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.
Finally, after determining the repair costs and fixed costs, you’ve reached the most important aspect of the equation – your desired profit.
This input is entirely in the eyes of the rehabber.
If you are interested in securing a $10,000 profit, you’ll back that into the equation. If you are interested in $15,000, you’d back that number instead.
It’s up to you to figure out what number makes the most sense.
Obviously, the higher the desired profit you chose, the lower the MAO becomes. More often than not, the less profit you are okay taking, the more attractive your bid becomes.
Find that sweet spot and hit the ground running.
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.
The MAO Formula is a great equation to use as a guide for flipping houses. It is similar to the 70% Rule and it’ll help you keep all variables in mind to ensure you make an adequate profit no matter what.
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) 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.
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