What is MAO in real estate?

"Maximum allowable offer" (MAO) in real estate is essentially the highest offer an investor can make while also making a profit on an investment property or home. Understanding profitability helps investors to make informed decisions, avoid risks and maintain competitive advantage, among other benefits. Since profitability and good decision-making are key components of successful real estate investments, it's generally a good idea to familiarize yourself with how MAOs work and how they're calculated.

How do MAOs work?

Calculating MAO in real estate is generally a straightforward process using the MAO formula. This formula requires knowledge of a few key figures:

• Renovation and repair costs
• After-repair value (ARV)
• Fixed costs
• The 70% rule

Here's what those figures mean and how you may pinpoint them:

Renovation and repair costs

If you're trying to bring a property to its optimal condition, you're probably going to have to pay to fix it up in some capacity. This could mean a relatively inexpensive task like painting a room (or even the entire home), or a more complex undertaking such as a bathroom remodel. To accurately calculate MAO, it's best to have an estimate of how much repairs will run you in total. One way to do this is by getting estimates from local contractors after the property is inspected.

After-repair value (ARV)

After-repair value (ARV) is the estimated value of the property after those repairs have been completed. This estimated value is usually found by surveying comparable sales in the area of the property and assessing the property's location and condition. Once you've found a few similar properties, you can use the average or median sale price to get an estimate of the ARV.

Fixed costs

Fixed cost refers to expenses such as closing costs, real estate commissions, insurance and property taxes. Once you've figured out the sum of those costs, or a close estimate, you'll be able to plug it into the MAO formula.

70% rule

The 70% rule is a widely accepted guideline that may help buyers and real estate investors recognize potential deals and avoid overpaying. The 70% rule suggests that you should not pay more than 70% of the ARV, minus the repair costs. The idea here is that using these calculations will help you make an informed decision that give you your desired profit. For ease of calculation, the 70% rule is converted into a decimal value of 0.7 when being plugged into the MAO formula.

How are MAOs calculated in real estate?

Once you've calculated repair costs, the after-repair costs and fixed costs you can plug them into the MAO formula. While this formula may vary depending on the source, you'll find it's usually some variation of the following:

MAO = (ARV * 0.7) - Estimated repairs - Fixed costs

For example, let's say you're interested in purchasing a home that you intend on renovating and then flipping. You've determined that renovations and repairs will cost $30,000, fixed costs will be $10,000 and the after-repair value will be $320,000. The MAO calculation for this example should look like this:

MAO = (320,000 * 0.7) - 30,000 - 10,000

After running the numbers in this scenario, the MAO would be $184,000.

Depending on your situation, you may have more or less flexibility with your profit margins, so remember that the 70% rule is just a guideline. Some people might use a smaller number in their formula, and others may use a larger one. It may be good to do your own analysis of the property, its condition and any hypothetical costs you might incur before deciding to use the 70% rule. Another option would be to consult a professional to help you pinpoint the right MAO for you.

In summary

MAO in real estate is a figure that represents the maximum allowable offer you can make on an investment property while staying profitable. The exact formula to calculate MAO may vary based on the property in question and your own situation, but it's generally calculated by multiplying the after-repair costs by 0.7, and then subtracting fixed and repair costs. While this isn't an exact science, knowing how to calculate MAO could help you make more informed decisions, avoid overpaying and hopefully enjoy some healthy returns on your investment.