If I had a nickel for every time I get asked this question… well, you get the idea. The real question isn’t “How much do I pay for a deal?” Rather, it should be “What’s the most I can pay and still make a comfortable profit?” I’m sure you, like me, are always willing to pay less, so the real key is knowing your “walk-away-and-look-at-the-next-deal” point. Bid any more, and the potential profit is no longer enough to keep your interest. We’ll call this your Maximum Bid Price, and heck, let’s go ahead and make an acronym out of it and call it your MBP. Once you know your Maximum Bid Price or MBP the negotiations can begin.
The formula to arrive at your MBP is pretty straight forward.
MBP = ARV – Rehab – Purchase Costs – Holding Costs – Selling Costs – Profit
Let’s simplify it a bit and call the Purchase, Holding and Selling costs P/H/S, so
MBP = ARV – Rehab – P/H/S – Profit
So the formula doesn’t look too intimidating, does it? Just be careful. The formula is a bit deceptively simple. In “real life” it starts to get messy when you go about figuring the ARV, Rehab, and P/H/S costs. Let’s take a look at what I mean:
ARV is probably the trickiest. ARV represents the After Repaired Value, in other words, what the property will be worth once you’ve fixed it up and worked your magic. I’ve heard the ARV also called the “Approximate Retail Value” which is pretty much the same concept. Basically, fixed-up and looking pretty, how much could you sell the property for? To determine the ARV, you need to study comparable sales data and also take a look at current listings. Try to find properties with as many similar characteristics as you can to your subject. Some very important characteristics to consider are location, size, age, condition and amenities. You can usually find a real estate agent to help you get good market data from the local MLS. If you can find one that will help you for free– great. But expect to pay at least $5 to $10 per comp report.
Rehab dollars differ from renovator to renovator, depending whether you do the work yourself, use less expensive sub-contractors, or use an expensive general contractor. The scope of the work should be the same—whatever is required to make the investment look like comparable properties. 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 property. Is it an exact science? No, but neither are the bids; there will always be something missed. You’ll just need to give yourself some cushion.
Purchase/Holding/Selling 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. Many investors boil all these costs down to a simple percentage value of ARV, perhaps around 15%.
We all agree that more profit is better, but it’s time to get realistic. If you get too greedy, you’ll end up with nothing. Have you heard of the story of the greedy monkey who has a fist full of food stuck in a jar? He won’t let go of the food to get his fist out, even when the hunter comes along and scoops up the monkey and jar and takes both home. Don’t be a greedy monkey!
Your profit goal should reflect the amount of risk involved in the deal, the time and energy you are going to be putting in, and a decent return on your capital. If a property simply needs a quick clean in a hot selling area, a low $10,000 profit could keep you happy. If a property needs foundation repair, has major pest problems, and plumbing and electrical work is required, then you’ll want a much higher profit for your added risk and time involvement. 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. Again, that’s not necessarily what you SHOULD pay– it is the maximum you’ll pay. It is the deal-breaker.
This formula is best suited for “flipping” a property (buying, fixing up and selling the property.) If you are doing something else, there are other formulas that may be more appropriate for your investment objectives. For example, if you’re planning on holding the property long-term as a rental, a different set of considerations and a rental-focused formula will be helpful. (More on that in an upcoming post.)
We’ve spent countless hours developing EvaluateMyDeals to make it easy to determine your Maximum Bid Price for numerous investing strategies. EvaluateMyDeals also makes this brutal process of calculating your rehab, purchase, holding and selling costs a breeze. If you haven’t given EvaluateMyDeals a spin, stop monkey-ing around, and try it today!