Overanalyzing
If anyone were to constantly watch me since I found out I won the bid on Offer #6, the first thing they'd say is I have analyzed this deal way too much. On almost a daily basis, I have pulled up the spreadsheet I have on this property and tweeked numbers, added sheets, moved cells, etc. Why? Because I want to forecast what I'll get out of this deal with the best information I have at the time. Sound plausible? Okay, how about ... This being my first deal, I'm scared to death I'll lose money in it. That's probably more like it. :-)
Looking back and analyzing why I am overanalzying this deal, I feel it is a combination of two things: (1) because it is my first deal, and (2) because the deal falls outside the comfort zone of LeGrand's famous formula. If this deal had more leeway in it financially, I would probably have still analyzed it profusely, but probably not to this extreme. For those unfamiliar with LeGrand's formula, it is simply ...
MAO = 70%ARV - Repairs - Fees
MAO = Maximum Allowable Offer
ARV = After Repair Value
Repairs = Cost of repairs
Fees = Any ad hoc fees (i.e., birddog)
Now, there are mutations of this formula, for instance Steve Cook has one when the percentage yeild is just too low. I'm not sure if he got the formula from LeGrand directly, or from someone else, or created it himself. It's ...
MAO = 70%ARV - Repairs - Fees
MAO = ARV - Repairs - Fees - $25,000
Whichever MAO is smaller is the one to use. For example, if you find a property that has an ARV of $50,000, needs $10,000 worth of repairs, and you have to pay a birddog $500 for his/her help then ...
MAO = 70%($50,000) - $10,000 - $500 = $24,500
MAO = $50,000 - $10,000 - $500 - $25,000 = $14,500
Since, $14,500 is smaller, you would use this as your MAO. Using the other MAO would probably work, but with all the stable costs involved in buying, holding, and selling, your profit would dwindle quickly. Suppose the ARV is $100,000, and the repairs and fees are the same ...
MAO = 70%($100,000) - $10,000 - $500 = $59,500
MAO = $100,000 - $10,000 - $500 - $25,000 = $64,500
In this case you would use the first MAO as it would produce the higher profit. Of course the mathematicians out there would want to know what the cut-off value would be. IOW, at what ARV price do you start using one formula over the other. Since the repair and fee values negate one another, we would simply have:
70%ARV = ARV - $25000
ARV - 70%ARV = $25,000
30%ARV = $25,000
ARV = $83,333.33
So at any ARV below this price, one would use the second formula. Anything above this price and it is wise to use the first formula. You can use either if the price is exactly $83,333.33.
Note: There are also formulas floating around to use when ARV's are $200,000+, but I haven't seen anything concrete being pushed by the gurus. If anyone knows of any, please let me know (not that I'll be buying any expense properties - yet).
Okay, so why all this talk about ARV's and MAO's and such? Well, if one were to use the formulas on my deal, they would quickly see that I shouldn't have even bid on the property. Yeah, at worse I'll probably come out breaking even (and that's REALLY a worst case), but not applying the formula means I've thrown more stress into the deal than needs be. I figure an ARV on my deal of $134,000. Most people I've talked to think that is a little high, though. They think $130,000 is the highest value with $126,000-$127,000 being "average". Even using my $134,000 figure, my deal still goes way outside LeGrand's (and Cook's) formulas:
MAO = 70%($134,000) - $1,000 - $0
MAO = $92,800
(And that offer doesn't include the 1.5% I'll be giving my RE agent.)
Bottom line, always, always, always stick to the formulas. Yes, depending on the price of the house, you can probably still make a decent profit, but why stress yourself?
BTW, if anyone sees an error in any of the above, PLEASE let me know. I'm notorious for typing faster than my brain can think. :-/
My RE Agent
Something I've never said in all my postings so far is the fact that I have a contract with my RE agent - a buyer's contract. In the beginning of our investor-agent relationship, I was submitting offers and having to sign a buyer's agent contract with her for each one seperately. Of course this got old real quick. So I (yes, it was my decision) suggested just having a contract in place to cover all my offers for a short term. Well, the term was for three months, and is set to expire soon. When it does expire, I'm positive I won't renew it. I already know where to get information on bank REO's and government-owned foreclosures, which has been the only properties I've found on these daily feeds that meet my criteria. Don't get me wrong, I like my agent for the most part, but for various personal reasons, I feel that the proverbial umbilical chord should be severed after this property.
If I decide to go with another agent in the future, I will definately call her up first. And, if I decide to sell my current property reatil, I will definately use her services. Most agents I've heard, don't truly understand the investor's mentality, and it is hard to find one that does. She has definately helped in my endeavors, for the most part.
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4 comments:
Just remember, for HUD homes at least, the offer HAS to be submitted by an agent. You could always use the listing agent, who is guaranteed at least whatever percentage HUD pays them without it affecting you, but they may want something above from on your end as well.
Exactly. This is part of my reasoning for not using a buyer's agent with anymore government-owned properties or bank REO's. If I use my current agent, HUD is guaranteed to pay 6% on commission, but if I use the listing agent directly the worse they'll pay is 6%. Aanother advantage is the listing agent will only get 3% if I use a my (buyer's) agent, but if I go with the listing agent directly, they'll get >3%, in most circumstances. This will give me a slight advantage over other bidders who are using buyer's agents as the listing agent has more flexibility in my deals. any slight advantage in this market can be huge in the end. ;-)
Read LeGrand again. That MAO is for ugly houses, houses that need alot of work. He says "There's no MAO formula that applies to pretty houses, but the rule about getting free equity stands." If you have $1000 budgeted for repairs, I'd classify that as pretty. At this point, it really becomes an issue of how are you going to get out of the house? If you are going to lease option, how much cashflow do you need to make to make it worth your time? How long can you wait to get a tenant that pass your screening and can afford it? I guess I could find them if I looked through your blog, but I dont know most of the relevant numbers so its a little hard to say exactly what I think. I will say this - youre going to be nervous and worried until you get rid of it. At least I was. It all went away when I got that option check for $5000 in my hand. Well, it mostly all went away - every month when the lease payment comes it goes a little further away ;)
Thanks Ryan. To be honest, I haven't read LeGrand myself. I'm only going by what I've read from his "students"., but I would say that you are correct about the ugly house part. As far as an exit strategy, see the entry I just wrote (April 15). You'll se I am still debating the isue whether to retail or L/O (mainly due to my wife). In the beginning - and throughout this ordeal - I have always held spreadsheets for each exit strategy. As it stands right this second (from the latest Good Faith Estimate), if ...
... I have to hold the property until October 1st and sell retail, I will make about $9,500 (or almost $15,000 if I can sell it by June 1st).
... I have to hold the property until August 1st and L/O it on a 1yr term, I stand to make $7,800 if NOT sold and $27,000 if sold. If on a 2yr term, I stand to make $11,400 if NOT sold and $36,500 if sold. (Now you see why I want to L/O - and that doesn't include the tax advantages either.)
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