Determining Accurate Spreads

Mike: Welcome back to the flipnerd.com REI Classroom, where experts from across the real estate investing industry teach you quick lessons to take your business to the next level. And now, let’s meet today’s expert host.
Brian: Hey guys, Brian Meara from the Investor Entourage here, today’s host of the REI Classroom. And we’re going to talk about determining accurate spreads.
Mike: This REI Classroom real estate lesson is sponsored by theinvestormachine.com, FlipNerd’s private investor coaching program and your blueprint to investing success.
Brian: All right, guys. A lot of times when we’re analyzing deals, a lot of you have sent in a lot of questions and you’re not really sure about how to determine what’s a good spread and what’s not. Specifically, when dealing with a short sale, the standard investor formula, if you take your after repair value, your ARV, you multiple that by 70%, you subtract out the cost of repairs, that’s going to give you your maximum allowable offer. Your MAO. Standard formula. We all know it, if not, I hope you wrote that down.
Here’s the point. That’s going to give you the maximum price you can pay to still allow for your profit, right? In a short sale, it doesn’t work that way. For two reasons. Number one, you don’t know the purchase price. I had this conversation yesterday, and I was talking to somebody. In every other real estate transaction, if you stop and think about it, you know the price.
When the seller agrees to sell, the buyer agrees to buy. It’s at a specific price and that doesn’t change. With a short sale, you go into a contract with a starting price, but because it requires third party approval, because it has to go out to the bank and they have to agree to that, you literally don’t know what the purchase price is going to be. So it’s a very unique situation. That being said, you can’t just run it through some standard formula like that 70% figure. But we do have a formula that’ll work.
So here’s what we do. We take the three lowest comps we can find. Comparing apples to apples. If it’s a single family, single family, same number of bedrooms, same number of give and take square footage. Don’t worry about bathrooms, we tend to find that kind of messes the data up, because they’re not always entered in properly from the agents. But anyway, you take the three lowest comps, generally going, I would say, out a mile. If you can get closer, great, but give yourself a mile and go back six months in time as a general spread.
Of course if you’re in the inner city, you’re more in an urban area, you’re going to tighten up that radius. But for the general parameters, let’s just say it’s six months and a mile. You’re going to average out that figure. You’re going to average the three lowest comps. It’s going to give you a figure. If it’s a 100,000 or less, we’re go in at 65%. If it’s 150 and up, we go at 80%.
We then ask for the three average comps. Now you’ll notice I didn’t say the high comps. We don’t want a CMA and we don’t want the high comps, we don’t want them after repair value. We want the average sale. This house, this particular house, in today’s market, in it’s current condition with no work, what is its 30 day quick sale value? What’s the true value of that house? And we generally like to get at least three, even more, three, four, five comps and we average them out.
Now, when you take the average of the low, and the average of the average, we generally look for $40,000 on our spread. Now, a lot of you may be saying, “Brian, if you take a $200,000 house, 70% using the old formula, gets you to 140. Let’s say you need 30 repairs. You can only pay 110. You say, so you’re taking 40 grand off you mean you’re willing to pay 160 for the house?”
Here’s why that works, guys. We’re looking for 40,000 there because remember our starting offer is on the low comps. So whatever those low comps are, we’re going in at 65 to 80% of that figure which is generally, about equal to that 40 grand. So we’re still creating around the same spread. We’re just working it backwards because of the nature of how a short sale works, how they determine value, and frankly how the numbers kind of pan out.
So worst case scenario, if you’re not getting the spread that justifies you to purchase it, and actually do your renovations and resell it for a profit, you can wholesale it. You can actually wholesale a short sale. It’s called a release in termination of contract and that’s another topic for another day. So, anyway guys, I hope that helps. Until the next time, we’ll talk to you soon.
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