As a real estate investor, you’ll want to stick to certain principles that will give you a leg up against your competition. Abiding by these rules will not only raise your chances of achieving financial freedom, but will increase the speed, precision, and accuracy with which you make your decisions. This will free up more time for other profitable opportunities.
One such rule is the Maximum Allowable Offer Formula (MAO Formula) - a rule that will surely make you a better and more effective real estate investor.
The Maximum Allowable Offer (MAO) is a tried-and-true calculation real estate investors use to determine the price they would like to offer on a particular investment property.
It is an equation that ensures investors maintain the desired profit while considering expected fixed and rehab costs.
The MAO formula is calculated in the following way:
After Repair Value (ARV) – Fixed Costs – Rehab Costs – Desired Profit or Equity = MAO
This formula is designed to be open-ended and based on the individual investor’s preference. Real estate investing is a fluid game and each investor can cater to the MAO formula however they like.
Although some costs will likely remain constant from one investor to the next, desired profits can shift dramatically based on the particular hurdles you'd like to achieve.
Investor A might be content with $10,000 in profit, while Investor B might wish for $20,000. If all else remains constant, the MAO calculated for Investor A will be slightly higher than the equation calculated for Investor B.
This differentiation is the main driver in what makes a market.
There are four essential components to the MAO formula:
Let’s dive into each one of them.
Calculating the ARV or “after repair value” is vital in determining the MAO.
The most effective way in calculating the estimated ARV for any given property is by conducting extensive market research in the subject property’s surrounding neighborhood. Typically, that will include scoring the surrounding market for comps and reaching out to appraisers, lenders, real estate agents, and market experts.
In doing so, the investor will come up with a ballpark price for houses of similar size and make-up. Thus, while embarking on this research-driven journey, the buyer will slowly get a better sense of what to expect after he or she purchases the property and conducts the rehab.
As an aside, have an idea of the scope of work you will be conducting on the home as you do your research. It is a waste of time to conduct research on five-bedroom homes with garages if you are planning on converting a two-bedroom house into a three-bedroom house with a carport.
Be specific in your search to get a true sense of what your finished product will look like and what comparable properties cost.
Although it's not an exact science – working smarter and more efficiently will reduce mistakes and free up more time for more real estate investments.
Repair costs can include anything from the cost of hiring a plumber to the cost of a bucket of paint. Costs will be entirely dependent on the scope of work you’ll be performing and the state of your property.
The key to estimating repair costs appropriately is determining the materials and man-hours you’ll need to get the job done.
First, I’d recommend walking through the property.
It’s very difficult to get an idea of what work needs to be done from just pictures and videos. Looking under the hood is essential in creating an appropriate budget.
Then, I’d write down all the items you’d like to get fixed and adjusted. Every last detail is vital in this stage. For example, write down how many lightbulbs you’ll need, how many rooms you’d like to get painted, if the driveway needs repaving, or if you’ll need to order another vanity set.
If you want to flip a house, you must be scrupulous with expenses. Flippers spare no details.
Next, you’ll want to call as many contracting companies as possible.
Get 3-4 different quotes for your painter, head over to a few different stores to pick out an appropriate vanity set, and get an idea of how long each task will take.
Then, when you’ve finally jotted down the full breadth of work you’ll be performing, add another 15% - 20% to the overall cost.
This is known as the margin of safety or a contingency buffer.
There are always issues that emerge throughout the process that you might not be aware of. Perhaps a pipe bursts or you find mold eroding the drywall from within.
As a rule of thumb, anything can happen when flipping houses. Budget accordingly.
Calculating estimated repair costs usually takes a little bit of experience, but if you are a novice investor don’t get discouraged. With some trial and error, research, and practice you’ll get the hang of it pretty quickly.
Fixed costs are any costs that aren’t variable.
Variable costs would include rehab and repair costs mentioned in the prior section, whereas fixed costs would include real estate agent fees, title fees, holding costs, taxes, insurance, and utilities associated with carrying the property.
It is imperative to do your research and determine the fixed costs associated with any given project. Speaking to Realtors could be a great way to learn about typical fixed costs for a property of similar size.
If you anticipate you’ll hold the property for a total of three months – two for repairs and one for selling – you’ll need to budget the costs accordingly.
Over the span of working on the property, you’ll have to pay for holding costs, real estate taxes, and utilities such as electricity and gas.
Over the span of selling the property, you’ll have to pay real estate agent fees, closing costs, attorney fees, title search fees, and maybe even Homeowners Association (HOA) costs and lender fees.
Take the time to understand your market and the level of expenses you should expect. The last thing you want is to buy a property expecting to rake in $10,000 in cash flow only to realize after the fact that half of that is going to go to fixed costs.
Lastly, after you've calculated the repair and fixed costs, we come to the crux of the MAO formula – your anticipated profit. This is the key component that is entirely at the discretion of the flipper.
Are you aiming for a profit of $10,000? Incorporate that into your calculations. Maybe you're seeking a higher margin, say $15,000? Use that figure instead.
The goal here is to determine a profit number that makes sense to you. Remember, as your desired profit increases, your MAO correspondingly decreases. Conversely, the more flexible you are with your profit margin, the more appealing your offer becomes in a competitive market.
Striking the right balance is crucial in your house-flipping venture. And, once you've found your sweet spot, you're ready to dive into the exciting world of real estate investing.
Interested in getting more insights and guidance on how to navigate the house-flipping landscape using tools like the MAO formula? Sign up for our FREE real estate training. With our expert tips and strategies, you'll be equipped with the knowledge to maximize your profits and minimize your risks. So, don't wait – hit the ground running and start your real estate journey with us today.
Let's walk through a simple example to understand how the MAO formula works in a real-world scenario.
Suppose you've identified a potential investment property. Here's what you've estimated:
$300,000 (ARV) - $20,000 (Fixed Costs) - $50,000 (Rehab Costs) - $40,000 (Desired Profit) = $190,000 (MAO)
So, according to the MAO formula and your desired profit, the highest price you should offer for this property is $190,000.
Wholesaling is the act of contracting a home from a motivated seller and simultaneously finding a different buyer for the same home at a slightly higher price. Typically, wholesalers look to flip contracts on attractive investment opportunities and distressed properties. In doing so, they retain a small fee.
The beauty of the MAO formula is that it can be applied to wholesaling real estate deals as well.
Instead of calculating the formula as After Repair Value (ARV) – Fixed Costs – Rehab Costs – Desired Profit/Equity, a wholesaler would simply add their fee to the equation and bake it into the value of the property. Thus, the formula would look a little like this:
After Repair Value (ARV) – Fixed Costs – Rehab Costs – Desired Profit or Equity – Wholesale Fee = MAO
By backing in his or her desired profit, the wholesaler ensures the price of the house offered results in a good deal for both the wholesaler and the buyer. Keep that in mind as you cold-call prospective clients to kick off your wholesale business. Now, let's go over an example together!
Let's assume that the After Repair Value (ARV) of a property you're interested in wholesaling is $250,000. You've estimated the repair costs to be $30,000, and you've set aside $20,000 for fixed costs (closing costs, holding costs, etc.). Your desired profit is $15,000, and you plan to charge a wholesale fee of $10,000.
The formula would look like this:
$250,000 (ARV) – $30,000 (Repair Costs) – $20,000 (Fixed Costs) – $15,000 (Desired Profit) – $10,000 (Wholesale Fee) = MAO
So, $250,000 - $30,000 - $20,000 - $15,000 - $10,000 = $175,000
Based on these numbers, the Maximum Allowable Offer (MAO) you could make while still ensuring your desired profit and covering all costs and fees, would be $175,000. If you can acquire the property at this price or lower, you're in a good position to hit your investment goals.
Absolutely, the MAO formula is an excellent tool for house flippers!
Just like the 70% Rule often used in house flipping, the MAO formula serves as a comprehensive guide for investors. It takes into account all potential costs associated with flipping a house, and ensures you make a satisfactory profit in the end.
Let's illustrate this with an example.
Assume you've found a potential house to flip. Based on your calculations and market analysis, the figures are as follows:
Now, let's plug these numbers into the MAO formula:
$350,000 (ARV) - $25,000 (Fixed Costs) - $60,000 (Rehab Costs) - $45,000 (Desired Profit) = $220,000 (MAO)
So, in this case, your Maximum Allowable Offer for this house flip would be $220,000. Anything more, and you'd risk not achieving your desired profit.
Remember, the MAO formula is a critical tool for house flipping because it ensures you consider all the financial factors before jumping into a deal. It helps you set a price limit on your property purchase, protecting you from overbidding and guaranteeing your profitability.
Creating a step-by-step spreadsheet is a fantastic way to keep costs controlled throughout your research and renovation journey.
Although the investor can cater the spreadsheet to his or her needs and desires, the gist of it will be the same from one investor to the next.
For example, all MAO spreadsheets will include a section for the estimated after-repair value, a section for renovation costs, a section for fixed costs, and a section for desired profit. In the end, the spreadsheet should compute an MAO that is best suited given the provided inputs.
Below we’ve included a sample MAO spreadsheet. In theory, you’d have one spreadsheet for each property you are analyzing.
Based on the spreadsheet above, the MAO for this particular property would be $119,050.
Keep in mind, the MAO is not an exact science. Just because I put $150,000 as of the ARV, doesn’t mean I’ll fetch that offer. Each line item is an estimation, so it might be better to create a sensitivity table to determine the MAO given a large variety of inputs.
For example, I should know the MAO if the ARV comes in at $125,000 instead of my desired $150,000. I should also know the MAO if my miscellaneous fee comes in higher than the $1,000 I budgeted for.
Flipping is a game with a lot of moving parts. If you stay on top of the variables you’ll surely come out on top.
Check out this video about calculating a real estate investment using a more sophisticated spreadsheet:
In the real estate business, paying the right price for an investment can make or break your success. Navigating the fast-paced nature of this industry and monitoring your costs can prove to be very challenging for even the most experienced of investors.
The Maximum Allowable Offer (MAO) formula can keep you in check to ensure you are always making the right decision. This formula should help anyone proceed with confidence, whether they are house flipping, wholesaling, BRRRR, or buying a rental property.
You make your money when you buy - this formula will ensure you buy right and you buy smart. Good luck!
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