This is part of the Real Estate Contract Fundamentals Series. I’m not giving you legal advice – you’ve got to get that for yourself from a qualified attorney. To get a free copy of the Real Estate Purchase and Sale Agreement upon which this series is based, visit the Monster Purchase And Sale Agreement Download Page.
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If the 3 primary purposes of a real estate purchase and sale agreement are to identify the buyer, identify the seller, and identify the property being purchased & sold, then the most important secondary purposes are to identify both what will be exchanged for the property, and in what form that exchange will take place.
Of course, there are some exotic contracts that swap real estate for consideration other than money. But for now, we’re going to ignore those and focus on normal deals where the consideration is good ole’ cash.
How much should you pay for a property?
The answer to that depends entirely upon your objectives and tolerances, and the biggest variable is you. Your rules may be entirely different from the next investor’s, yet both of you could be right. For example, you might refuse to buy a property for any more than 70% of it’s appraised value, whereas another investor might be willing to pay full retail because he has inside information about an upcoming change in local zoning. In that case, your buying criteria are very different, but both are correct.
Here are some general guidelines I’ll recommend:
- Become intimately familiar with the property value – preferably through a certified appraisal
- Make a determination of what you will do with a property in advance of making an offer. (For example, if the mortgage payments on a rental property will be too high to cash flow if you pay $300,000 for a property, then you know you $300,000 is more than the property can afford.)
- When making a property offer, always offer less than you are willing to pay in the beginning of the negotiation
- If your exit strategy will involve flipping or resale to a third party at some time in the future, make sure that the price you pay leaves room to offer the third party a price that will make the deal attractive
As an example, my rules for property flips worked like this:
- Determine after-repaired property value (usually through an appraisal or a Broker Price Opinion)
- Subtract necessary rehab/fix-up costs
- Subtract carrying and transaction costs
- Subtract my assignment fee
- Subtract 20% of the after-repaired value of the property
- Whatever is left is the most I could pay for the property
It was my rule to always leave at least 20% equity left in a deal for the next investor in my flips. So let’s put some numbers to this example:
If a property has an after-repaired value of $200,000 and needs $25,000 in repairs plus another $2,000 in carrying/transaction costs, that means that the property is really only worth $173,000 – but that’s the retail value, and I need to make a profit and to buy the property at wholesale. So if it’s my objective to make $15,000 for myself when I flip the deal, that drops the price I can offer down to $158,000. But even at this price, there will be no profit left in the deal for the next investor. That’s why I reduce the offer price by 20% of the after-repaired value ($40,000), bringing my maximum offer price down to $118,000.
Using this formula made it impossible for me and my clients to get many deals that we wanted. But it always guaranteed that the deals we did get were very good ones.
Better safe than sorry!
The point of this information is not that you need to follow my formula. The point is you need to have your own formula. Even more importantly, you need to follow it consistently.
In the next installment of this series, we’re going to leave behind a discussion of “how much” to pay for properties and focus on “how” to pay for them. The options are many – cash, bank financing, seller financing, subject-to, etc – and I’ll give you some really powerful secrets to maximize your investment results.
Thank you for reading the Real Estate Contract Fundamentals Series here at FreeRealEstateTraining.com!
Hi Bryan,
I just wanted to take a minute to thank you for the never ending info you send out to everyone- everyday! You truly seem to care about us “other” investors and you don’t seem to hold anything back. As a “newbie” I for one certainly do appreiciate all the helpful hints and guidance you give out so freely!
Ron LeGrand never gave me such help, and I spent $$$$ with him! If you ever make it out to So. CA., I would love to meet you and buy you lunch sometime. Just let me know!
Thanks again!
Steve Hendren
Thank you for your very kind words, Steve! I really appreciate what you’ve said! — Bryan Ellis
Wow Bryan!
Your insight, knowledge and delivery of the information you provide is both eye opening and refreshing. You have a way of sharing real time info in a few short paragraphs that investors can use right away. In my humble opinion, your site and what it contains is one of the best things to come along since sliced bread, and I for one appreciate you and all your efforts.
Keep up the good work, I’m sure it will come back to you a thousand times over!
Kindest Regards
Calvin Hayden
I second that vote. Thanks Bryan
Your maximum offer formula is exactly right. I use my custom Excel spreadsheet that follows the same steps. You’re also right that most sellers, even *motivated* sellers, will decline your cash offer (mostly because they simply don’t understand how to value a property or they are upside-down and cannot accept such a low offer). Takes about 15 seconds to punch in the numbers and know exactly my maximum offer. (I start negotiations about 5% to 10% lower and grudgingly increase up to my max offer.)
Without showing the profit margin, it’s important to show the motivated seller how an investor arrives at the offer. That’s why I start with the ARV, subtract profit and assignment fee to calculate my “total investment to value” (ITV). The ITV is the most that I will invest in the property. Then I subtract the “entry costs” (the hard costs to acquire, carry, repair the property) and the “exit costs” (the soft costs to sell to a retail buyer). Hard costs are costs that require cash. Soft costs are costs deducted at the closing with the retail buyer. I have to charge my soft costs to the seller, or I must pay the soft costs from my profit margin.
By showing the ITV, entry and exit costs, the seller simply cannot argue with the math. It’s not about emotion. It’s about the numbers. I don’t show profit margin, because it’s non-negotiable. The seller cannot argue with my costs, because the seller doesn’t have his own numbers to show. My offer is what the *property* can afford to pay. No emotion. It’s not personal. It’s only business.
MaxOffer = ARV-profit-assignment-entryCosts-exitCosts
Jeffrey, Brian,
I would love to have a pre-built Excel spreadsheet for figuring Wholesale deals from someone who is actually in the trenches. I’m a newbie to wholesaling and “challenged” in creating spreadsheets. Is it detailed enough to figure rehab costs? Just asking…
All real estate is local. Rehab costs vary greatly by location. You can go to http://www.MillionaireSystems.com/ and hunt for their free spreadsheet downloads (you may have to enter your name and e-mail to get access).
They have a detail spreadsheet for entering all of your rehab costs, like a checklist. Just walk thru the house with your general contractor (GC) and go down the checklist. Your GC will estimate the repair cost of each item and you enter it into the spreadsheet (on your laptop or on a printed copy).
Then you will use one of the other two spreadsheets, the “buy-and-sell” or the “buy-and-hold” spreadsheet. Enter the repair costs from the detail sheet onto the next sheet, then enter the remaining values (like market rent, mortgage payment, taxes, insurance, closing costs, etc.). The spreadsheet calculates the offer. Seems more complicated than it really is.
I use my own very abbreviated spreadsheet that follows my formula above. I get the repair costs from my own estimates or GC.
My assignment fee is generally the greatest of: 3% ARV, 15% profit margin, or $6,000. Just plug that number into my formula to calculate the maximum offer.
The MaxOffer formula rarely results in an accepted offer, which is as it should be. If all of your offers are being accepted, then you’re offering too much. If all of your offers are being declined, then you’re not offering enough. You’ll need to make adjustments to your offers according to the current market conditions, and make adjustments to how you are finding sellers (maybe they aren’t motivated enough).
Just to be clear on my assignment fee is greatest of: 3% ARV, 15% profit margin, or $6,000.
Example: ARV=$250,000; Profit Margin (PM)=$30,000;
assignment fee = greatest(6000,3%*ARV,15%*PM)
= greatest(6000,3%*250000,15%*30000)
= greatest(6000,7500,4500)
= 7500
Now is the time to have systems in place to get a appraisal that is base on todays market. Systems to calculate cost and profit. And a marketing system to flip it as soon as possible
If one doesn’t have a marketing system to sell the house right away, like Ernest stated, you will be in trouble over the next year. So get the marketing system going first or the risk will be very high for the next 12 months.