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.