What is a Maximum Allowable Offer?
How to Calculate the Maximum Allowable Offer
Real estate investors and wholesalers who can accurately determine the maximum allowable offer for a property stand a better chance of minimizing their risk and maximizing their potential returns on real estate deals.
There are many different variations on what constitutes a real estate investor’s MAO. The formula for calculating the maximum allowable offer depends entirely on the specific strategy, property type, risk tolerance, and other factors.
One of the more common MAO calculations is known as the 70% rule.
The 70% rule says that an investor should pay no more than 70% of a property’s after-repair value (ARV) minus the cost of repairs.
For properties with a high ARV—typically $250,000 or more—investors may tighten the rule to 75%. They may also use the 75% figure in highly competitive markets.
For properties with a significantly lower market value commonly seen in the land investing business, investors may drastically decrease the rule to as low as 10% – 30%.
One example of the MAO formula using the 70% rule might looks like this:
MAO = (ARV x 0.70) – RE – CC
- ARV is the after-repair value
- RE is the repair estimation
- CC is the closing costs
Example: Cora finds a property she plans to rehab and rent. The after repair value is $155,000, the repair estimation is $25,000 and the closing costs are $2,000.
Her maximum allowable offer using the 70% rule would be $81,500 ([$155,000 x 0.70] – $25,000 – $2,000).
Obviously, any MAO calculation is only as accurate as the values the investor applies, so it’s important to be thorough in the preliminary work of determining a property’s after-repair value, repair estimation, and closing costs.
Want to run the calculations yourself? Try our easy 70% rule calculator below!
Calculating After Repair Value (ARV)
The ARV is what the property will be worth after all repairs and improvements are complete.
ARV is usually based on comparable sales. Most real estate professionals look at 4 to 6 comps within the last six months and use the average as a starting point for ARV.
Some prefer a more precise estimate and calculate the price per square foot from the comps. They then multiply the square foot price by the square footage of the property to arrive at ARV.
If the price per square foot from the comps is $100, for example, and the property is 1,400 square feet in size, the ARV would be $140,000.
Calculating Repair Estimation
This figure is more complex to determine. Some investors and wholesalers partner with contractors and have a good idea of what various repairs and renovations will cost. Others use a rule-of-thumb price per square foot based on the type of work required.
For example, an investor may know from experience that a total gut rehab for a flip will cost roughly $75 per square foot in their market, while a cosmetic rehab for a rental property runs $25 per square foot.
Whatever method is used to calculate the repair estimation, an investor should remember to include any potential finance costs for the work.
Fixed Cost Method of Calculating MAO
While many investors use some variation of the 70% rule, some prefer the more detailed approach used in the fixed cost method.
This method may also be useful for wholesalers who need to factor in another layer of profit when determining their MAO.
The formula using the fixed cost method is as follows:
MAO = (ARV x 0.70) – fixed costs – RE – investor’s profit – wholesaling fee
Using this method, the investor determines the ARV and RE as they would for the 70% method, but then itemizes the fixed costs.
Although specific costs may vary from project to project, most include the following expenses:
- Lender and financing fees
- Closing costs
- Taxes and insurance
- Home warranty
- Advertising and MLS fees
The profit figure also varies from project to project, but the investor should have a figure in mind for each deal. Wholesalers who deal with fix-and-flip properties need to factor in the investor’s profit as well as their own wholesaler fee to arrive at the final maximum allowable offer.
Example: George is a wholesaler who discovers a suitable property for a fix-and-flip. Based on comps and square footage, the ARV of the property is $180,000, the RE is $45,000, fixed costs are $15,000, and the investor expects to make a profit of $25,000 on the project. George wants to pocket $10,000 for his wholesaling fee.
Thus, his maximum allowable offer using the fixed cost method would be:
($180,000 ARV x 0.70) – $15,000 (fixed costs) – $45,000 (RE) – $25,000 (profit) – $10,000 (fee) = $31,000 MAO