What is MAO?

For real estate newbies MAO is the Maximum Allowable Offer you can make on a property and still remain within your margin of safety.

And I bet you thought MAO was a condiment! :)

So how do we arrive at the MAO?

Well first of all you should know that MAO is not a fixed in stone formula that is the same for everybody. This is simply because not everyone requires the same margin of safety. However, having said that, a common formula for MAO is as follows:

Start with the ARV or After Repaired Value of the property. The ARV must be based on recent comps in the area. DO NOT base your ARV on Zillow! The better your comps the more accurate your Maximum Allowable Offer will be.

Estimate the costs of repairs you will need to do to make the property ready for resale. This includes major repairs needed, any updating required, and don't forget paint and carpet, etc.

Take 70% of the ARV and subtract from that the costs of repairs. That's your Maximum Allowable Offer, your MAO. You need to back a little bit more off this value before you begin your negotiations with the seller. It also doesn't hurt to add a bit more to your repair costs to allow for a little wiggle room. But not too much or you might not be able to purchase the house!

While MAO doesn't guarantee success it certainly gets you in the ballpark. As a beginning investor you will still need to be able to put proper financing on the property, manage it well during your holding period, and do a good job when it comes time to sell.

How the Risk Balance Affects the Price I Can Pay

When evaluating properties and the offers I make it all comes down to this:

The more risk I have to take, the less I can pay you.

The less risk I have to take, the more I can pay you.

So, knowing that, as a property owner trying to buy my money with your property which route would you have me take?

The bottom line is I'm in this business to make a profit. If I can't make a profit there can be no deal. But that still leaves plenty of room as to how we can work together to meet both of our needs.

What is Appreciation?

Appreciation is the gain in value of a property that is realized when the property is sold.

There are a lot of factors that may contribute to a property appreciating in value. Zoning, the local economy, local property values and sales, improvements (or neglect) of the surrounding area all affect appreciation.

Keep in mind however that one of the major contributors to property appreciation is actually the decline in value of the local currency. That's one of the reasons that real estate and precious metals are hedges against inflation--they appreciate in value as the value of the currency goes down.

Cash Flow vs Appreciation

Here's a simple fact to consider. Appreciation is a feel-good speculative number. It is what might be...maybe...if you can sell at the right time to the right buyer. But you just never know until you collect your check from the title company or attorney how much "appreciation" you really got when you sold your property.

Unfortunately too many speculators and flippers discovered that appreciation can be a negative number as well and can eat your financial statement alive.

Cash flow, on the other hand is money in the bank. Another way to put this is "Cash flow is what is, not what might be"

Just food for thought...

Financing and Management Determine Cash Flow

Of the two financing is probably the most important. With bad financing it's easy to create a situation where the property will never cash flow until it has been paid off (which may be sometime after you have gone bankrupt and/or lost the property to someone else).

On the other hand, with good financing virtually any property can be made to cash flow.

Often there is a trade off between properties which are most likely to cash flow and those most likely to appreciate in value. Never speculate on appreciation. Make your business model to only buy properties for cash flow and let appreciation be the icing on the cake when you sell.