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In this episode, David and Mike talk about making offers to motivated sellers. They discuss the MAO formula to figure out what to offer on a Property. You can learn a lot with this episode. Check it out!
Things you will learn in this episode:
- How MAO Formula works
- Making offers to motivated sellers
- Make money
- How to figure out what you want to offer on a property
- 2 ways to estimate repairs
- Determine your MAO
- MAO = ARV x DISCOUNT RATE (70%) – REPAIRS
Definition of Terms:
- MAO – Maximum Allowable Offer
- DISCOUNT RATE – set to 70% by default
- ARV – ACTUAL REPAIR VALUE (actual value after you repair)
Quotable Quotes in this episode:
“You make your money when you buy. You get paid when you sell.”
David: Welcome back to the discount property investor podcast. This is your host David Dodge with co-host Mike Slane. Hey Mike
Mike: Hey Dave, how are you man?
David: Man, I’m doing great.
David: I’m excited for this episode today. We are talking about making offers to motivated sellers.
Mike: One of my favorite things to do man- making offers.
David: One of our favorite things. Now, we try to make several offers a day. We have a goal in our office to make five offers a day. We don’t always hit that goal but we have that goal.
Mike: You know why I like making offers so much?
Mike: Because you make your money when you buy your house.
David: Ooh that’s so true.
Mike: So, when you’re making offers that are low, I just think about making money.
David: That’s right.
Mike: I like making money
David: I’m going to repeat that: you make your money when you buy, you get paid when you sell. But you make it when you buy and that’s- Mike, boom. You nailed it.
Mike: Yeah, we’re kind of greedy around here. We like to make money. I’m not even embarrassed or ashamed to admit that. I like to make money.
David: That’s the definition of business the act of making money.
Mike: Yeah, we’re in business to make money guys. Let’s do this
David: If you have a business that doesn’t make money, you don’t have a business.
Mike: You don’t have a business, get out of here. No big deal though. Let’s talk about making offers. Alright, Dave. So how do we figure out what we want to offer on a property? Period. How do you figure it out?
David: That is a great question, we use a simple formula. It’s called the MAO formula and it stands for maximum allowable offer. So basically, we are solving for our maximum allowable offer. We’re going to come back to that in the end and explain why that number is not the number you make.
Mike: Don’t worry if you failed algebra in high school, you’ll still be able to figure this out.
David: If you know how to do simple math
Mike: It’s kinda like those word problems you know, that you used to come across. It’s like: if Peter has 40 Snickers and gives 3 to Garrett, you know. So again, you’re going to have to do a little bit of math
David: I love it man.
Mike: You’re going to have to figure out how many Snickers bars are left but again, it’s going to make you a lot of money and that’s why we like making offers so much. So, the MAO Dave, maximum allowable offer. Let’s talk right off the bat about what number were getting. We’re getting the maximum number we can offer.
David: The maximum. So that doesn’t mean that that is the offer that you make. It means that: that is the most that you are willing to pay.
Mike: The highest
David: So, you have to save that number guys. Take that number and put it in your back pocket and that’s what you’re going to negotiate to.
Mike: Love it.
David: And that negotiations could take 10 minutes, it could take 10 months, but you don’t go above that number cuz if you do, then you’re buying it for too much and we just said you make your money when you buy, you get paid when you sell so if you’re not buying it right, you’re probably not going to be able to wholesale it or you’re probably not going to have very good profits on your exit whenever that might be. So, the maximum allowable offer is the number that you want to get to in the end or hopefully stay below. But that doesn’t mean it’s the number that you make your initial offer at. So, let’s break this formula down. All right, MAO stands for maximum allowable offer. The equation goes like this: MAO = ARV x your discount rate, which we are going to default to 70%, and then we’re gonna subtract out two things: repairs and wholesale fee. That’s it, that’s the entire equation. I will literally pull out my iPhone when I’m with a seller and I will try to find an ARV, you know, or I’ll have one before I go. I’ll multiply it by 70% I’ll subtract out my repairs. I’ll usually pad those repairs to reflect my wholesale fee and then I’ll take that number and I’ll take off 5 or 10 grand and that’s the offer I make. I can do this in the field, on the fly. It is not hard. So, if you are new to wholesaling and you don’t know what some of these acronyms are, part of the equation is ARV. Mike what’s ARV?
Mike: ARV is our after repair value. So, it’s basically the value of the property after its fixed up. It’s the market value. It’s what the nice properties are going for- is how I look at it again, it’s what’s your top, you know top 20% of the market.
David: Love it
Mike: What are those guys selling it for? And again, you’re using that number because it’s after you fix up this property. It’s your top number, it’s the most the property is worth.
David: So, it’s the value that the subject property will be worth after you fix it up. So, it’s kind of strange to think about when we’re making an offer that we actually want to start with this piece of crap property that we’re probably standing in front of right? when we’re going to be determining how much it’s worth.
Mike: What’s great about this though. Excuse me. What’s great about this and it’s really fun to say: well mister seller, this house, I agree with you. I think it would be worth five hundred thousand, except it needs all these repairs so right now it’s not. So again, because they like their- most likely they like their property. Again, when you own something, you think it’s worth more.
David: I love that.
Mike: So, you wanna start out on the same team and be like: Oh, I agree, I think the ARV is that 500,000. Just like you said, it is really high.
David: It needs 200.
Mike: Unfortunately, it needs all this work and I’m an investor and I have to make money.
David: That’s right
Mike: So, I can’t pay you the 500, you understand you called an investor out right? I can’t pay the retail value and make money.
David: That’s absolutely right.
Mike: So again, it’s great to start out on the same page: yes, I do I agree with you, the value of this property will be that number that you were thinking. I agree.
David: I love it, I love it. So, ARV is after repair value. It’s basically what we think the property will appraise for once we rehab it. Okay, but you have to repair it or update it in order to be able to get to that value. All right, so that’s what we start with. To determine our maximum allowable offer, we literally start with the after repair value or what we think it’ll be worth once we fix it up. Okay. Next, we are going to multiply that by 70% and that 70% is what we like to call our discount rate. Now at 70% is basically the average or it is the most that we feel comfortable paying for a property. Now in some areas, we may go a little higher- 75, and in the best nicest parts of town, we may go to 80% but we always start at 70% because it’s a good normal average number. It pads in 15 to 20% profit margins and then the other 10 to 15% is typically going to cover your costs to hold it, your hard money cost, your utilities, your closing costs, so on so forth. So, in the worst parts of town that 70% will be discounted down to maybe 60 or 50, and there’s even part s of town where I’ll discount it down to like 10% which basically means I want nothing to do with the houses in this neighborhood unless you’re willing to give it to me.
Mike: And there’s a lot of areas in St. Louis where that is 100% the case and I’m not even embarrassed to offer.
David: There’s a particular neighborhood in town Castle Point and it’s kind of infamous just for being dangerous. If you look it up in the news will see, you know, lots and lots of bad stuff.
Mike: Just a few shootings here and there.
David: A few shootings over there, of course but yeah, I mean, whenever somebody calls and says they have a house over there. I mean it’s like, okay, I’ll give you 2 grand. You know, the ARV is probably only 30, maybe not even but it’s just I don’t want to deal with that so you can discount that down as low as you want, but don’t go over 80, start at 70 and that’s it. I don’t want to complicate this. Let’s keep it simple. So, you start with the ARV, you multiply that by 70% or the discount rate whichever you feel comfortable that number might be and then you do two more things and that’s it. You subtract your repairs and you subtract your wholesale fees. Let’s just talk briefly about the repair estimates. If you are not a contractor, if you are new to this and you don’t know how to estimate repairs there are two simple ways that we go about doing it: square footage multiplier or the rule of fives. And another way to go about learning how to do repairs would be to hire a contractor to come with you. Give him fifty bucks or a hundred bucks to walk with you and give you estimates of what the repairs will be.
Mike: I love doing that and here’s why. Again, one, you wanna make friends with your contractor.
David: Sometimes that contractor wants to be the buyer.
Mike: Sometimes that hahaha that’s great
David: Pro tip
Mike: And that’s true. Sometimes that contractor wants to be the buyer, sometimes they have clients who they rehab properties for that could be the buyer. You can also use their estimate when you are marketing your property for sale back.
Mike: So then, somebody says: oh, you’re crazy. You couldn’t do that rehab for 50 thousand, that’s a 120 thousand rehab all day. We say: oh well here’s my contractors contact info; would you like to talk with them? They said they could do it for 50. You know, it’s like, what are we missing here that would be 120?
Mike: So again, a really really good way to learn repairs is by making friends with some contractors. You can do that at networking meetings and all sorts of places.
David: Yeah, but I just want to caution you. You’re going to see a lot of people out there that say: we’ll give free bids and just because they say that, doesn’t mean that they’re going to go give you a hundred free bids. They’re doing that because they’re wanting to get business. So be transparent with these people, tell them you’re wholesaling and ask
them what they charge to give a bid because you’re most likely not going to be hiring them. Just be transparent, I just don’t want people to go out there burning bridges.
Mike: I love that. No yeah, it’s true.
David: Or if you have somebody that you were already working with, ask them and they’ll either say I will do it for free or they’ll charge you a little bit. I’m more than happy to pay somebody 50 to 100 bucks to come out and give me those and write it up. Absolutely, because then if I call him when I need him again or I need him 29 more times, they’re like cool, here’s the fee.
Mike: Well, I think the thing is, just be respectful of people’s time.
David: Be respectful. Exactly.
Mike: Again, they’re in it to try to make money as well. Don’t waste their time.
David: Let’s talk about the two other ways that we like to go about estimating repairs.
David: The first is the square footage multiplier, which essentially is nothing more than the square footage of the property x 1 of 3 tiers. So, I have a low tier, meaning it doesn’t need a lot of work. I have a middle grade tear, meaning it needs some work but not everything and then I have a high-tier which means it needs everything. And in your market, it may be a little different depending on your cost of labor or your cost of materials, but we basically say 10 to 15 on the low-end, 25-ish on the middle side, and 40 to 50 on the high end, and it really just kind of depends on a couple things but keep it simple don’t complicate it. So, if it just needs paint and carpet- $10 a square foot. How many square feet is the property? 2600? well times 2600 by 10, okay. If it needs a new bathroom and windows, so middle of the grade, you know, it doesn’t need everything the roofs in good condition and maybe the plumbing stack, may need a bathroom and may need some windows, it may need some exterior work. Well, that’s about 25 bucks a foot. If it needs to be gutted to the studs and it needs a new kitchen, a new bath, new electrical, new plumbing, new roof- the works, you are going to be between 40 and 50 dollars a foot. Okay now again-
Mike: And that holds true here around the Midwest I’d say, it’s a good estimate.
David: Yeah, and if you’re in California or you’re in New Jersey or you’re in Texas or whatever it might be, you’re in Florida. Those numbers may be a little different but all you need to figure out is the cost per foot for low, medium and high and that’s really all you got to do. You literally multiply those numbers one of those numbers depending on the scope of work that’s needed by the square foot and that will get you super close to how much that rehab will cost. The other way that we go about doing it is the rule of fives. Mike, I think you might have even taught me the rule of fives. I’m going to have you-
Mike: That’s what I was just wondering. Did we make that up? I don’t even know.
David: No, you taught it to me I believe. I’m going to let you run with this one and explain.
Mike: Well, that’s what I’m saying though. Did we make it up? I don’t know where it came from.
David: You must’ve-
Mike: We’ll give it credit to somebody
David: You must’ve read it somewhere because you were the one who told me about it but it’s a great way to determine the repairs
Mike: I like this one just because when I’m walking through a house and talking with the seller, I’m not great at really noting everything. So again, I’ll be taking pictures, you’re chatting with the seller. I like to just literally just take 5000 here, 5000 here, 5000 here, and what do I mean by that? Well, if it’s got one bathroom, there’s 5,000 I’m going to spend 5000 on the rehab. If I’ve got to refinish the flooring- 5000, if I have to paint-5000, if I have to do a new roof- 5000, if I have to do the kitchen- 5100, maybe ten thousand for the kitchen because again, you’ve got a lot more stuff in the kitchen, it adds up faster. So again, that way you’re able to walk through a house and just say: 5,5,5,5 and it’s going to get you, say 15 to 25,000 repairs. You can use that number, plug it in, it’s going to get you close enough. Again, it’s not super accurate-
David: Yeah, it’s not exact but it’s an estimate though
Mike: It’s going to come in pretty close, going to give you an idea of how much work the property needs
David: And after you start doing these guys and you start walking through properties and you start determining your repairs, you will get better at it I promise you. I’ve been doing this full-time, little over 5 years and I still sometimes will underestimate my cost of repairs. It’s rare that I will overestimate.
Mike: We always underestimate it because a lot of times, we wanna deal the work. So, you’re just like: ahhh repairs, maybe we can get it done for 10
David: We can do it for 10 but it’s really 16, right? Exactly
Mike: It really is tough but again, you’ve got to try to stick with those numbers. If you see something that kind of needs work or attention, it’s going to need the work and attention.
You got to include that in your repair estimate.
David: Love it. All right guys, there’s only one more thing that we would need to do to determine our MAO. So, let’s back up and recap, we found our ARV which is just basically what we think it’ll be worth when it’s all fixed up. We multiply that number by 70% or depending on your area the discount rate, then we’ve determined how much our repairs are using a couple different ways and we’ve subtracted those repairs from the ARV times the 70%. So now we have a number, next we need to subtract out our wholesale fee and that right there, once you strike the wholesale fee out, that gives you our MAO. So, if you are new to the game, put your wholesale fee at let’s say $7,500
Mike: Just make it 10
David: Make it 10, round it up
Mike: The reason I would say 10 is because the more you take off upfront, the more padding you give yourself to make sure you’re able to sell your deal.
David: I love that. That’s a good point, a very good point
Mike: So, I would just say round it up to ten. Shoot for 10 too guys we’re not in this business to make a thousand dollars, you’re here to make some money. Let’s make some money.
David: That’s exactly right. So now that we’ve gone through this equation, we have what we like to call our MAO or our maximum allowable offer. So, let’s just assume that we get to an MAO of $85,000. Okay, for whatever reason, we determined our ARV, we multiplied it by 70% then we determined what our repairs are, we took those off. And then we took another $10,000 off for our wholesale fee which essentially is what we are going to get paid. We now came up with our maximum allowable offer. Now, we are never going to make that offer, the number that we came up with, as our offer cuz we said it earlier, we want to end at our MAO. We want to negotiate to that number, so what we’re going to typically do is we’re going to take an additional five, ten, maybe 20% off of that number. It’s going to kind of vary based on where you’re at and how motivated the seller is, but we are going to go even lower than that. One of my favorite things is taking an MAO, taking 10 or 20% off of that number, making the offer and then it getting accepted and just like, woah I was willing to pay 10, 15 grand more for this property, but they were so motivated that they accepted that offer. See you want to have some wiggle room in there and that’s why we don’t make our offer at the MAO, we make it below it. That way we have some wiggle room to come up, everybody likes to negotiate and feel like they’re not getting taken and when you are willing to negotiate up a little bit, I’m not saying that you need to negotiate up a lot but when you negotiate up a little bit. The seller is going to feel a lot more comfortable working with you okay. Also, whenever you have a higher wholesale fee, let’s say you do 10,000 like Mike suggested, and you go to market that property and you’re getting people that are making you offers basically just below where you are marketing that property for. If you have a large wholesale fee, you can still get those deals done if that wholesale fee is really skinny, you might not have much room to negotiate on your end. You have to remember, when you’re negotiating, you’re negotiating on both sides of this transaction. You’re negotiating with your motivated seller in the beginning, but then once you get that under contract and you have it in your inventory, and you’re going to go to sell it, now you’re going to be negotiating with your buyers or cash buyers. So, in terms of your ARV, I would be conservative when you’re looking at your ARV when you’re dealing with your motivated seller. When you’re looking at your repairs, I would do the opposite. What’s the opposite of conservative? liberal
Mike: I guess
David: Maybe something like that.
Mike: Yeah, sprinkle a little extra repairs. Yeah, liberal.
David: Yeah, A) because you may not know what they are but B) once you start ripping things out and down, you find other things that you cannot see. So, it’s always a good idea to pad your repairs. Some people will say 10%, I’m really leaning more towards 20%
Mike: Easily 10%. We always spend more than we expect and we do this all the time. I hate to admit that but man, we consistently spend more than we expect. So again, we say: oh, I think we can do it for 20, we still- we’re gonna have a bunch of 30
Mike: Because we’re probably gonna spend 25-27.
David: Yeah, I was just gonna say we’ll be at 27 if we think it’s 20. It just, it always happens that way.
Mike: Exactly, if we don’t, it just doesn’t work out that way.
David: So, we’ve started padding those numbers we’ve said, okay, we think we’re going to be at 20, let’s estimate 30 and guess what, if you get it done for 26, then you just made yourself 4 extra grand.
Mike: Here’s the thing I think it’s fun to being somebody who’s like that, is yeah, I could probably sit down and figure out and calculate to the penny or within five hundred bucks. But why? I would rather move on to the next deal. Like, just round it up five grand and move on to the next one
David: That’s exactly right.
Mike: I mean, so that’s what we do. That’s kinda what we do. We just got to keep moving guys, you gotta make money in this business.
David: So, let’s wrap this up. What we just did is we explained to you the MAO formula and how it works. Okay, but once you get your Mao and then you even discount that down and you get a number, you still need to make the offer. So, if you are with the seller, you know, you can make that offer verbally. Obviously, you’re going to want to communicate with them but I highly recommend that you bring contracts with you and you fill it out and you give it to them. If they aren’t willing to sign it right then and there, leave it with them. If you’re just doing this over the phone, let’s say you’re virtually wholesaling or you’re following up or you didn’t know your numbers when you were there looking at it and you needed to go back and do some due diligence at home. Make sure you get their email and send them your offer in writing. So many reasons that we send our offers in writing, I can name a couple off the top of my head: I’ve had deals where I was the lowest offer but the only one to send it in writing. Mike, I know you have too. Literally, I had people that said: I’ll give you ten thousand more for the property sir. Then what I was willing to pay but they didn’t send an offer, I did and then they couldn’t reach that person again, they didn’t know who they were cuz they had 20 guys come over and give him an estimate on the value.
Mike: I like hearing that story too and sometimes you’ll actually hear, we’d call that person back and we’re waiting on them. We keep waiting to hear and they keep saying they’re going to send us an offer and they never do. So again, that’s how you win the deal guys, put your offer in writing.
David: Send it out. Absolutely. Send it in writing. Another reason that I like to send my offers in writing is it lets them know that you are serious, because when they get an offer immediately from you, they know that you are serious and that this isn’t your first rodeo, even if it is.
Mike: Well Dave, you kinda skipped over it too, you said bring an offer, write the offer. Think about how serious that is, you show up with a contract ready to buy that house.
David: Ready to buy the house.
Mike: Think about how you’re presenting yourself. I’m here to buy this house. Let’s do it.
David: Yeah, I’m not here to look and just determine if I maybe want to- No, I’m here to buy houses today. That’s what I’m going to do. Absolutely, absolutely.
Mike: That’s cool
David: The only other thing that I would recommend on this particular podcast, in this topic is if you want some help calculating your offers or determining your repairs, check out freewholesalecourse, we actually have a good description of how the MAO works on here, another video as well. But we also have an offer calculator which is really basic. It’s just an Excel sheet that you download but it helps and if you don’t know- let’s say you’re listening to this while you’re driving, this will definitely explain a little bit more because it shows- you can put a couple comps in
Mike: Oh, I’m so visual too
David: You can average those comps
Mike: Yeah, and it’s gonna do the MAO formula for you, which is cool.
David: It does the MAO formula for you which is cool and then last but not least, we have a repair estimate sheet, which if you aren’t good at the first two methods or don’t want to use those, you can literally walk around the house and just put a check in a box on anything and everything that the home may need in the sheet, depending on your size or your square foot, will help you determine those repairs. So, guys, you know that we talk a ton about the free wholesale course, but we put it out there to help you and if you are new, there is a motherload of content and education that we have put out for free. We love helping, we love seeing people do their first deal. So, get out there, make those offers. Mike, anything you want to add?
Mike: Go make offers
David: Love it. Make some offers. Guys we’re signing off until next time. See you then.
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