Calculating the Maximum Allowable Offer


 Calculating the maximum allowable offer (MAO) on a rehab project can be the beginning of a great return or the beginning of the end.  Knowing what your maximum allowable offer is will probably be the most important thing you do prior to your purchase.  That being said, you have to know that all of the components  going into the maximum allowable offer calculation are independently as important.  If you don’t get all of the parts right then you obviously don’t get the big picture right.

There is a quick and dirty calculation that many flippers use to calculate their maximum allowable offer.  That calculation starts by determining the after repair value (ARV) and multiply that by 70 percent.  It is often advisable to use a 65 percent calculation rather than 70 percent.  How you do it depends on how conservative you want to be and what is happening to the real estate prices in your area.  After doing the multiplication you then take that answer and subtract the rehab expenses.  The resulting amount becomes your maximum allowable offer.  This figure basically becomes your top-end offer, not your starting offer.

I have always used a spreadsheet instead of  this type of calculation.  If your spreadsheet is set up correctly you can do a fairly quick calculation without losing much time before you make your offer.  With a spreadsheet, you are able to see both the raw dollar amount of your projected profit as well as the amount as a percentage.  The spreadsheet allows you to put in specific amounts for buying expenses, rehab cost, holding cost and selling expenses.  You get a more precise picture of where the money is and you are able to make a more educated and confident offer.  Without a doubt, a spreadsheet is the best way to go.

Final Walk-Through


As you go through your real estate investing you may feel that a final walk-through of your new purchase may not be necessary.  If you are buying a flip house that you have been in a couple of times and you know it is empty, there is a temptation to skip the final walk-through.

Do not skip the walk-through.  Be sure you or someone who works with you does a walk-through.  You may think that there is no sense to this because you are buying the place as is, you know it needs lots of work and you know it was trashed.  After all, that is why you got such a good deal on it, right?  That is true, but I will explain to you why this is important and what happened to me once when I decided to forego the chance to see the place a couple of hours before I closed on the deal.

I went to my closing, knowing the owner had moved out weeks before.  The house needed quite a bit of work.  The person living there had not cleaned the place for months, if not longer.  The owner was also a hoarder.  I really didn’t feel up to going through that place again.  At the end of the closing I was told that the key had been left on a kitchen counter.  So, I guess that meant that the house had been unlocked for weeks.

I decided to go to the house immediately after the transaction had taken place to revisit what I needed to do to get started and to lock up.  When I got there all the doors and windows were locked.  I figured the guy had locked the key inside, so I was trying to decide how to get into the house without causing unnecessary damage.  I had already tried the front and back door, and as I stood there thinking about my dilemma, a woman came to the front door!  What?!!

In a matter of weeks, having an unlocked vacant house, I had inherited a squatter!  I wasn’t sure she knew how hard or how easy it would be for me to get her to leave.  I have a real problem being mean, but after all, this was my business.  I advised her that she could not stay, and somehow I convinced her to leave, at least for a while.  I immediately changed all of the locks.  When I had another conversation with her I told her that she had until the next afternoon to come and pick up her belongings.  If she wasn’t there by the drop-dead time I gave her, I would put everything on the curb.  I had a tough time with this, but it was a result of my own doing.

I was fortunate that she did not press the issue of leaving, and she did show up to get her belongings.  If she had given me a hard time, it may have been weeks or more to get her out of that house.  If you do what I did, you may not be quite so lucky.  Do your final walk-through.  This will give you a chance to hold up the closing if you find an issue that had not been noticeable earlier, or if you find what I did, a squatter.   

Tax Liens and Tax Deeds


 Tax liens and tax deeds should be a serious consideration if you are thinking of investing in real estate.  Each state has its own set of laws and rules when it comes to tax liens and deeds.  You should make yourself familiar with those laws and rules in any state where you are considering investing in a lien certificate or deed.

Tax liens occur when a property owner fails to pay the property taxes that are due on a piece of property that he or she owns.  Once a certain amount of time passes after a tax payment becomes delinquent, the taxing authority can place a lien on the property.  The taxing authority, of course, must collect taxes in order to provide the services needed in that community.  If they do not collect the tax they will not have the funds to provide those necessary services.  To be sure that the taxing authority can collect funds they will sell tax lien certificates to investors.  The certificate will include past due tax, any penalties and interest.  The interest rate will depend on the state and the format of the auction that is conducted when selling the certificates.  If the property owner pays the amount due to the taxing authority in the prescribed amount of time (the redemption period), the taxing authority will then pay the tax lien certificate holder (the investor) the principal, penalties and interest.

A tax deed purchase is when you actually acquire title to property at the tax deed sale.  Generally, in most tax deed states, you will own the property free and clear of any other encumbrances that may have existed on the property.  In a pure tax deed state once you, the investor, own the property the prior owner has no right of redemption.    

As mentioned, some states are tax lien states.  To be clear, in a tax lien state you do not acquire ownership or title to the property.  Some states are tax deed states.  In a tax deed state you acquire ownership and title to the property. 

There are a number of states that are considered hybrid states.  Their process is a mix of tax liens and deeds.  For example, Connecticut is a hybrid state.  You can actually acquire title to the property but it is subject to the prior owner having the right to redeem (by paying the back taxes, interest and any penalties in full) within a six-month period, and getting the property back.

Tax liens and deeds can be a lucrative investment.  You can earn as much as 18 percent or more, or even come away with property that is worth much more than what your capital investment is.  When you know what states you have an interest in you should research the process and properties before you bid.  If you are investing in a lien or hybrid state you must know how long your money may be inaccessible to you.  Don’t give up.  You may find that there is heavy competition in some areas, but if you can get in the game it can be lucrative.

Cash on Cash Return – Maximize Your Investment Earnings


Maximizing the cash on cash return on a real estate investment is what all investors should want.  People often wonder how others have done so well with real estate investing.  There is often an assumption that people who have accumulated wealth through real estate investing must have started with a good deal of money, got in at the right time, inherited property or had lots of cash.

Many people who have created wealth in real estate have done so by being creative or understanding how to maximize the return on their real estate investment.  Maximizing the return on real estate investments can be accomplished in a number of ways.

Many investors know that using leverage is a way of getting into real estate in a bigger way then just using available cash.  Leverage is basically using borrowed money to buy the real estate.   Buying rental property with the help of a conventional mortgage or negotiating owner financing are ways of using leverage.  Leveraging your investment increases your cash on cash return.

You determine your cash on cash return by taking your net cash revenue (cash in minus cash out) and dividing it by the cash you had to use to acquire the rental property.  For example, let’s assume you buy a 3-family house for $200,000.  You have $40,000 as a cash down payment and you finance the remainder.  Assume too, that the property generates a net cash flow of $1,000 a month, or $12,000 per year.  Your cash on cash return is the $12,000 divided by the $40,000 cash used to buy the property.  This gives you a cash on cash return of 30%.

Now let’s you had paid all cash for the building.  Also, let’s assume your mortgage payment in the prior example was $1,000 per month.  Now you wouldn’t have to pay a $1,000 per month mortgage payment.  In this example, your cash increases by $1,000 per month.  Therefore, your cash on cash would be $24,000 net cash flow annually divided by the $200,000 used to buy the property, or a cash on cash return of 12%.  Still a good return, but not the rate that you get when you use leverage, as the 30% cash on cash rate of return in the first example indicates.  The fact that you have used leverage (borrowed capital) in the first example shows that you have maximized the return on your cash investment.

As time passes refinancing rental property can allow the owner to take money out of the property and purchase more rental units.  The ability to refinance a building and remove cash is a result of appreciated value on the property as well as paying down some of the original debt.  Also, refinancing a larger percentage of the value of the building then what was originally financed increases the amount that can be taken out of the deal.  In other words, if you originally financed 80% of the appraised value and you can now refinance 90% of the appraised value, you are financing an additional 10%.  Even in a situation where there is no change in the value of the building you conceivably can to take out money through refinancing.

An investor can also obtain property that is turn-key and has positive cash flow.  Turn-key is obtaining property that needs no work and little effort on the part of the owner.

The actual after tax return on any real estate investment can be increased if the funds used to acquire the property are within a Real Estate IRA, which can accumulate earnings tax free.  In this approach financing can also be obtained to free up funds for another investment. Howerver, if you are using an IRA to buy the property and also have the property mortgaged you must be aware that there is a distinct tax treatment you must follow.

Hard Money Lenders


A Hard money lender is a lender who loans money to real estate investors.  Typically the lending period is a short period of time, generally not more than one year, and the interest rates are quite high.

Hard money lenders do have a place in the real estate investment game.  Most flippers, and sometimes landlords, take over property that is not acceptable to a bank for a conventional loan or mortgage.

The use of a hard money lender in a house flipping business is quite common.  The flipper has purchased a house that needs work.  Obviously, for the flipper to buy the house, it is a home that does not command getting sold for a price that would be the normal selling price of the house if it was in reasonable condition.  The flipper has no intention of keeping the house long term, but needs some additional funding to either buy the property or to do the updating and rehabbing work.  A bank will not finance a house in this condition for a short period of time.  In addition, a conventional lender would have too long of a process to obtain the funding.

The whole business plan of a house flipper is to get in, fix it and get out as soon as possible.  Generally a hard money lender can accommodate this need.  They are niche lenders and can do quite well when lending to the right people in the right location with the right value being placed on the property.

If you have ever used a hard money lender you know that the interest rates you find are high.  I have seen rates as high as 5 points and 15 percent ranging down to 3 points and 9 percent.  The most frequent rates that I have seen are 3 points and 12 percent and 2 points and 10 percent.

Usually the hard money lender will require that the borrower have some “skin in the game.”  By that I mean they want to see the investor have some of his or her own money at risk, which is an indication that they will not walk away from the investment.  Also, most hard money lenders want a first position mortgage, and may not allow second mortgages.  They often require payment of monthly interest while the project is a work-in-progress, and they will deduct the points that they are charging from the proceeds of the loan.

For example, if you sign a note with a hard money lender for $100,000 and you are paying 3 points and 12 percent interest, you will actually receive $97,000 at closing (3 points = the $3,000 taken from the proceeds).  You will usually make a monthly interest payment while the working on the house and until the loan principal amount, which is $100,000, is paid at the time of sale of the property.  The lender will also require the borrower to pay all closing costs related to the loan.  Again, hard money lenders certainly have their place, but of course the numbers have to work for the borrower in order to make the job profitable and the borrowing worth it.