Recently, there is a new flock of Guru on the internet trying to teach how to calculate the Maximum Allowable Offer (MAO) for a wholesale property. The After Repair Value (ARV) is determined from a Comparable Market Analysis (CMA) from a real estate broker. The Guru are using variations of the wrong equation:
MAO = (ARV * 70%) – REPAIRS; <== WRONG EQUATION!
The percentage of 70% doesn’t really matter. I’ve seen it as low as 60% and as high as 80%. My point is that the equation is WRONG. I’ve seen stupid variations where the Guru suggests also subtracting double your wholesale assignment fee. These stupid Guru are just fishing around for an answer when they really have no idea how to formulate the question.
The Guru simply assume that after selling to the retail buyer there will be enough money left to cover other unspecified costs and provide a profit for you. Can you determine what is your profit from the above equation? Of course, not! Why would you commit to a project without knowing first what your anticipated profit will be when you resell to a retail buyer?
The other unspecified costs are entry costs and exit costs that you must absorb from the 30% gross margin. You must also account differently for the entry costs versus the exit costs.
Entry costs are hard costs that require cash during the project. You need this cash to pay for the project costs, in addition to the purchase price from the motivated seller. You need to obtain cash from your private financier for both the Maximum Allowable Offer (MAO) and the Entry Costs for the project.
Exit costs are soft costs that are paid by the retail end buyer (or by the refinance lender) at the conclusion of the project. You do not need to obtain private financing for Exit Costs. Exit costs are charged to the motivated seller and paid by the retail buyer (or by the refinance loan).
The correct, professional way to operate a wholesale business, whether as a buyer or seller, is to start by locking in your profit margin, then subtracting your entry costs and then subtracting your exit costs to calculate your Maximum Allowable Offer (MAO). That is the only way to know whether the project is worth pursuing, because you will know your true profit.
I wrote a short article with more detail that you can find by clicking here.
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