How much above estimated market value should you offer on a home that is not for sale in order to actually entice a home owner to sell?
How much should you offer on a home that is not for sale? How much above estimated market value? Is there a standard calculation for gauging what might be tempting to a home owner.First, it depends on your objective. So you want to live there yourself? Do you want to u201cflipu201d the house? Do you want to use it as a rental? Each of these will produce different answers to the question.Iu2019m tempted to go into a lot of detail on this, but Iu2019ll refrain. Iu2019ll just begin by saying that the question is full of false and inaccurate assumptions.And to quickly answer one question: u201cIs there a standard calculation for gauging what might be tempting to a home owner?u201d No.Itu2019s also missing a couple of key points. The first is that the question is u201cHow much should you offer?u201d The question is not how much you should offer, but how much you should spend. Those two can be quite different. The other key pointu2014as weu2019ll seeu2014is whether youu2019re paying cash or borrowing the money.Letu2019s consider those three options:Live there yourselfFlip (and wholesaling)RentalLive There YourselfPay no more than the fair market value of the house in its current condition minus double the amount needed for repairs. Example: The house is u201cworthu201d $300,000, but needs $15,000 in repair. The most you should pay is $270,000. u201cDouble the amount need for repairsu201d helps build in a u201cfudge factoru201du2014a cushionu2014to account for unexpected repairs. It also helps compensate the buyer for having to go through the hassle of getting the repairs done.FlipPay no more than 70% of the after-market value minus repair costs. In our example above, 70% of $300,000 is $210,000. Subtract $15,000, and the most you should pay is $195,000WholesaleA wholesaler puts the property under contract, and then assigns/sells the contract to a rehabber. We already know a u201cflipperu201d (rehabber) wonu2019t pay more than $195,000. The wholesaler subtracts his/her fee. So if the wholesaler wants to make $10,000, he/she has to put the house under contract for no more than $185,000.RentalThe calculations for a rental property are entirely different. Here, it really doesnu2019t matter what other houses are selling for if theyu2019re being lived in. Instead, you look at income the house will generate and then factor in a figure (often incorrectly called the u201ccap rateu201d when referring to residential rentals). This varies geographically. Still, the question is: What do you want (and what will the market allow) as the return on your investment? If you spend $300,000 on a property, you might decide you want to make 10% on your investment. That would come out to $30,000 a year, or $2,500 a month. Youu2019ll have to investigate and see what you could get for rent on such a property. Another very rough rule of thumb says itu2019s a good deal if you can get rent per month equaling 1% of the purchase price. Using this formula, youu2019d expect a $300,000 house to produce $3,000 in monthly rental income.One point I raised above is whether youu2019re spending your own cash on the property or whether youu2019re borrowing the money. If youu2019re spending your own cash, you can spend as much as you want. It might be a poor investment, but you could do it. On the other hand, if youu2019re borrowing money, there are going to be constraints. For example, if youu2019re living there yourself, youu2019re only going to be allowed to borrow some percent (80%-96.5%) of the value of the property. You can spend more, but you wonu2019t get the money from a lender.If youu2019re an investor, you may be borrowing the money from a hard money lender. In this case, there are different constraints, mostly based on the after-repair value of the property and how much it needs in repairs. Itu2019s rare for the calculations to work out that the investor has to spend no money. And even when the calculations do work out that way, many hard money lenders expect the investor to have some u201cskin in the gameu201du2014often 5%-10%.And a final (I promise!) point: The question asks u201cHow much above estimated market value?u201d Above market value? Zero.Oh, I guess there are some reasons why someone might want to overpay on a house. Maybe it was the buyeru2019s childhood home, and heu2019s buying it for sentimental reasons. Maybe itu2019s in a childu2019s school district, and keeping the child in the same school is worth tens of thousands of dollars. Whatever the reason, itu2019s going to be a horrendously expensive purchase. Consider the $300,000 house, above. You decide to pay 10% over fair market value. Letu2019s say the buyer gets a 20% mortgage. The buyer is already paying $60,000 down. Paying 10% over market value means the buyer will now pay $30,000 more, or $90,000 total. But it gets expensive when you realize that if the buyer had to sell tomorrow, the buyer/seller would have lost his entire $30,000.
