How Much Should I Pay For This House?
By Joe Brillante & Lou Castillo
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.
We call this the MIN-O.
Joe & Lou
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