The MAO:What's the real numbers?

Question

In his book " How to Be a Quick Turn Real Estate Entrepreneur in Any Economy" Real Estate guru Ron Legrand claims that your MAO(Most Allowable Offer)shouldn't go above 70% of the ARV(After Repair Value)of a property. Another famous Real Estate Investor,Armando Montelongo in his "Flip and Grow Rich" book also teaches the same precept. At the exception that he goes even further below,asking the new investor to bargain for as low as possible(he shoots for 65%.)

I have since included those stratagems in my overall strategy of putting properties under contract. I start at 65% then work my way up to the 70% bench-march. The fact that most sellers balk at selling their properties at 65 cents or 70 cents on the dollar pushed me to question the logic beyond these bench-marks.

The answer came in the form of a phone call from a Vice President of a Bank specialized in commercial lending.

He posted his home for sale as a fsbo on Craiglist. The home looked nice,based on the pictures and didn't need any major repairs i concluded. Again,i picked my calculator,came up with a MAO,the Montelongo or Legrand's style and sent him an email with my phone number. He called me back.

He asked to know how i came up with my offer price? As i explained vaguely how,that's when he proceeded to tell me some of the  the reasons buyers require those thresholds.Simply put,the buyer's hands are tied up from the get-go.

He continued to explain that these buyers go to hard money lenders and ask for loans. Their hard money lenders charge them "points"(a point is 1% of the amount of a loan.)In addition to all other closing costs,plus the down payment. Needless to say that the buyer leaves all his  or her feathers with the hard money lenders.

The way for those buyers to recoup their investments is to ask for deeply discounted deals with the proverbial "motivated" sellers,which,as you know,can't be found on every street corner.

This is my version of what could be interpreted as either a myth or a reality,depending on whether applying the MAO rules has brought you success or the lack of it.

What do you know about the 70% rule?

How has it worked for you?

Where it was not applicable,what did you do to still get a deal?

Joe Villeneuve · Answer

As you found out, it doesn't work in most markets...or most economies.  For that matter, using "%" to estimate anything doesn't work.  When it does, it isn't because it was a good rule to follow.  It worked by accident.  "Buy low, and sell high" works great in the Stock Market.  If you could find enough properties to satisfy all the REI looking for those 65-70% rule properties then it would be worth depending on in REI.  There just aren't enough properties, so it doesn't work as a strategy you can depend on...without getting really frustrated.

What I will tell you is this.  If you work your analysis in reverse, starting with what you need (exit strategy) to end up with in the end (minimum profit/cash flow in DOLLARS...not %), you may find that there are many markets out there where you don't need to discount to make money on.

It's all about knowing "how money works"...and being good in math, which most are not...and just because you can add up to 10 in the winter, and 20 in the summer, doesn't make you good in math.

Unfortunately, way too many REI (actually people in general) are the ones in math classes that said, "Why am I learning this, I'm never going to use it?". The unfortunate thing is, that they were right.

My 2 part test, to see if someone has the math skills to take advantage of what REI has to offer (that other investments don't), is if that "someone" can tell me:

1 - what this equation means, and how it applies to REI

x = y^

2 - What is the significance of this number sequence

1073741824

...and the two answers are related.

Kenneth Garrett · Answer

I never use the infamous 70% rule minus rehab.  If your going to be an investor you need to be able to work the numbers.  The only thing that matters is what your offer is.  Many people get hung up on the asking price.  The asking price is irreverent.  When you calculate what the projected ARV will be and subtract acquisition cost minus rehab minus holding cost minus profit if flip then that is your number.  70% is a rule of thumb and doesn’t work for most projects especially in today’s market.  It is at best a teaching tool for beginners so they can see how the numbers are calculated.

Basic formulas don’t work and by the way that’s not being an investor.  Developing creative financing and structures is using skills you have acquired and you were able to make the deal work when others couldn’t.  That’s being an investor.  Bring your own niche to the table.

Adam Gollatz · Answer

@Mo Sylla my specifics are the same everyone else is using. I take the purchase, rehab, closing costs from the purchase, carrying costs, and the closing costs from the exit. What allows me to go to 75% is my confidence in the numbers. This also works because I go after purchase+rehab jobs in the 200k range which leaves the ARV of around 265 (265 x 75%=200).

@Joe Villeneuve said it best when he said look at the dollars as a number, and not as a percent. With a purchase and rehab of 200k, I'll make on average 10-12% of the overall ARV or 26-30k. Its streamlined for me and I just coordinate, so at the end of the day Im basically asking myself if I want to spend 40hrs of my time sending emails and making phone calls over the course of 6-9mo to make 26k? Its an easy answer.

There are 2 issues I see with a lot of wholesalers in my market, so this may not apply to you.

1.  They are drudging up the worst of the worst bottom of the barrel properties, which tend to to be really low end properties. With these low end properties, you still have the same fixed costs to cover, but that 25% of ARV isnt going as far since its a low value property. Imagine you have a 100k ARV property, with 70% rule, you need the purchase and rehab to come out to 70k. Now I have 30k left over to pay for my costs AND make a profit and appraisals and inspectors dont care, that 3/2 for 100k and 3/2 for 265k cost the same to appraise, inspect, etc. So when its all said and done, even though I started with a bigger percentage (30 vs 25) I'll make the same 10-12% which is in the grand scheme of things is less.

2. They never get the numbers right. The 40k purchase with 25k rehab and an arv of 109,900 (how they zeroed in on that extra 900, idk) looks real good from a percentage standpoint. Until you find out that all of those newly rehabbed comps are really like 105k. And that 25k rehab is an estimate from someone with no contracting experience or a fly by night "contractor" with no license or reputation.

It takes a lot of time and skill to price a distressed property accurately, your essentially trying to do a real estate agents job and a contractors job all at once. The best ones Ive seen are real estate agents, contractors, or they are teamed up with one. As you do, remember why a lot of wholesalers get into the business: They want to do rehab type investing, but dont have the financing or risk level acceptance to get started. So run the numbers as if you were going to do the whole deal yourself. If it makes sense to you, it'll help you find and sell your wholesales easier.

Keep me in mind for any good ones you get ;)

Adam Gollatz · Answer

It is very market specific and it depends on your situation, ie doing some rehab yourself, cash buying, etc and how certain you are of your numbers. I created a calculator in excel with my specifics and analyze deals based on that. Ive found that Im comfortable doing a flip where the purchase and rehab costs are 75% of the ARV. The more you refine your technique and process the more competitive youll be against other investors and youll be able to get more deals and higher quality deals.

It comes down to do you want a large piece of bad pie or a lot of small pieces of good pie. I settle for the latter.

Mo Sylla · Answer

All great answers.

If you don't mind mr. Gollatz,i would like to connect and ask more detailed questions regarding this topic.

With numbers.

Mo Sylla · Answer

@Adam Gollatz,

I am still running after my first deal. I can feel though that i am getting closer by the day.

Could you please elaborate on some of the specifics in your calculator that allows you to flip deals above the 70% bench-mark?

Admirably

Mo Sylla · Answer

@ Mr. Villeneuve,

i certainly appreciate your contribution. My only worry though is that it may have added more fog to an already foggy situation.

What's the link with that equation where y has a circumflex? I hardly see the rapport,unless you clarify the context for us.

You also say :"If you work your analysis in reverse, starting with what you need (exit strategy) to end up with in the end (minimum profit/cash flow in DOLLARS...not %), you may find that there are many markets out there where you don't need to discount to make money on.."

Suppose my end goal is to wholesale a property i laid my hand on,how does your formula operate from that end goal?

I appreciate your solicitude.

The MAO:What's the real numbers?

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