How to compute for the Maximum Allowable Offer or MAO for foreclosed properties

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 justmight be worth buying. Furthermore, a property priced way below the MAO can be truly a great deal because:

1. 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.
2. 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 one of my mentors, Trace Trajano (meet Trace in person atTRQ 2.0, click here for more info), in his bestselling book “Think Rich Quick“, the Maximum Allowable Offer or MAO can be computed as follows:

MAO = CF x ARV – Repairs – Profit

Where:

CF – CF stands for the cost factor. A cost factor of 90% or 0.9 means it will take around 10% of the value of the property as the cost for acquiring, carrying, and selling the property. 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. 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. Refer to this article on 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

= Php960,000

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 brokeror 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 you MAO has been breached, 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!

Jay Castillo
Real Estate Investor
Real Estate Broker License #: 20056
Blog: http://www.foreclosurephilippines.com
Follow me in Twitter:http://twitter.com/jay_castillo
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Text by Jay Castillo and Cherry Castillo. Copyright © 2010 All rights reserved.

How to compute for the ARV of foreclosed properties

Real estate investing is a numbers game and one such number that a real estate investor who is into flipping properties needs to determine before buying a property is the ARV. ARV can stand for Approximate Retail Value, After Rehab Value, but the common term often used is After Repair Value.

Isn’t ARV the same as Market Value?

I believe market value is technically the same as ARV except that ARV refers to a futuremarket value, which is the market value of a property after it has been repaired and is already in Ready For Occupancy(RFO) condition to be exact.

Market Value on the other hand is the value of a property at its present condition or the “as-is” value. In my opinion, this “as-is” market value is synonymous to a property’s appraised value.

The obvious difference between the “as-is” market value and ARV is the repair cost plus the added gain in value due to the repairs, if any.

When to use ARV

I find ARV to be quite useful when trying to determine how much one can increase themarket value of a property by simply repairing it, provided a property’s value has declined due to deterioration, lack of maintenance, etc. This is very applicable to foreclosed properties where a lot are in dire need of repair, which is good because this helps lower their selling price, well, most of the time.

By repairing a property, an investor can bring back a property’s value to it’s full market value, which is the ARV. However, the repair cost and the selling price of a property needs to be considered to determine if a profit can really be made because if the selling price or the repair cost or both are too high, this can translate to zero profit.

How to compute for ARV

Based on my definition above that ARV is just the future market value of a property after it has been repaired, then one can simply use the same approaches I talked about in my post “How I estimate market values of foreclosed properties”, excluding the calculation for any depreciation of a property, more on this later.

As mentioned in my article on market values, we can use the market approach and the cost approach. Income approach is more appropriate to multi-unit properties.

Market approach

1. Look for “comparable” houses that got recently sold in the immediate vicinity of the foreclosed property you are evaluating. They should be very similar in terms of lot area, floor area, number of bedrooms, number of toilets and bath, capacity of garage or parking slots, age of property, etc.

2. Ask around the vicinity, or you can get the telephone numbers of all the “for sale” signs that you see and for sure you will find a number of a broker that specializes in that vicinity who will know the current going rates in that area. The same tactic can and should be done online.

For example, you were able to get the price of 3 comparable properties that got sold within the vicinity of the foreclosed property you’re evaluating and their average price is Php2.5M, then Php2.5M is your ARV.

What if the closest comparable property is still quite different, for example, the lot area  is bigger by more than  10% or the comparable property has a corner lot, etc.?

In these cases, you will have to compensate. In the example above, you can subtract the cost for the discrepancy in lot area(just get the going rates for lots per square meter and multiply by the difference), and you can also subtract the premium for corner lots (a broker that specializes in that area can help you with this) .

Cost approach

1. Determine the average price per square meter of lots in the same vicinity of the foreclosed property you are evaluating.

2. Multiply the price per square meter you got above with the lot size of the property you are evaluating. The result is the approximate cost of the lot. For example, if a lot near a foreclosed property in Marikina has a price of Php5,000 per square meter, then the approximate cost of the lot of a foreclosed property that has a size of 300sqm would be about Php1,500,000 (300sqm x 5,000pesos/sqm)

3. The cost of the improvement is equal to the usable floor area multiplied by the current going rates for construction of improvements per square meter of floor area. I currently use a conservative construction cost of Php15,000 per sqm of floor area. For example, if a house has a usable floor area of 100sqm, then the cost for the improvement is about Php1,500,000 (100sqm x 15,000p/sqm)

4. Add the cost of the lot and the improvement to get the total cost. Following our examples above, the total cost shall be Php3,000,000 (Php1,500,000 + Php1,5000,000).

Using the cost approach, the ARV is Php3,000.000. We no longer needed to compute for any depreciation cost as we are looking for the cost for the house and lot in brand new condition, not its “as-is” condition.

The cost approach obviously has it’s limitations. You can only apply this approach to house and lots. I believe it wold not be an accurate tool for condos, buildings, etc.

Which ARV should I use?

A prudent real estate investor should of course use the lower ARV which is based on the market approach in this example. At this point, if you can see that the ARV is smaller then the selling price of the foreclosed property and the estimated repair costs combined, then that property is not a good deal.

A promising property should have enough room for profit even if you consider holding costs.

What next?

The ARV is just one of the numbers one has to get when “doing the numbers” and due diligence. You will need the ARV to calculate for your Maximum Allowable Offer or MAO, which is basically the maximum price you can pay for a property that will still allow you to achieve you target profit. MAO will be discussed next.

Happy investing!

Jay Castillo,

Foreclosure Philippines