As promised in my post on how to compute for the After Repair Value or ARV of foreclosed properties, I will now discuss about Maximum Allowable Offer or MAO. Determining your MAO is probably one of the most important things you need to do, before you even consider buying a foreclosed property. This is because you need to make sure that a deal will really make money for you, and the MAO will help you know this. But what exactly is MAO?
What is MAO?
In real estate investing, MAO is basically the highest or maximum offer or price that you would be willing to pay for a property, where you are likely to achieve your target profit. The MAO helps lessen the risk of losing money by being the ceiling price that you should be willing to offer or pay for, without paying or offering too much.
Why do we need MAO?
Simply put, if you found a foreclosed property priced higher than the MAO, and you decided to buy it, at the very least, you will definitely not meet your target profit, and you may even end up losing money. Therefore, what the MAO really tells you is it answers the question “Should I buy this foreclosed property or not?!”.
On the other hand, if you found a property priced below the MAO, then that property just might be worth buying. Furthermore, a property priced way below the MAO can be truly a great deal because:
- There is more allowance for one to make a profit, even if unexpected costs like cost overruns for repairs, increased holding costs due to prolonged time to sell, etc. were to surprise you later on.
- If you are not too greedy, you can actually sell the property also at below market value which is synonymous with ARV. This will denitely help you sell the property faster.
How to compute for MAO?
Borrowing the formula used by Trace Trajano in his book “Think Rich Quick“, the Maximum Allowable Offer or MAO can be computed as follows:
MAO = CF x ARV – Repairs – Profit
CF – CF stands for the cost factor, which is just an estimate. A cost factor of 90% means 10% of the value of the property will the the estimated cost for acquiring, carrying, and selling the property. A CF of 70% means 30% of the value of the property will the the estimated cost … and so on and so forth.
If this is confusing, I believe that instead of multiplying ARV with CF, you can just subtract the projected costs for acquisition, carrying costs, marketing costs, etc. from the ARV. You also subtract the cost of Repairs and target Profit to arrive at the MAO. In effect the formula would look something like this:
MAO = ARV – Repairs – Profit – acquisition costs – carrying costs – marketing costs
ARV – ARV refers the After Repair Value. (Related article: How to calculate ARV)
Repairs – This is the estimated repair cost you got from the contractor you are most likely to choose. Make sure you get at least 3 estimates from reputable contractors and use the one that is most favorable to you in terms of cost, time for completion, etc.
Profit – Profit is your target profit from this particular deal. How much profit really depends on you. How much profit for you would make this deal worth all the time, money(if any), and effort you will put in it?
Sample MAO calculation
Sample property: After short-listing close to a hundred foreclosed properties, you found a very promising foreclosed house and lot which was selling for only Php900,000 within your village. After some research, you found out that your village is a hot market, hence you use a CF of 90% or 0.9. After following the instructions on how to compute for ARV, you get an ARV amounting to Php1.4M. Your best contractor submits a proposal with an estimated cost for repair of Php100,000. Lastly, you want your profit to be at least Php200,000, equivalent to about 4 months of your take home pay at your current job, where you are always stressed out. Is this a good deal?
To find out, lets compute for the MAO:
MAO = CF x ARV – Repairs – Profit
= 0.9 x Php1.4M – Php100,000 – Php200,000
Since the selling price of Php900,000 is below the MAO which is Php960,000 by Php60,000, then this is probably a good deal.
In this case, do you buy the property since the numbers look good?
Well, my advice would be to test the market first. Will someone really buy the property for Php1.4M? If you arrived at your ARV using comparable properties that were sold during the last 6 months, then it is more likely that people are going to buy at that price.
Another thing to consider would be the accuracy of repair estimates. Is the Php100,000 repair estimate really accurate? Did you get at least 3 contractors? Will the time frame for the renovation(if any) increase holding costs?
How about the cost factor or CF, are you sure that using a CF of 90% is accurate?
Using a CF of 90% means the estimated cost for acquiring, carrying, and selling the property is just Php140,000 ( I got this by multiplying the ARV by 10%). Depending on the payment terms with the bank where you found the foreclosed property, the Php140,000 might not be enough to cover closing costs(taxes and fees, etc), holding costs(your monthly amortizations, if any, for the number of months needed to renovate and sell the property), and marketing costs ( may include professional fees if you decide to hire a licensed broker or referral fees for successful referrals, cost for advertisements, etc.).
“What if the property is being sold through public auction, how do I make an offer?”.
If it were for sale through a public auction, first you need to check if you can make a pre-auction or knock-out bid. If not, you will have to attend the auction and bid on the property, while keeping in mind that the maximum bid you can make is only up to the MAO (or a little less to leave room for allowance for cost overruns, etc). If someone else is bidding for the same property, and the current bid has exceeded your MAO, don’t forget to put down your paddle!
Am I making any sense?
I really hope that what I am sharing above is really helpful, but before it can be helpful, it should make sense right? I am teaching how I get my MAO based on how I actually do it in the real world, but this would be worthless if no one understands what the heck I’m saying. Whether you understand this or not, I would appreciate any feedback. Thank you!
To our success and financial freedom!
Real Estate Investor
Real Estate Broker License #: 20056
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Text by Jay Castillo and Cherry Castillo. Copyright © 2010 All rights reserved.
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