David: Alright guys, welcome back to the Discount Property Investor podcast. This is your host David Dodge, with co-host Mike Slane.

Mike: Hey guys! How are we? Hey Dave, how are you doing?

David: I am doing good, buddy. I want to talk about the MAO formula today. MAO. What is our MAO?

Mike: Perfect. Guys, if you are new to the podcast, thank you so much for joining us. We primarily focus here in our own company on wholesaling real estate. So it's buying it at a discount, selling it at a discount. Just a little bit less so you can make a nice spread in-between there. Today we are going to be talking about a small piece in that which is kind of figuring out how much you can offer, so you can then make a profit. Sorry got distracted there, guys. So you can make a profit. What is MAO? Dave, did you define that for us already?

David: No I didn't.

Mike: Just define MAO for our listeners real quick.

David: MAO, so the MAO stands for the Maximum--.

Mike: Allowable--.

David: Did I spell that right?

Mike: Doesn't matter. There is no spell check on white boards, so we are writing on the white board, if you guys are listening--.

David: Maximum Allowable Offer.

Mike: If you are not listening, check out our YouTube channel.

David: That's right. We have got videos posted up there of most of our podcasts. Maximum allowable offer. Why is the maximum allowable offer important? Well, as an investor you have to keep in consideration the cost of your repairs as well as your profits, and maybe even your wholesale fee. So you have to make offers that make sense. In this episode we would like to break down how we make offers, and how we determine our own maximum allowable offers. So when you are able to take the emotional out of real estate investing, and you actually start investing on the numbers, you are able to mitigate your risk. Wouldn't you agree, Mike?

Mike: Yeah, it is just so different because I don't know when I mentally make that shift either. I think it's still difficult a lot of times to truly make sure you are just thinking about the numbers versus I like this house, I want this house. Or, I like this house, I would like to wholesale this house, or whatever that may be. So yeah, that mind set shift is-- one, it's important, two, it just happens at some point where you are like, meh just another house, meh just the numbers. Some guys are really good at doing that, and they will make offers out in different markets without seeing it. You get a little crazy on it once you are really comfortable with the numbers.

David: That's right.

Mike: Super important. How do you first off-- Dave, we talked about Maximum allowable offer, where does it start? It starts with the ARV, right?

David: Yeah, so the maximum allowable offer is an actual equation first and foremost.

Mike: A simple one.

David: Very simple equation. It is basically just an equation that we use with three or four different points of data to determine what a good offer would be. Now, before we even jump into the calculation of the formula, I want to make this very clear. This is the maximum allowable offer formula. Which means that this is the most you are going to be willing to pay, or can pay as an investor. If you determine an MAO, it doesn't mean that's what your offer is. That is the most you are willing to pay. If that takes sometimes a few weeks or even a few months of negotiating, that's where you want to end, okay? You never want to start with this number, you want to end with it. We are going to circle back to that towards the end of this episode to explain that in a little bit more detail. But, right now let's jump in, what is the MAO formula? Again, the MAO formula is just a formula to help us determine an offer. How does it work? Simple, we are going to solve for MAO. The formula goes like this, MAO = Our ARV x Our discount rate - Minus the repairs of the property - Minus our wholesale fee. So again, we are going to be solving for the MAO. So the first thing we need to know is what our ARV is. Mike, what is an ARV?

Mike: That is the After Repair Value of a property. The ARV is the After Repair Value of the property. This is where a lot of people when they first get going are going to get hung up, and the market has changed so much since I started. I just remember before-- maybe the past few years it was like, well how do I find out what a property is worth? How do I find the ARV? The only place-- almost the only place was through the MLS, or the realtors basically listing book, because they could see that data, they could see what the property sold for. You couldn't find that info five or ten years ago as easily as you can today. Back then you either had to become a licensed agent to get access to all that number. You could work backwards through Zillow looking at the sold properties, not necessarily the listed ones, or you become a licensed agent's assistant, then you will be able to get access to the MLS. Now, we are super spoiled, guys. We have got an awesome service that we use that helps us pull comps, and find the after repair value of properties. Dave, thank you so much for writing the URL there on the board. It is DPIPodcast.com/Comps. So DPIPodcast/Comps.

David: This will help you determine what the comps on the property are. That way you can know what the ARV is. The whole goal here is to get to the ARV.

Mike: It's not a service we have, but again, we have a link on that page--.

David: And it's the service we use to run our own comps.

Mike: Exactly, and it's-- I think it gives you a discount when you sign up, right? So you get a little something back from it. So very cool, so check that out. That is how you are going to find your ARV. You are going to visit that website, plug in a few-- basically the address--.

David: Need to get some darker markets.

Mike: Just the address, we have a permanent one over there, the Sharpie if you want it.

David: Oh, buddy.

Mike: You plug that in and again, it is going to give you as good or very close to the gold standard, which is MLS comps, it pulls most of that data out. I believe it aggregates even, pulls from multiple sources, gives your-- again, it's awesome. There is also on there-- in the MLS there is the real-- or the AVM, doesn't this have something--?

David: It has its own estimate tool as well.

Mike: What's it called?

David: Just the estimate value.

Mike: Okay, yeah yeah.

David: But it also has the ability to see when the property changed hands, it has the ability to see what they owe, and how many different mortgages they have on the property, when they purchased the property. Tons and tons.

Mike: Yeah very cool.

David: We use it to analyze every single property that comes in the door which is twenty a day.

Mike: Yeah, the reason I mention that estimate tool on there, is because it's really cool.

David: It works pretty well too. Especially for the ARV side of the business.

Mike: Yes.

David: The high end.

Mike: When you are-- and we haven't even gone through the rest of the formula. When you are on the phone with a seller, if you pull up-- you just type in the address, pull it up. You will be able to figure out if they are motivated or not, just based on looking at-- hey this is a ball park number, this isn't the actual number. But this is a great ball park to get started on figuring out what my ARV is, my after repair value.

Okay so circling back to the formula. MAO = ARV x Discount Rate - Repairs - Wholesale fee. So-- we talked about the ARV, you are going to have to go find that on our-- on the tool we just mentioned. Then, you are going to figure out the discount rate. The discount rate is pretty subjective, wouldn't you say, Dave?

David: Yeah, the discount rate is very subjective. It defaults to 70% typically in our market, and in most markets around the United States. The reason is, people are typically wanting to make 10-15% minimum on their investment, sometimes as much as 20%. Then, you need to calculate in at least 10-15% of the price to cover your holding costs, and your utilities, and your closing costs, and your costs of money. All the incidental miscellaneous costs of actually doing the transaction, that also includes the costs of your real estate agents and commissions on the back end. So when you multiply a property by let's say 70%, and you are taking 30% off, that's of the after repair value by the way, that is the high end of the comps, you are taking off at least 10-15% for your costs, the remaining 15% roughly let's call it, even as much as 20% is your profits. So that's why we default it to 70%, but like you said a second ago, it's-- it varies.

Mike: It does.

David: It's a range, it's a rate range.

Mike: But you almost never-- I would say in the heat of the market, I would say the most I've heard people paying as investors was 85%. That was the most.

David: That's the most we've ever payed.

Mike: In great areas, top of market, very competitive, 85 is about as high as you're going to go. How low do we go? Well it gets real low, we go down to around 50%, or again-- throw out a really low number. So why is that? Why would you discount it significantly more? Couple of reasons, one, just like today, there is a little bit of fear in the market place. So people get a little bit more conservative with their money, so they are going to discount it more. The bigger reason I would say is the areas, the quality of the areas. So we are here in St Louis Missouri. One of the examples I like to give is east St Louis. East St Louis is notorious for being an unsafe area, or a kind of run down, not the best area to be buying in. We will up that discount rate to about 50%. I mean sometimes way more than that. We literally just get rid of it. We have to, just hack it down. What I was going to say though was-- Dave was running through the discount rates, why is that so important? Because these are very real costs, you have holding costs, you are going to insure the property, you're going to have taxes, you're going to pay that real estate agent. These things are all cost. So discounting your after repair value just insures you taking those costs into consideration. So very important.

David: Right. So let's talk about a scale for our discount rate. We have a discount rate in St Louis where we do all of our investing. As Mike said, the high end of the spectrum, let's start at the top is .85. We will go down at as low as maybe .1 or even .2.

Mike: We are talking war zone type areas for sure.

David: It's going to go anywhere in-between the two of these. We default it at 2.7. The reason that we do is because a 30% discount on a property is typically enough to make it work for an investor. Here is one thing I do want to highlight, Mike. Here is the formula that all investors are typically using, right?

Mike: There are your landlords--.

David: If you're not watching here, it's MAO = ARV x Discount rate of 70% (typically) - Repairs. As a wholesaler, this becomes your new formula here with the bigger brackets. The reason is, because you are going to be subtracting out your fee to make it still look like this to the end buyer, okay? We talked a little bit about the ARV and how to get it. You have to run comps, you need to determine the after repair value by finding like properties of size and location, bed, bath, and condition. We do so by going to DPIPodcast.com/Comps, there is a tool on there you can get 14 day free trial. But, this is what we use to determine our comps. It also helps us know-- or figure out in advance what the seller owes. Knowing that is very helpful. Then we times that by the discount rate. That number can vary, right? You start at 70%, why would it vary though? We haven't really talked about what a whole lot, Mike. Why would it vary? If it's in the best part of town, high demand, low supply, people are going to want to pay more for it. You are going to need to discount it less. Your discount rate is going to go up. You go from 70 - 85 or 70 to 80, that means that you are discounting the property less. As you go down from 70%, so what part of town would we go down from 70%, Mike? And why?

Mike: Typically it is going to be your slummier areas, or your less than standard rental areas. So again, we call them the war zones, less desirable. We even talk about properties on a scale, your class A's, those are going to be your high end.

David: Right.

Mike: Your class B's and C's--.

David: Class A's are going to be your .8's.

Mike: Yeah, 85 is extremely high.

David: Yeah, .8 is more realistic.

Mike: Is the high end.

David: Then your .7's would be your B's and C's. Maybe a .5 would be your D's. A .2 or a .1 would be your F's, properties that you literally do not want.

Mike: I have never even heard of class F--.

David: We are going all the way down. The reason is though, if somebody calls me and they have a house in North City St Louis for example. I don't buy there typically. However, if I can get a house for two or three grand up there, I will buy it. There is more value in the bricks sitting there than that two or three grand. I am pretty-- excuse me, I a pretty confident that I can flip that property and make a profit on it. But, our default is .7, let's stick with that for sake of conversation and simplicity. So we found our comps, we multiplied it by 70%, which takes 30 off, which covers our profit and our holding and closing cost. Next we have to get to the repairs. So before we even talk about the repairs and different ways that we would help people that are new to determine those repairs, why are we taking off the repairs, Mike? Of the after repair value x our discount rate. Why does the formula goes in this order? I think it's very important that we describe that.

Mike: Okay, so you are starting with your ARV, right? So that's the most it could be. You are going to take your discount rate first, because that is taking into--.

David: Profit. Profit has to come off of the highest number, because that's that's what it's selling for, right? Then our repairs come off next. Not before. If you take your repairs off, then you multiply it by your discount rate, you are factoring in profit of a number that won't ever happen in real life. Otherwise-- you would have to have quotes around there. Repairs are going to come off next. If you are new and you're having trouble calculating repairs, the easiest way Mike and I like to teach it is-- the square footage multiplier. In every market it is going to be a little different, we totally understand that, we get that-- however, there is basically three stages. There is the house that just needs the cosmetic work, very light. There is the property that needs a rehab but it's not a gut, needs maybe a kitchen, bath, flooring, windows and so on and so forth. Then there are the ones that just need a complete gut, okay? We have stages for these, we look at typically 10-15 dollars per square foot for stage one, low end, right? Doesn't need a whole lot. We look at anywhere from 25 to let's say 30 dollars a foot for the medium of the range repair estimates on a rehab that does need a lot, it needs a roof, needs a kitchen, needs a bath, needs floor, and maybe needs doors, right? If we are looking at a rehab on a high end property that is going to be a retail fix and flip, we could imagine typically a minimum of 40, maybe even as high 50 or even 55 dollars a foot. So we basically take those amounts, right? Stage one two or three, let's call it 15, 30 and and 50 dollars a foot, and we literally multiply that by the amount of the square foot in the property.

Mike: It's easy.

David: So easy.

Mike: You can do that over the phone, when you're discussing or talking with your sellers. You can figure out, hey how much work does this need? Ask them, are there holes in the wall? Is the ceiling falling in? Hey, when was the last time you updated the kitchen and the bathroom? That's going to give you an idea or not whether-- if the ceiling is falling in, you are thinking gut rehab. Whereas if they say, we updated the kitchen maybe five years ago, then it is maybe paint and carpets, on the lower end. So you can figure these things out a little bit ahead of time before you even go and see the property.

David: That's right.

Mike: That's even if you go and see the property at all.

David: Sometimes you don't even need to see the property to determine the repairs, just from what the seller tells you over the phone. Now you can't necessarily take that and go buy the property, but you can at least start coming up with your formula here if you know that the kitchen was just rehabbed three years ago and it has a new roof last month. Well that's going to tell me it's probably not a gut rehab project.

Mike: Right, you're not going to put a new roof on.

David: Yeah so you can definitely use that to scale. So our ARV would be the after repair value, guys This is the high end comps, what we think it's going to be worth, also what we think it will appraise for, after we do our repairs. So that;s one of the hardest things for people try and figure out in the beginning is-- you can't look at each individual rehab or property that you are going to be buying and investing in as its current state when you are looking at it. You actually have to imagine what what will look like, and how much it will be worth when everything that you see that is broken or out of date is fixed and updated, okay? That is how we get our after repair value. So the After repair value on one property could actually be multiple numbers depending on what kind of repairs you do. So keep in mind that this number and this number are very closely correlated, alright? You can determine and after repair value by running comps, but you can also determine and after repair value by looking at what's in the neighborhood and determining whether you're going to go high medium or low on your rehab. So these numbers are correlated in some way shape or form, keep that in mind.

Mike: Exactly, like you were saying about the repairs, there are different finish levels too. This is going to come into play a lot more for your rehabber than it is probably for your rental investor. Your rental investor is probably going to have that middle of the line finish quality to their work, whereas a rehabber, your end buyer there is going to have-- is going to associate the rehab with the area. If you're looking at medium priced homes, they are probably going to do a medium rehab. If they are in an area where the prices are shooting up if it's a nice area, they are probably going to do nicer finish work, and that is going to cost them more money. So again, you are going to have to adjust your repair estimate based on your idea of that.

David: Exactly right, very true.

Mike: Cool. How do you determine what your wholesale fee is?

David: I love this. So before we jump into that though, I want to say this, so all the investor buyers are buying at this formula right here, okay? So if we don't even talk about the fee yet, which we will get to in just a second, if you are buying a property and selling it to an investor, you need to be using this formula, because they are using this formula. So in wholesaling-- what is wholesaling? Well wholesaling is very simple. It is providing liquidity to the market place We are trading convenience for a discount. So really what that means is that we have to buy something great, and this is where the great comes in, alright? To be able to sell it for a good price. This here is our good, okay? So when we add our fee, it comes off our MAO. It is additionally-- subtracted to it, right? If we take off in this scenario, it's getting a little messy here, but if we take off let's say 10k as our fee, well that brings our MAO down even more.

Let's run through a really quick scenario here, Mike, so we can actually use some real numbers, ARV 100k, discount rate 70%, repairs-- let's call the repairs 10k, and our fee is 10k. So what does that get us? So our MAO in the scenario is $50'000. We have a $100'000 ARV, we have a discount rate of 70%, which is 30% for all the holding costs, all the closing costs, the agent commissions, seller concessions and our profit, minus the repairs of 10k, minus the fee of 10k. That puts us at 50 grand. What that tells me if I take this fee off, most people would be willing to buy that property at 60 grand. That's where the fee comes in. We have to go buy it at 50 grand. We have to get it at a great price to be able to sell it at a good price. Not investors are going to be buying properties outside of the good price range. They are very rarely going to be paying retail or even close to retail if they are good investors, they are seasoned and know what they are doing.

Mike: Since we are running through it, let's do one modification here.

David: Please.

Mike: 70% was our number for kind of the median. Let's illustrate what the discount rate does, so if we said that this is a nice area, and we are thinking top retail, Dave, what does it look like when we change that to 80% discount rate, or 20% discount rate?

David: Yeah, let's go to 80%.

Mike: Okay.

David: Now we're at 80%, so that puts us at 80'000, minus 10--.

Mike: 100'000 for the ARV x discount rate--.

David: Multiplied by 80%, which is basically take 20% off--.

Mike: So 80 grand minus our repairs of 10--.

David: 70.

Mike: Minus our fee of 10.

David: 60, so goes from 50 to 60 on our MAO.

Mike: Again, just to illustrate what we call the discount rate or the percentage that we are paying, it just changes it. So again, the higher the discount rate number, it really means you're paying a higher number.

David: It's inverse.

Mike: Say that again, I just want to illustrate that. The fee-- what was the other thing? Where were we going with this?

David: The fee is when you are buying great. You add the fee in there because people are going to be buying--. When I'm wholesaling I am using the entire formula. But when I'm buying from a wholesaler, there is no fee in there anymore, because I am not planning on wholesaling this, I don't need to make a fee. I can drop the fee and work off of my MAO formula with just my ARV, discount rate and repairs, very simple. So the fee is only for those wanting to wholesale or are wholesaling, that's how they make their money, that's the spread from great to good. Very simple. In the beginning we had preference with the MAO, and it is never the offer that we want to make. So we have an MAO formula, we have written it down, we have found comps, we have determined our discount rate, we found the repairs, we even added in a fee, Mike, we got to 60'000. Now what?

Mike: Send them an offer for 60'000?

David: Nope.

Mike: You have to send an offer for lower than that, guys. Dave was illustrating, this is our maximum allowable offer.

David: Exactly right.

Mike: This is not the offer we want to start with. So if we are 60'000 at our 80% discount rate, well forget about it. That's not what we want to do, we want to go-- oh man, getting all crazy now. You don't want to go in with that offer, because then there is no room for negotiation. It gives us no wiggle room if we figured out ARV out a little higher than other people see it. So again, you want to come down from that number.

David: What would be a comfortable offer for you, Mike, if we had an MAO at 60k? Where would you like to start?

Mike: I'm probably going to throw 10k less.

David: Me too.

Mike: As a wholesaler--.

David: I'd be at like 50 or 52, somewhere in that range.

Mike: As a wholesaler I'm shooting for a 10k profit on each deal. But again, we have done this enough times that we know a three or four thousand dollar deal for us is not necessarily worth as much because of all the systems we have. We have a full fledged business around this. A lot of those things cost money. We've got a closing coordinator, we have buyers, we have this and that. Again, you have to pay all those people along the way to where if we're not targeting a 10k profit, the deal might not make sense for us to even do.

David: That's right.

Mike: That is why I recommend starting at 10k, also who doesn't get excited about a 10k check? That's a lot of money. That is an exciting number. Again, start with the 10k. The other reason 10k is so important, when you are new, you probably are not as seasoned or as skilled at doing some of the analysis. So what does that do? If you are able to get that property under contract for the 50'000 number instead of the 60'000 number, it pads all that for you.

David: That is so true.

Mike: Again, if you are a little bit off on your repair number--.

David: Yeah, if your repairs are a little high, guys, that's a good thing. It may be more difficult to get that property under contract, but whenever somebody is ultra motivated, and they just take an offer that is given to them, that pads in more profit if your repairs are actually estimated higher than the actual cost. I personally like to over estimate repairs on purpose every time, because even though I over estimate them, I am typically aligned with what they are. Repairs are expensive, and you always want to pad those repairs with at least a 10 if not 20% contingency. Again, that is where I will usually just round up. If I see repairs at 36 grand, I'm just going to say, those are 40 grand repairs over there, because who knows what you're going to find when you start ripping down walls or pulling roofs off and so on and so forth.

Mike: Let's move to final thoughts. One thing I started with was-- we are going to talk about current market place, fear in the market place, and how this effects wholesalers, what do you do? Guess what, guys? It's pretty simple. The fear in the market place just increased your discount rate, or decreased it rather, because people are afraid of what's happening. That means a lot of your cash buyers might be holding off a little bit, or a bit more conservative. Well that just means the sellers are probably a little bit more desperate because there are not as many people making offers, and people are probably lowering their offers right now.

David: People are asking me-- a lot of wholesalers reaching out, hey are you still buying? Yeah absolutely. I am not going to stop buying because of a little short term pandemic crisis that we're facing at the moment. But my value in my cash is-- has gone up in perspective to the property. So basically what I mean is when we are wholesaling, we are trading convenience for a discount. Well, you are going to have to give me a pretty significant discount right now for me to even want to offer you my convenience.

Mike: It's not even that so much, but why? Why Dave? Because there is uncertainty in the market. Again, there is a lot of fear and a lot of people acting in fear, but there is also some uncertainty. If the market really does tank, if banks stop lending money, guess what? We are stuck with a property then that we can't get our money back out of. Or we can't refinance it to get our lender's money back, our private lenders. So there is a lot of good reason to act cautiously with buys. This is not like a-- hey let's take advantage of the market place, the market place is demanding this.

David: That's right.

Mike: There is a lot of stuff behind it, we're not trying--.

David: Hopefully it's short term, hopefully it's temporary, but you never know. It could go on for weeks and months. The point here is that the discount rate in this equation is the only thing that's really effective right now.

Mike: Exactly and you don't need to explain that to your sellers, you just say, listen here's why. Kind of what we just talked about. The banks are not lending, maybe not going to be lending. So it's very interesting. Dave, any other closing thoughts before we tell people what we're offering?

David: Not necessarily, guys. I would just say, keep it simple with the MAO formula. This is a formula that every investor is using. If you are wanting to be a wholesaler, use the same formula and just add in a fee, okay? We are all getting our comps from DPIPodcast.com/Comps. Go there if you need help getting comps, they have a 14 day free trial. We use them in our own business to run comps and analyze deals. Use that to get your ARV. Your discount rate if you don't know, start at 70%. Don't go up from there, go down from there. But that's a default, alright? Start there, the repairs, don't over think them. 15, 25, 45 dollars a foot, those are the three tiers. Does the property need a ton of work? A little amount of work? Or not work? Even at no work, start at $10 a foot. Take that discount, that number we just said of those three tiers, multiply it by the square footage of the house. If you have a 1500 square foot house and it needs nothing, so that's 1500 square feet times 10 dollars a foot, that's 15 grand in repairs. It may look like it needs nothing, get an inspector in there. There will be a 25 page list of things it needs. Pick one of those three tiers for your repairs. The fee is up to you, guys. This is the difference between good and great. So if you don't think that it is a good deal already, you may want to reduce the fee that you charge. If you think that the seller is motivated and they will accept a really low offer, then increase your fee, that is just more money that you make. That is the MAO formula, it is super simple, don't over complicate it--.

Mike: Cool, let's get to our little offer we are doing right now, because there is fear, we know a lot of people might not be working, they are stuck at home because of everything that's going on. We want to offer access to our weekly wholesaling mastermind group for-- what did we decide, Dave? $99 a month?

David: Yeah, it's usually $299 a month. But we are going to open it up, it's not going to last long, I would say we would open it up from anywhere from 4-6 days, a week tops. People are at home right now, so we want to help you guys learn, but we also know that money is tight. So we are going to drop it down to 99 bucks a month for the maybe four to six days.

Mike: That means if you sign up it's going to be $99 a month for as long as you stay in the program.

David: There are not contracts, so you can cancel at any time.

Mike: Exactly.

David: We basically reduce the cost by 66%.

Mike: Where can they go to find that, Dave? Do we have anything set up?

David: Yeah, go to DPIPodcast.com. In the tool kit there is a coaching master mind group in there.

Mike: Excellent. Like we said, if you're listening live, we will make sure that is active here in the next half hour or so--.

David: It's already up, look right here.

Mike: At the discount price?

David: We will do that now, here in a minute.

Mike: If you're listening live you will get that, if you're listening on the podcast that is recorded, it will be done by then. So check out DPIPodcast.com, like Dave said, it's over in the tool kit section. Look for the coaching mastermind. Guys, thanks so much for joining us today, we look forward to talking to you guys soon.