A huge fear for investors getting started in the business is actually making offers to purchase property.
Of course, you can’t wholesale any houses if you never make any offers to buy and get them under contract.
Is that your fear? Are you afraid to make offers?
There are usually two reasons for this fear:
- Fear that you may overpay because you don’t know how to determine the right price to pay.
- Fear that you’ll be stuck with the house because you made a mistake.
Let’s see if we can eliminate both of those fears today so you can go out and start making a bunch of offers.
There is a formula for determining the right price to pay for a house I plan to wholesale. I have been using it for over 20 years and it has served me very well.
ARV – Rehab – BSH– Investor’s Profit – Assignment Fee = MPO
ARV = After Repair Value
BSH = Buy, Sell & Hold Costs
MPO = (Maximum Profitable Offer)
Determining the ARV is an art more than a science. Of course, I start by looking up sold comps and focus in on the properties that are the closest to my subject property and most similar in bed/bath configuration; square footage; age; location, and overall design. Although appraisers may go as much as a mile away and up to a year in sales, I prefer the houses that are less than a quarter mile away and that have sold in the last 6 months. If there are several price point groupings of past sales, I use the highest grouping that still matches the subject property after rehab.
When determining the rehab cost for a wholesale deal, there is no such thing as the “right” number. If you send out 5 investors, they’ll come back with 5 different figures. As a wholesaler, what you need is a reasonable number that some might think is a little low and others might think is a little high, but no one will think you’re attempting to lie to them.
I do see wholesale deal ads where the wholesaler markets the house as needing just $10,000 in repairs, and when you go out to the house, it needs a new roof, new flooring, interior and exterior paint, and bath and kitchen upgrades. This just leaves a bad impression of the wholesaler and makes me less likely to even look at his future deals.
All you need to do is carefully walk through the house and look for what it will take to make the house look like the comparable houses you are using. Don’t attempt to calculate each and every repair. Just ball park the overall cost. For instance, let’s assume the house we are looking at is a 3 bedroom/2 bath wood siding ranch house in a working class neighborhood with 1200 square feet. Let’s say that it needs the repairs we discussed above. What is your estimate?
Now compare your estimate to mine…
I’d market this house as needing $23,000 (between $20-$25,000) in REPAIRS. How close were you? I’ll bet you were fairly close. If anything, you over-estimated which means you’ll still never get a bad deal. You may close less, but they’ll all be great.
Buy, Sell, and Hold (BSH) costs can be easily calculated as a percentage of the ARV. I have seen it run as little as 12% to as much as 20% of the ARV. Most come in at around 15%-18%. For wholesale deals I always just calculate it as 15% of the ARV.
Investors look to earn a minimum of $20,000 on a project and up to 15%-20% of the money they put into the project (Purchase + Rehab dollars). I look at the price range of the house and the scope of repairs to determine a profit margin that I think will attract buyers. A quick acid test for profit is to add the MPO you calculated plus your Assignment Fee (together they equal your Investor Buyer’s Purchase Price) plus the rehab expense. Their profit potential should be equal to at least 15% of that sum.
Your Assignment Fee should be the least amount that you would be happy with in this deal. My number (and I recommend the same for you) is $10,000.
Now you’re ready to perform the calculations in the formula to determine the MPO. This is the max you should pay. You want to negotiate as far below that threshold as possible. As long as you do not pay more that the MPO you’ll know you paid the right price.
As for the fear that you missed something and might get stuck with the house, my number one defense is my Purchase and Sales Agreement which limits my liability to just my earnest money (EM), and I always pay just $10-$100 as EM – unless you are working with a Realtor or a bank owned property. As long as you can afford to lose your EM, you should never be in fear.
Here are some other points to look at, however, so that you don’t even have to put your meager EM at risk:
- Are houses regularly selling close to the subject property?
- Are the comps similar to what the subject property will look like after repairs?
- Is there anything odd about this property that will reduce its value to investors. For instance, is it on a main, busy road? Does it back up to a railroad or highway? Is the property next door a business rather than another house?
- Stand back and look at this property like a buyer – does anything stand out that cannot be rectified?
If you take a moment to re-focus away from the numbers and just look at the “deal”, you’ll be able to see 90% of what would turn off a buyer. Don’t force a property to become a deal. Find a good deal and market that for quick large profits.
You no longer need to fear making offers, but nothing is better for dissolving that fear than actual experience. Go out there make some offers and ask other investors for their opinions. Learn from what your buyers tell you.
Expect abundance,
Lou Castillo
