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,
Real Estate Investing
National Trainer and Mentor....
www.InvestorRiches.com
