A maximum allowable offer is the highest price at which a purchase still pays: the value expected at exit, minus the costs to buy, hold and sell, minus the margin the buyer requires. It is a walk-away number, and the first offer goes below it. The value at exit moves the answer more than any other line; on the example parcel below, a 10 percent miss on value takes almost 16 percent off the maximum.
The formula, one line per decision
Maximum allowable offer
= value expected at exit
- costs to buy
- costs to hold
- costs to sell
- required marginEach line gets a number and, beside it, where the number came from: a sale, a quote, a tax bill, a public record, an estimate, or a guess marked as a guess. The maximum offer worksheet prints with a source column on every line.
Value at exit comes from the comps
The first line is the price the buyer expects to sell for, taken from confirmed, adjusted comparable sales. A comp range has a low end and a high end, and the worksheet records which point in the range goes into the arithmetic and why. In the worked example below, using the top of the range ($55,000) instead of $47,500 raises the maximum by $6,525. The comping guide builds this number.
Every cost the deal carries
For vacant land the usual cost lines are:
- To buy. Closing and title costs, recording fees, a survey where the deed description is unclear, and any back taxes the seller owes that the buyer agrees to pay.
- To hold. Property tax for each month of ownership, insurance, loan interest when the purchase is borrowed, and any upkeep the county requires.
- To sell. Commission or marketing, and the seller's share of closing costs on the resale.
Farm and timber land can carry one more line. The federal land appraisal standards note that many current-use assessment programs, which tax farmland, timberland and open space on their current use, require back taxes and a substantial penalty when the land is converted before an agreed period ends (Yellow Book, 2016, section 1.3.1.7, note 43).
Texas is one example. When land under the state's agricultural appraisal changes use, the owner owes a rollback tax for each of the previous three years it got the lower appraisal (Texas Comptroller, agricultural and timber appraisal). The tax is the difference between taxes on agricultural value and taxes on market value, and some land owes interest too. The county assessor or appraisal district can say whether a parcel is enrolled.
The margin as three lines
The Offerbender worksheet puts the margin on three lines:
- Profit. What the deal has to pay the buyer for the money and the time.
- Risk buffer. A dollar amount for each known risk not yet ruled out, named one by one. An untested septic site is a risk buffer line.
- Error buffer. Room for the estimates being off, set as a share of the exit value, since that line moves the answer most.
When a test comes back clean, its risk buffer goes to zero, and the maximum rises by that amount.
A worked example
Invented numbers: the parcel is the 10-acre lot from the comping guide, with a likeliest value of $47,500. Selling costs are assumed at 8 percent of the exit value, the error buffer at 5 percent and the holding period at 9 months.
| Line | Amount | Where it came from |
|---|---|---|
| Value at exit | $47,500 | Comp range $45,000 to $55,000, closest-matched sale |
| Closing and title to buy | minus $1,200 | Title company quote |
| Survey | minus $2,500 | Surveyor quote |
| Back taxes owed by the seller | minus $800 | County tax record |
| Property tax, 9 months at $50 | minus $450 | County tax bill |
| Selling costs, 8 percent of $47,500 | minus $3,800 | Guess |
| Profit | minus $8,000 | Set by the buyer |
| Risk buffer, septic not yet tested | minus $2,000 | Estimate |
| Error buffer, 5 percent of $47,500 | minus $2,375 | Set by the buyer |
| Maximum allowable offer | $26,375 | Rounded down to $26,000 |
Costs total $8,750. The margin totals $12,375, of which $8,000 is profit and $4,375 covers the untested septic site and the chance that the estimates are off. Rounded down, the walk-away price is $26,000.
The 70 percent rule on a cheap parcel
The 70 percent rule is a rule of thumb from house flipping, with no single source: the maximum offer is 70 percent of the after-repair value, minus repairs, and the 30 percent held back is meant to cover closing, holding and profit together.
On the example parcel, 70 percent of $47,500 is $33,250, with no repairs to subtract. That is $6,875 above the line-by-line answer. The gap comes from costs fixed in dollars. The survey, the closing costs and the back taxes add up to $4,500, about 9.5 percent of a $47,500 parcel and under 1 percent of a $475,000 property, and a flat 30 percent allowance cannot tell the two apart.
The line that moves the answer most
The table changes one line of the example at a time:
| Change | New maximum offer | Drop |
|---|---|---|
| Value at exit 10 percent lower, $42,750 | $22,242.50 | $4,132.50 |
| Survey costs twice the quote, $5,000 | $23,875 | $2,500 |
| Held 6 months longer | $26,075 | $300 |
The value line moves the answer most because the selling costs and the error buffer move with the value, while the fixed costs stay put.
Farmland values have moved far more than 10 percent within a decade. An FDIC article from 2008, looking back at the farm crisis, records that farmland values rose 80 percent in inflation-adjusted terms from 1971 to 1981, then fell between 1981 and 1992 to near their level before the 1970s, and that 297 farm banks failed between 1977 and 1993 (FDIC Quarterly, 2008, volume 2, number 4).
When the answer is zero or close to it
Sometimes the maximum comes out at zero, below zero, or below any price the seller could accept. On the example parcel that happens when the value at exit falls to about $17,200: the fixed lines (the $4,950 of buying and holding costs, the $8,000 profit and the $2,000 septic buffer) total $14,950, and the selling costs and error buffer take 13 percent of the value. A buyer with lower costs, a smaller margin or another use for the land can still pay more for the same parcel.
New evidence partway through a deal
Continuing the example, the survey comes back at 9.2 acres instead of 10. At the same $4,750 an acre, the value at exit becomes $43,700, the selling costs fall to $3,496 and the error buffer to $2,185. With profit and the risk buffer unchanged, the maximum falls from $26,375 to $23,069, so any agreed price above $23,069 no longer fits the sheet.
Past the walk-away price
The sheet stops at the walk-away price. Where to open below it and how to answer a counteroffer are negotiation questions, which this site does not cover.
Sources
- Interagency Land Acquisition Conference, Uniform Appraisal Standards for Federal Land Acquisitions (the Yellow Book), 2016 edition, published by the U.S. Department of Justice. Section 1.3.1.7 and note 43.
- Texas Comptroller of Public Accounts, Agricultural, Timberland and Wildlife Management Use Special Appraisal, undated web page.
- Federal Deposit Insurance Corporation, Do Record Farmland Prices Portend Another Steep Downturn for Agriculture and Farm Banks?, FDIC Quarterly, 2008, volume 2, number 4.