With the continuing, and even growing number of new investors in the DFW area, I feel it is time again to share a very basic concept when determining what is a good deal. Here is the magic formula:
ARV x 70%, minus repairs, equals Max Allowable Offer.
Example:
House is worth $100k all fixed up, needs $20k in work to get there.
100k x 70% = 70k, minus 20k repairs = 50k Max Allowable Offer.
Maybe in a competitive market you can do 75%, but beyond that you're pretty much rehabbing a house for no profit, or possibly a loss.
This may adjust slightly if you're keeping it as a rental, but not by much, and it will mean you're leaving a good chunk of money tied up in the property, even after you refi.
Some other advice:
Wholesalers don't care about your profit margin. They care about their profit margin. Shockingly, they sometimes lie outright.
If you see a wholesale deal that requires a 5k deposit, ignore it or bring a licensed inspector and a reputable contractor with you before you sign anything. $350 spent for an inspection is less than 5k or more lost later. Ask me how I know.
If you see a wholesale deal that doesn't offer a repair bid with its numbers, ignore it. Wholesalers, do YOUR due diligence if you want 5k to 10k for your wholesale deal.
If there is a repair bid, verify it with an inspector and a reputable contractor before your sign anything. Trust nobody.
Why am I sharing this:
I got burned early on by not following these basic rules and am now the wiser for it. But my errors pale in comparison to what I'm seeing today, which is why I'm writing this.
Today I saw a wholesale deal with no repair estimate and a 5k deposit, sell in MINUTES, at over 90% ARV minus repairs. (I visited the house, so I knew the repair amount). This was a private wholesaler, not a big company, so the problem is widespread.
There are two major problems this causes:
1. The investor that bought this deal is in trouble. They are going to lose money. Even if they make it a rental, it will negatively cash flow. We will never hear from them again.
2. With so many people buying overpriced deals, the investing business has become unprofitable. Even if you're marketing heavily and getting leads, you're likely to lose out to a wholesaler who can find a sucker newbie to pay even more.
The solution is simple, yet difficult. EDUCATE the newbies early on! Stop them from buying overpriced wholesale deals. Please share this post on every forum you can think of. If you run a club, attend a club, or engage with anybody who is interested in investing, ask them if they know the MAO formula, then share it with them. This market needs to come back down to earth. The truth is that there are still tons of deals in our market, we're just overpaying for them. Wholesaling comes with minimal risk and should not be more profitable than rehabbing or holding rentals.
Robin and Cindy, I implore you to add the the MAO formula to the start of your meetings, with an example with actual numbers showing purchase costs, holding costs, rehab costs and costs to sell or to refi into a rental. It will help newbies understand what is truly a good deal, and hopefully reel in the out of control wholesaling problem.
That's my rant. Comment, please.
AJ
