000. It is probably not worth less than. The house is almost definitely not worth less than $100,000 because two small houses that were 900 sq feet and 1000 sq feet sold for $99,000 and $105,000.
We can do the same exercise a little quicker by just using the lowest comp on a square foot basis. For example the lowest comp per sq foot was $90 per sq foot. So just using this number, we can assume that 1300 x $90 = $117,000 which is probably a conservative estimate for what this house is worth. I call this method using the low comp and I always instruct my students to “give me the low comp”.
ALWAYS USE THE LOW COMP PER SQ FOOT TO GET A CONSERVATIVE ARV
Now that we have covered the first variable of our formula let’s move onto the next variable which is the repair estimate.
Repair Estimate
In wholesale real estate lingo, repair estimate can also be the rehab estimate or “how much work does it need”. The bottom line with a repair estimate is how much money would an investor need to spend in order to have the house fixed up and ready to sell. Once fixed, the house should reflect 100% of the ARV. Prior to being fixed the house would be worth the ARV less the repair estimate.
Calculating repair estimates is definitely an art form and not an exact science. The reason is because no two people will get the same results. If you call three different general contractors and you ask them for an estimate of repairs you will get three different results that can vary tremendously. An investor that is doing the repairs themselves can repair the house for the cost of the materials since their labor is free. If a general contractor is also an investor then he will be able to do the work for much less than other investors would. And finally, some investors are more able to find labor and materials at cheaper prices.
Good rehabbers that rehab many houses for a living can get really good prices that a general contractor would never be able to compete with. You can use some of the numbers as a good rule of thumb when trying to estimate repairs. For the numbers below, we are assuming a small 1,000 sq foot house that is made of concrete block and is going to be a rental property. For this reason, we are going with the cheapest components that would be available at a store like Home Depot along with the cheapest labor possible to get the job done. Naturally, if you are a beginner you will have a very hard time getting work done at these prices. These are good prices that are the cheapest you could get a job done and these prices include labor and materials. You probably won’t be able to get these prices but for the purposes of your wholesaling formula, you can use these numbers as a rough estimate which will be fine for wholesaling:
New Roof $4,500
New Central Air $4,000
New Windows $2,000
New Drywall $4,000
Paint Interior $1,000
New Kitchen $3,000
New Bathroom $1,000
New Electrical $4,000
New Doors $800
New Tile Floor $2,000
If you add all of these numbers up you will see that to completely redo a small 3 bedroom 1 bathroom 1,000 sq foot house will cost you around $25,000 to $26,000. If your repairs are only cosmetic like putting in new tile floors and repainting then you should be able to do that for only $3,000. Most cosmetic repairs come in at $5,000 or less. Anything more than $10,000 would be considered a rehab.
Once you have a good handle on your repair estimate and you have a good conservative ARV you can use the formula to calculate your maximum offer price (MOP) Some people also refer to this as MAO (Maximum Allowable Offer). I always suggest that you start out offering $5,000 less than your maximum offer price in order to have room to negotiate up when you get countered.
Here are some examples for you to practice the formula:
Example 1
Assume a 1,200 sq foot house with a low comp estimate of $85 per sq foot. Assume that the
house requires $12,000 worth of work.
1,200 x $85 = $102,000 (low comp estimate of the ARV)
102,000 x 65% = $66,300
$66,300 less $12,000 repairs = $54,300 Maximum Offer Price (MOP)
Begin your offer $5,000 below this number (round up to $50,000)
Example 2
Assume an 800 sq foot house with a low comp estimate of $137 per sq foot. Assume that the
house needs only $3,000 in cosmetic repairs.
800 x $137 = $109,600 (low comp estimate of the ARV)
$109,600 x 65% = $71,240
$71,240 less $3,000 repairs = $68,240 Maximum Offer Price (MOP)
Now that you know how to calculate low comps, repair estimates and after repair values you are
ready to begin making offers.
Traditionally wholesalers found most of their customers by using yard signs and other forms of advertising. These distressed sellers would contact the wholesaler who using the methods above would sign a purchase contract to buy the house. Typically the wholesaler would offer a low deposit of $10 or $100 directly to the homeowner who was often in foreclosure. They would then draw up a contract to purchase the house at a price that would be equivalent to the maximum offer price using the methods that you just learned.
The wholesaler would usually give themselves a 14 day inspection period to inspect the house prior to committing to buying it. At least this is what the wholesaler would tell the homeowner. Once they had a valid purchase contract to buy the house, the wholesaler would use these 14 days to try and find a cash investor that would buy the house. The wholesaler would advertise the house for maybe $5,000 more than their contract price and if they found a cash investor they would ask for an “assignment fee” of $5,000 for the cash investor since they found the deal.
Notice how the above is not really any different to being a bird dog. The only difference is that the wholesalers name is on the contract and that the wholesaler can sell the deal to whoever they want. However if the wholesaler was a bird dog that worked for a cash investor that agreed to pay a $5,000 assignment fee then really there would not be much difference. The difference is more psychological than anything else. The main advantage that a wholesaler has is that they can offer their deal to many cash investors.
Successful wholesalers have many cash buyers and can usually move a deal within 24 to 48 hours. The longer you are in the business the more cash buyers you will have. If you get into the habit of email blasting your deals out to these cash buyers and your deals are good then you should have no problem finding cash investors to buy your deals. The most effective way to build your buyers list is to advertise your deals. If you advertise your deals in the newspapers, with yard signs and online then you will have cash investors calling you. When they call you
should make sure to save their name, telephone number and email address. Then you can add them to your buyers list.
Profit Margin
This is the least amount of profit you are willing to accept on your investment. Your goal is to offer the lowest amount that the seller will take. This should be far below the MOP, ensuring you a higher profit margin. The MOP is the deal breaker. If you must offer more to purchase the property, then walk away from it and look for other homes for sale for your investment.
Here is a spreadsheet you can use to help you in evaluating property and find the MAO. Download HERE (Word 07 format )