Determining the Value of Property

Real Estate Valuation

There are many methods of determining value of a property. Investors who are landlords use some, flippers use others and wholesalers use all depending on what kind of deal they are working with and the buying criteria of the investor they are purchasing for.

Amateur wholesalers find a property and then buyers for it. Those who know what they are doing build a buyers list of active investors and look for the types of properties that they want. That way the day you get the contract is the same day you sell the property and you are now on to your next.

Methods used by Landlords:

There are various methods of valuation due to the fact that there are various types of property in different locations. A property in a low income area that typically does not appreciate much if at all can not be judged with the same formula as one in a high end area that gets lots of appreciation. The reasons for this include not only appreciation but the speed that it will sell, low income tenant drama vs upper end tenants that pay their rent, etc. Lets start out at the bottom and work our way up.

The Hooch Method Of Valuation:

This method is to be used for low income property in both low income white and minority areas. This is basically a junker formula. The Hooch Method is easy to quickly determine a properties value. It is a formula used by landlords, as the determining factor for a landlord has to be based off of rent, not the After Repair Value (ARV) as a flipper would use. A landlord could care less what the ARV is unless they are intending to sell the property within a short time frame.

– The Hooch Method Of Valuation is Rent X 30 - repairs (and repairs include splitting up the utilities on a multifamily if needed) The maximum offer would be Rent X 35 minus repairs. Never go over 35 on junker property when buying wholesale. Remember, we are talking about wholesale, not retail. The Hooch Method is specifically designed for low income areas. There is room in this method for your profit. So lets say you think there are $5,000 of repairs on a house you found and the place will rent for $900…

$900 X 30 = $27,000 - $5,000 = $22,000 This is your offer.

Triplex example
1br - $425
1br - $425
3br - $595
Total rent = $1,445 X 30 = $43,350 total value of the house with no repairs needed.
Now lets say that you have about 5k in repairs.
$43,350 - $5,000 = $38,350 This is the total that you will offer in the rent X 30 scenario.

2% Rule

The 2% rule is useful for nicer areas. In this scenario you are talking about property that appreciates some, lawns that are taken care of, a higher end blue collar or low end white collar area. You shouldn’t see many houses that are in need of repairs. People in this area are NOT living paycheck to paycheck. They have a little bit of expendable income. Most houses are also not rental property like you would see in the low income areas. There will be many owner occupiers with a few rental units here and there. Using this rule you determine the value by the rent equaling 2% of the total purchase price. So, if the rent was $900 than multiply it by 50 and you have $45,000 for your offer. You also must subtract repairs in this method. There is less cash flow on these types of houses for a landlord but less drama to deal with as well. They also have more appreciation than the low income housing.

1% Rule

Do a search on the internet and you will see more people talking about this 1% rule. In this scenario the rent should equal 1 % of the purchase price. So $900 rent ($900 X 100) should mean that you pay $90,000 minus repairs for the house. This is the rule that the novice investors use and get burned on. You would have to put a significant amount of money down to make a house cash flow with this formula. This formula is only used by idiots in my opinion. But if I were selling a house I would be using this formula as if it was tried and true.

Cash Flow Analysis

Here is an example of a quick determination of value based on profit per door on a triplex. I use this formula on every house I buy along with the other listed formulas, as I want to make sure that the house will bring the minimum cash flow I require. And the big question is will the property will cash flow or will it not,which is obviously very important. Many investors want a minimum of $100 cash flow per door per month. This formula is based on a 100% loan as if you were going to pay yourself back for what you put down on it too which is what a wise investor does.
Gross Income: $1,445/mth = $17,340 annual
Expenses (50% rule of thumb) -8,670
NOI: $8,670
43,350k@7%/20yrs: -$1,865
Yearly Cash Flow $6,805
Or, $567 per month or $189 per door @3 units

Other methods of valuation include the Gross Rent Multiplier and Capitalization rate but these methods are not needed for a wholesaler. You are trying to determine a ballpark value. The investor will do that as well along with the GRM, and the smart investor will be figuring it by the CAP rate.

Flippers
Maximum Allowable Offer (MAO)

Flippers use a different formula based on the properties Maximum Allowable Offer (MAO). Flippers are determining the After Repair Value (ARV) of the property and subtracting repairs and holding costs and deciding if there is enough profit in between.

To give you an idea where you should be with your numbers as a wholesaler, most flippers I know won’t touch a property unless there is a 20K or more spread between their costs to purchase, repair and hold, VS the ARV. So when figuring this stuff out, you run the same numbers and subtract your fees and you then know what to offer which is known as your MAO or maximum allowable offer.

Many wholesalers like to be between 65-70% of the ARV. In my opinion that is high and if a wholesaler came to me with a property in that range I would tell them to come back when they have some real deals. BUT, I buy cheap and am NOT the typical investor since I typically do my own wholesale deals. I like to work the seller down much lower than that and suggest that on your initial offer you should lowball it and then let the seller work you up.

Lets look at this formula based on a high 65% of the ARV. Lets say that you have found (without a doubt) that the after repair value is $100,000 and it needs $15,000 of repairs to make it worth 100K.

65% of the ARV - Cost of Repairs = MAO (maximum allowable offer. Notice the word maximum! Don’t go over or you won’t be selling the property)
or
65% of $100,000 - $15,000 = MAO
or
$65,000 - $15,000 = MAO
or
$50,000 = Your Maximum Allowable Offer

So you take this 50K and reduce it by the profit that you want and you have your actual offer. Lets say you want to make 10K. $50,000 - $10,000 = $40,000. So you offer the seller $40,000 for the house.

Well, there you go. Now you know how to value property in various locations, to various types of investors. Now go start making offers and expect that 90% or more of them will tell you to take a hike!

Hooch.

thanks again… :smile

“…now go start making offer and expect that 90% or more of them will tell you to take a hike.”

Hey whatever happened to “…as a man thinketh .” :eek

why 20yrs: on this…?

I personally never take a loan for more than 15 yrs. I am investing in real estate for relatively quick wealth. Not the banks wealth but mine. Go to http://www.bankrate.com/calculators/mortgages/mortgage-calculator.aspx and check out the total interest paid from the amortization table on a 15 yr loan vs a 30 year loan. Significantly different.

The “bread and butter” of real estate is not your monthly cash flow. Sure it can help keep the bills paid if you have many units but cash flow does not make you rich. Your wealth comes from purchasing the property right, at a discount, and selling it right, at a premium. Your wealth is not actually “realized” until you sell the property.

so look for it to break even or with a lil extra you say going with a 15 - 30 yr loan like 100 per door so that your paying dwn principle for a lower loan balance so when you sell you can realize a larger profit… Ok the i shouldnt figure if it will cash flow with a 30 yr loan then look at 15/20… ok makes sense… Thanks Hooch…

Hooch I’m glad you put this information out for everyone to learn from. It’s useful information especially at this time in the market place.

The information presented here about the 2% Rule is totally inaccurate. The 2% Rule is a very good screening tool for low income properties. It is absolutely ridiculous to say that the 2% Rule is only useful for “higher end blue collar or low end white collar area(s)”. The 2% Rule works best in lower income rentals. Buying with rents at 2% of the acquisition cost (purchase price + rehab) will result in an adequate positive cash flow in almost all low income SFHs and most small multis. Of course, the 2% Rule is a SCREENING TOOL, which means that you always need to do a cash flow analysis to determine the cash flow for each deal.

Please note, that I’m not opposed to buying at rent X 30 or rent X 35, or any other number below rent X 50. You are always better off buying at a bigger discount. My only point is that it is certainly not necessary to buy at rent X 30 in low income areas to be profitable.

Mike

The information presented here about the 2% Rule is totally inaccurate. The 2% Rule is a very good screening tool for low income properties.

It is if you like to pay more for your property. “Totally inaccurate” is quite a long shot! The fact is that the 2% rule in combination with a cash flow analysis will show that the property will cash flow to a very small degree. And one must not do a cash flow analysis based on a 30yr time frame when the banks right now want 15yrs. Some people here have said that they have found banks that will do a 20.

It is absolutely ridiculous to say that the 2% Rule is only useful for “higher end blue collar or low end white collar area(s)”.

Where did you see the word “ONLY”? Are you having reading comprehension problems?

The 2% Rule works best in lower income rentals.

And the 1% rule works even better in lower income rentals. LOL Obviously the more you give someone the better it will work. Come on now, lets have a serious discussion that’s based on reason and logic.

Buying with rents at 2% of the acquisition cost (purchase price + rehab) will result in an adequate positive cash flow in almost all low income SFHs and most small multis.

“Adequate” means different things to different people. What you find to be an “adequate” amount of cash flow is not to me because I pay off my loans in 5 years and HAVE to have “more adequate” cash flow than the 2% rule will provide. And I do this because I am in the business of making myself wealthy, not the bank.

Cash Flow Analysis

2% rule
Low Income SFH - $700 rent
Gross Income: $700/mth = $8,400 annual
Expenses (50% rule of thumb) -4,200
NOI: $4,200
35k@7%/15yrs: -$3,775
Yearly Cash Flow $425
Or, $35 per month

Hooch Method
Low Income SFH - $700 rent
Gross Income: $700/mth = $8,400 annual
Expenses (50% rule of thumb) -4,200
NOI: $4,200
21k@7%/15yrs: -$2,265
Yearly Cash Flow $1,935
Or, $161 per month

Now, that said, there are some places in the United States that presently have booming real estate markets. If your demand by local investors is too high in comparison with your supply of real estate you will have a hard time finding a Hooch deal. But no matter what market you are in, you do have to actively locate them. Here in Roanoke VA they pop up as REO’s on MLS from time to time but for the most part require your active search for “people problems” that you can solve… Highly “motivated sellers” are your target.