Look around over the next few weeks and you will see something interesting. Some investors will be struggling or going under, while other investors will be excited by the opportunities to buy which the changing market represents. We are at the beginning of “the big shakeout.” By that, I mean that almost anyone who bought a house in the DC area from 2000 to 2004 saw their property value skyrocket over this period. We all knew that it couldn’t go on forever, but none of us knew just when this “meltdown/adjustment/downturn” would occur. Some investors have been calling for it for years. Well, it’s here and it’s going to be with us for a while! Hopefully, this excites you, because while most people will be sitting out the next few years of real estate investing because they are afraid, those who understand the fundamentals are chomping at the bit. I’m closing on a house ¼ mile from the gates of the Suitland Federal Center Metro this week at about 50 cents on the dollar. Yes, I’ve been waiting for this!
So, what do I mean by the Back to the Fundamentals Strategy? Many investors forgot the most basic rule over the last few years because the money was coming fast and easy. Lots of folks thought the music would never end. Well, it’s pretty quiet right now. And that presents opportunity.
The most basic rule of the Back to Fundamentals Strategy is Maximum Allowable Offer (MAO). And let me tell you that it is more important now than ever. The MAO rule of thumb states that the ideal price an experienced investor should pay for a house is 70% of the After Repair Value (ARV, that is the price the house will sell for when repaired and looking nice) minus the repair costs. An example is helpful: You get a lead on a house that has an ARV of $300k and it needs $30k in repairs. The MAO for this house is $180k. Unexperienced investors will look at this spread and think, “That’s so much of a cushion. Seems like I’ll do great if I pay $230k.” Wrong. When you properly analyze all the costs involved in buying (think closing costs, transfer taxes, commissions, etc) holding (think unexpected rehab costs, utilities, insurance, interest payments) and selling/renting (think commisions, advertising, closing costs, transfer taxes, etc.), you will find that MAO is a helpful guide that will keep you out of trouble. And when an experienced investor buys a house using this formula, he/she will almost always make a fair profit.
