I wanted to use this blog post to answer a question that I've been asked several times over the past few weeks.
It's actually one of the most important questions you'll have to answer as a real estate investor, and maybe you've already had the chance to wrestle with it first-hand. The question is this:
“HOW MUCH SHOULD I OFFER FOR THIS PROPERTY?”
As you can probably imagine, this is a very important question because your offer price has everything to do with your ability (or inability) to make money on a real estate deal. With this in mind, I'd like to provide a bit of explanation on the basic math that I use to come up with an offer price for any given property.
The Importance Of Price
No matter how you slice it, your offer price (i.e. – the amount of your initial investment) is going to play a major role in the overall scope of any transaction. With the right number, you'll have a grand slam deal on your hands. With the wrong number, you can lose yourself a lot of money in an instant.
There are a couple of sayings that a lot of real estate investors like to throw around:
“Begin with the end in mind.”
“The money is made when you buy.”
Well guess what, both are true. If you make the right assumptions about a property's market value and have an accurate idea of what your holding costs, closing costs and improvement costs (if any) are going to be along the way, you can essentially write yourself a pay check, simply by choosing an offer price that will allow the necessary room for your profit margin… however big or small you'd like it to be.
How Most Investors Think
Most of the people who flip houses and buy investment properties use something called the 70% Rule – perhaps you've heard of it.
This is a simple mathematical equation that takes the anticipated value of a property (i.e. – ARV or After Repair Value), times seventy percent (0.70), minus ALL costs, which will give you the “maximum offer price” that you should consider for any given property.
It makes sense on paper. You're giving yourself a 30% margin, from which you'll have to grab your profit. In theory, you're writing yourself a pay check which is being drawn from this 30% difference between your offer price, and the property's full market value.
It's not a bad framework for making offers IF the market is trending upwards, IF your assumptions are perfect, and IF you really are able to sell the property immediately, it could work…
Why I'm Different
After living through the “Great Recession” from 2008 – 2012, I've seen too many people lose their shirts using this “tried and true” 70% rule.
There is always an element of uncertainty with any real estate deal, and 30% just isn't a big enough profit margin to make me comfortable. I want more.
You see… a lot of the properties I buy are vacant lots, raw land, housing in lower-end neighborhoods, and as a general rule of thumb – these types of properties don't tend to sell quite as fast when they're listed at “full market value” (which btw, is an incredibly subjective number to begin with).
I've found that unless I'm offering some kind of crazy incentive in the form of:
- A ridiculously low price
- Seller Financing
- The most desirable property in a square mile radius
- All the above
…it's just not wise to rely on the 70% rule.
To put it another way… I don't want to leave ANY possibility of getting hurt, regardless of whether I've made some kind of judgment error.
In my mind, the only way to get around this is to make offers that are WAY below market value. Think 30%, 20%, even 10% of market value. You might think this kind of thing is crazy, but it's not a pipe dream – trust me. I make offers like this all the time and people accept them. It's just a matter of knowing how to find motivated sellers (which is a topic for another blog post).That being said, here's an overview of how I come up with my offer price:
Base Your Offers On Math, Not Emotion
The beauty behind this spreadsheet is that it tells me in very plain terms what my offer price should be. If I'm going to stick to my business model and keep my emotions out of the equation, it's as simple as following what the numbers say.
I always use this approach when I'm making offers, it doesn't matter what kind of property I'm dealing with. I don't know of any better way to do business, than to lay out your potential courses of action and make a decision based on what the data says.
Am I going to miss out on some opportunities because my offer price is too low? Absolutely.
Am I willing to compromise my business model just because I'm worried a seller might not accept my offer? Absolutely not.
Am I going to break my own rules and bump up my offer price just because I “fell in love” with a particular property? Um… are you kidding me?
YES – you will have to play the numbers game and send out a lot of offers. YES – you're probably going to hear the word “No” a time or two… but what do you get in return? You get peace of mind.
When someone does accept your offer – you get to be 1,000% SURE that you're holding the deal of a lifetime in your hands. And you deserve it! When you make data-driven decisions, you'll reap some huge benefits… and if there's anything I've learned about real estate investing, it's that data-driven decisions beat emotion-driven decisions every time.
If you'd like to use the same spreadsheet shown in the video above, you can download it by signing up for the REtipster email list below…
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