The real estate business relies heavily on the people and numbers you are confronted with on a daily basis. I am confident in saying that anything you do will involve these two aspects. However, for the sake of this article, let’s focus on the numbers; something we can actually quantify. To that end, the numbers should be your starting point on any deal. You will find that there are many costs that, when added up, have a huge impact on your bottom line. Without taking these expenses into account, a deal that looked like a home run will net only a small profit. Whether you are looking at a buy and hold property or something you can rehab, the numbers will dictate the strength of any deal. Here are some hidden real estate costs that you need to be aware of before you sign on the dotted line:
With every purchase that you intend to hold for any period of time, there are a set of costs that need to be accounted for: carrying costs. These are the costs that you carry from the time of your initial purchase to the time you sell or rent the property. They include large items like the mortgage payment, insurance and property taxes. They also include smaller items like utilities and maintenance. Every day that you own the property, you are on the hook for these items. When you sell, they will be prorated and factored into your bottom line. It is always best to go into any property with the worst case outlook in mind. These costs are usually much higher than you anticipate, and – if not – you should consider yourself lucky. If you are looking at a buy and hold property, you need to factor holding costs into your monthly bottom line. These costs will be there on every deal, big or small, and need to be accounted for.
Anyone that has ever purchased a property has a basic idea of the closing costs. These are the costs you pay to close the deal. Depending on how you financed the property, they will include bank (or hard money) fees, attorney fees, title search fees, lender points and title insurance costs. While your property tax escrows aren’t a true closing cost, they are still a cost that needs to be considered at closing. Your lender needs to hold some money in escrow to pay your property taxes and homeowners insurance. They will take anywhere from two to six months of taxes, and could take up to a year of homeowners insurance. The total closing costs are based, to some degree, on the purchase price (not the loan amount). Even if you are putting down a large chunk on the purchase, items like title insurance and commissions are based on the purchase price. A general rule of thumb is that your closing costs will be anywhere from three to five percent of the purchase price. Fortunately for buyers, there are now regulations in place that ensure your loan estimates will be within one percent of your actual costs at closing. Look at your estimate to get a better idea of where every dollar is allocated.
If you enlisted the services of a mortgage broker or real estate agent, they will be due commissions at the closing. There are a couple of different ways mortgage brokers get paid. The first way is by charging points based on percentage of the loan amount. The second is by getting paid from the lender based on the rate they provide. Under this scenario, there are no costs to you other than your increase in rate. Real estate agents only get paid by commission. They will get anywhere from one to three percent depending on what side of the transaction they are on, and what their agreement is. Real estate agents can also collect fees for finding tenants, and possibly even for finding comparable listings. You should also expect to pay a commission when, and if, you sell your property. Alone, the commissions will not break the bank, but together they will equal a fairly sizable chunk.
On every real estate transaction, Uncle Sam expects his money. However, there are a few definite advantages that real estate investors offer. In addition to the ability to write off depreciation and expenses on rental properties, you can defer your capital gains tax for a limited period of time. If you do not sell within this period, you are subject to a capital gains tax, assuming you made more than the qualifying number. This number could be as high as 15 percent. This has to be a consideration when listing your home and timing the sale. You can avoid this by reinvesting in a new property, but sooner or later you will have to pay the piper. Even if you don’t pay on this sale, you need to factor these numbers into your year-end tax return. One way or another, the government will always get their money.
As an investor, you are judged on your bottom line, and not just the number of transactions you complete. It is critical that you understand all of the costs and expenses involved in your deal. An omission of an expense or two can quickly turn a good looking deal into one that you wish you never got involved in.