Maximum Allowable Offer

The maximum allowable offer is a rule of thumb framework that provides the beginner real estate investor with a formula to determine a ceiling when making offers to sellers of distressed property. It's the simplest form of property investment analysis there is.

Where
ARV = After Repair Value
RE = Repair Estimate
WP = Wholesale Profit
The MAO Formula is expressed as follows:

Of course, if you are not a wholesaler, you don't need to subtract the wholesale profit. The simple premise behind the "maximum allowable offer" is that savvy landlords and rehabbers are most likely to do a property investment analysis with the aim of buying distressed properties at 70% of value (a 30% discount) for a house in perfect condition.

Such a discount gives a rehabber the margin for "fixing and flipping" and the rental property investor gets a better opportunity for cashflow-positive properties.

And it does a good job with that...

On the other hand, this advantage can be nullified if you "over-estimate" the value of the property. Knowing how to properly value property, and how to apply local economic and financing conditions to the value of local properties is the most important technical skill a new real estate investor can learn.

The next potential complication in the use of MAO is in under-estimating repairs. This may be the most dangerous and most common mistake made by real estate investors.

However long it takes you to learn how to estimate repairs, do so. You also want to make it a habit to leave a cushion in your deals to account for hidden costs.

The last potential difficulty with using the formula occurs when market conditions change. One of the reasons why the 70% formula worked is because private mortgage lenders (also known as "Hard money lenders") often used it as their "loan-to-value" limit - the ratio of the amount they lend to the value of the collateral that secures the loan.

When conditions change, these private lenders will usually revise their lending criteria downward. If you don't stay on top of things, you could end up locking up deals at prices higher than investors in your area are willing to pay or able to finance.