Real Estate Investing

Before you invest in real estate, it's important to look at carrying costs, closing costs, commissions and capital gains taxes. Here's why.

If you got your real estate information from reality TV and infomercials, you'd think all there was to being a real estate investor was fixing and flipping, then flaunting the cash you just made, or buying a rental property with *No Money Down!* then letting your serfs, I mean, tenants, pay your way to everlasting riches and unlimited fabulosity.

That's not exactly how real estate investing works. (Sarcasm intended.)

Fabulosity isn't free. Part and parcel of being an investor and {RE}Thinking Real Estate is getting face-to-face with the math that must be done to project whether any particular investment will be profitable or painful, financially speaking, and doing it right. In fact, part of what we do at {RE}Invest - the real estate investment consultancy powered by {RE}Think Real Estate - is to do the math for and with our clients, making sure that no foreseeable line item expense goes unaccounted for in the pro formas (projected cash flow and financial analyses) that we do before our clients purchase any investment property.

When I see real estate investors come into {RE}Invest as either novice investors excited about a potential investment opportunity or as experienced real estate investors looking for assistance in analyzing and managing their portfolio of real estate investment properties, there are about 5 very common line items that many of them have completely overlooked.

1. Carrying costs. Carrying costs are simply the costs attached to owning a property, namely:

  • Mortgage payments;
  • Property taxes;
  • Insurance;
  • Owner-paid utilities, and (for rental properties);
  • Management costs (if you pay a manager or tenant finder);
  • Vacancy expenses (i.e., the amount your occasional vacancies will "cost" you, depending on how much time your rental unit(s) spend vacant);
  • Maintenance costs (e.g., gardener, snow removal, property repairs and upgrades); and
  • Business license fees & taxes (if applicable in your town).

If you're trying to fix-and-flip a house, you need to account for the amount of carrying costs you'll need to pay during the construction/rehab period. If you are holding a property for rental, you'll need to make sure you have clarity on the dollar amount of your monthly expenses before you can know how the incoming rents will impact your cash flow.

2. Closing costs. A.k.a. transaction costs, closing costs are simply the price you pay to do business as a real estate investor. When you buy or sell a property, there are inescapable costs attached to all the products (mortgages, title insurance policies, homeowner's insurance policies) and services (of the Realtors, mortgage brokers, attorneys, escrow/closing agents, inspectors) you use in the course of consummating the transaction. If you are purchasing the property, and you elect to pay your property taxes and hazard insurance through your lender with an impound account, your closing costs will include a few months' worth or more of prepaid property taxes and insurance. And, last but not certainly not least, many cities and counties impose transfer taxes - a *special* tax that is imposed on every sale/purchase of real property within that jurisdiction. Closing costs vary based on your jurisdiction and the purchase/sale price of the property, but generally buyers should estimate closing costs to be around 3 percent to 5 percent of the purchase price of the property, while sellers should expect their closing costs to run about 7 percent to 10 percent of their sale price. If you are investing in real estate using a 1031 exchange strategy, you are buying and selling simultaneously, and stand to incur an additional 1 percent (approximately) in the costs associated with effecting the 1031 exchange (intermediary and CPA fees).

You can see how, if you want to rehab houses for quick resale or even buy, hold and sell rental properties, you need to factor closing costs into the costs of your fabulosity.

Zillow Real Estate Search

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