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 establishing a ceiling price that you are willing to pay, without paying too much.
MAO is a term coined by veteran real estate investor Ron LeGrand, and the term MAO has become an industry standard.
Why do we need MAO?
Simply put, if you found a foreclosed property priced higher than the MAO, and you decided to buy it, you will definitely not meet your target profit, and you may even end up losing money. Therefore, what the MAO really tells you is the answer to 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 you 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/ARV. This will definitely help you sell the property faster.
How to compute for MAO?
I’ll be using Ron LeGrand’s formula the Maximum Allowable Offer or MAO which can be seen below:
MAO = ARVx70% – Repairs
ARV refers the After Repair Value. (Related article: How to calculate ARV)
70% is a rule of thumb used by Ron LeGrand. According to Ron, he used 70% in his formula because he targets 20% profit and estimates 10% for the costs, excluding repairs. These costs would include the related costs for acquisition, carrying costs, marketing costs, etc.
If this is confusing for you, here’s an alternative. Instead of multiplying ARV with 70%, you can just subtract the projected costs for acquisition, carrying costs, marketing costs, and the target profit from the ARV. In effect the formula would look something like this:
MAO = ARV – Repairs – acquisition costs – carrying costs – marketing costs – target profit
Repairs refers to the the estimated repair cost. In the formula above, Repairs is separate because, according to Ron LeGrand, making an estimate for repairs based on a percentage of the selling price would be unreliable because it is determined on a case-to-case basis, and I agree. You better make sure to 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.
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 following the instructions on how to compute for ARV, you get an ARV amounting to Php1.6M. Your best contractor submits a proposal with an estimated cost for repair of Php100,000. Is this a good deal?
To find out, lets compute for the MAO:
MAO = ARVx70% – Repairs
= Php1.6M(70%) – Php100,000
Since the selling price of Php900,000 is below the MAO which is Php1,020,000 and with plenty of room to spare, then this is probably a good deal.
“Never Pay MAO!”
In a video training, Ron LeGrand mentioned that we should “Never Pay MAO!”. This means we should buy at a price lower than MAO, and how low would depend on whether the area where the property is located is sell-able or not. The better the market/area, the closer you can go to MAO, and if the market/area is bad, you should buy at a price way below MAO, according to Ron.
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 Php1.6M? 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?
Is the estimated cost of 10% accurate?
Using the explanation above, the estimated cost for acquiring, carrying, and selling the property is Php160,000 ( I got this by multiplying the ARV by 10%). Depending on the payment terms with the bank where you found the foreclosed property, the Php160,000 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 sharing 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
PRC Real Estate Broker License #: 003194
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Text by Jay Castillo and Cherry Castillo. Copyright © 2010 All rights reserved.
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Tagged with: arv, How to do the Numbers, mao, maximum allowable offer, real estate guru, Real Estate Investing, Trace Trajano