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Business Development

"How Much Should I Pay?" (Know Your MAO)

This is Jp Moses here to give you a few easy formulas for understanding numbers when flipping houses. When you’re in the fix and flip market, you buy a house, fix it up, sell it, and then hopefully, before it’s all over, you make a good profit.

The only way to make this happen, and make it happen repeatedly, is to create a relatively simple math formula. That way, whenever you look at a deal, you’ll be able to quickly analyze it to make sure you're buying it for the right price.

In other words, you’ll know the MAO: maximum allowable offer.

Playing the Numbers

When creating your formula, the first number you need to know is the ARV, or the After Repair Value. This refers to the approximate price the home should sell for once it’s fixed up.

Next you’ll have the buy price. The amount you’ll pay for the property.

After that, the number that is needed is the cost of repairs – what you spend in fixing it up in order to sell.

Add to that the soft cost, which refers to the fees you pay when you buy and sell a property. This might include closing fees, real estate commissions, property tax, title insurance, recording fees and so on. You will incur soft costs every time you buy and sell real estate.

Yet another number to be considered is the carrying cost, which is the cost of capital. You had to get capital in order to buy the property, and there’ll be financing costs on that capital. Whether it's private money, hard money, bank financing, or whatever, carrying costs will be involved.

The Shortcut

So, these are the costs that subtract out, after which – hopefully – you're left with a profit.

If you were to list these costs and figure this all out every time you did a deal, it could become cumbersome and time consuming. That’s why we use a simple formula as a shortcut.

The formula I like to use is: ARV X 0.65

We take the ARV – what it's going to sell for – and multiply that by 0.65. (It’s the same as subtracting out 35%.)

So, we're going to take out 35%. Why 35%? Let me show you…

Soft cost typically accounts for 10% of sale price, and carrying cost is typically 5%. With those two, we’re up to 15% of total costs.

Now we factor in profit, and I like to use 20% as my profit gauge. Why 20% profit? Some people say they’d be happy with10% or 15% profit. Here's my reasoning…

fractionsThings don’t always go according to plan. It might not sell for as much as you want. Or the costs might go over. If that happens, what does that cut into? Your profits. This is why I always go into my deals with a 20% profit margin.

If I hit that target, great. If I’m a little bit off, I still have room to make money. Nothing is worse than going into a deal with tight margins and then not making money, or worse, even losing money. That's not our goal here.

Now it’s time to subtract repairs. Repairs will vary on every single project. After they’re calculated, you subtract that number. Now we’ve arrived at our buy price – the MAO.

That's our formula. ARV x 0.65, minus the repairs (no matter if it's $10,000 or $20,000 or $100,000) equals the buy price.

Now, it’s important to note that MAO formulas can vary by area based on what your local market will bear. For example, some investors in California will use MAO = ARV x 80% - repairs (instead of 65%) because the market demand is so hot.

So you need to always be willing to tweak your MAO formula based on local market conditions.

The Wholesale Fee

Now, if you're wholesaling, you’ll have one more number to put in. After subtracting out repairs, we need to subtract out the wholesale fee. You want to make sure that you've calculated in your wholesale fee when you're going to flip this property.

Let’s use an example with simple numbers.

ARV $100k

Repairs $20k

$100k x 0.65 minus $20k equals $45k (our buy price). If we do that and hit those numbers, we'll make a 20% profit on that deal. And that's how it's done.

If we're wholesaling this deal and want to make a $7,000 wholesale fee, then you will subtract that. Now $38k is the MAO.

Formulas for Landlords

mathLet’s look at how a potential landlord will come up with their MAO formula.

Personally, I’m no longer a landlord. I no longer hold property as that’s not my current business model. But I do wholesale to a lot of landlords, so I can share with you what their formulas look like.

What I see from my landlord buyers are actually a couple of different formulas. One popular formula is 35 X rent. This means these landlords are willing to pay up to 35 x the rent amount. That’s how much they have to be into the property after repairs.

For example: $750/month rent x 35 = $26,250

They need to be all in at $26k. If the property needs $8k in repairs, then the most that landlord can pay is $18,250. (And as a wholesaler I’ll have to buy it even cheaper than that.)

I see other landlords who concentrate on a 10% cap rate (or capitalization rate).

(Capitalization Rate: A rate of return on a real estate investment property based on the expected income that the property will generate. Capitalization rate is used to estimate the investor's potential return on their investment.)

This is especially true for out-of-state landlords who want to see at least a 10% cap rate, and some who want to see a minimum 15% cap rate. If you’re a landlord, then you have to know what you want your cap rate to be in order to buy correctly.

Well, hopefully his simple math lesson was helpful. Plug in the numbers and you should be good to go.

Got Something to Add (pun intended)

Do you use a different formula than the ones I’ve gone over? Share with us in the comments section below.


Do It To It! Immediate Action Steps

1. Recognize that simple math formulas can help prevent overpaying on properties.

2. Learn the basic formulas whether you’re doing a fix and flip, wholesaling or landlording.

3. Use your formula as a tool for effective negotiating.

4. Know your MAO to prevent eating away your profit margin.

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