Investing in real estate can be a profitable venture, but it is important to understand the interplay of costs and profits that can affect your bottom line. Taking the time to clearly define costs, especially before making an offer on a property, will help to prevent surprises later.
For example, a new investor might find a house with a $100,000 ARV that needs only $20,000 in repairs, estimating they can purchase it at $50,000. This could make the investor think they can make a profit of 40% on this deal if they decide to fix it and flip it. But there is more to consider than just the initial profit after flipping.
If the house has been on the market for a long time, investors will likely have to pay for holding costs (including things like taxes, utilities, and insurance) during the time between purchasing it and reselling it. Additionally, this investor will likely have to list the house with an agent, who will take 6% for their role in reselling the home.
Whether you’re new to the real estate investing industry, or an experienced investor, you will probably find there are more costs involved in a deal than it first appears. Let’s discuss why this is the case and look into how to calculate these costs before buying an investment property.
- Seller’s Closing Costs
- Carrying Costs
- Seller Concessions
- Commissions
- Prorated Property Taxes
Seller’s Closing Costs:
Don’t forget to factor in the seller’s closing costs when determining how high to bid on a property. This includes the title company escrow fees, title insurance, recording fees, and other title company costs. To calculate the seller’s closing costs, contact a local title company and ask their customary charges for a sale transaction.
Carrying Costs:
Property taxes, insurance, maintenance, and repairs are all expenses you can expect to pay as a landlord. But there’s one cost that can cause significant cash flow problems if you’re not prepared for it. Carrying costs would include utility expenses such as water, gas, and electricity, as well as any interest expense if you borrowed money to purchase the property. If you’re a real estate investor, don’t forget to include carrying costs in your calculations.
Seller Concessions:
When a buyer chats with their real estate agent about how much money they need to bring to closing, the question of allowing for concessions is often overlooked. While that is generally an understandable mistake, understanding how important concessions are can save you from overspending in order to acquire your home.
Commissions:
When new investors, and even some experienced investors, are calculating their costs for flipping, they often forget to account for the commissions they will pay when they sell the house. When preparing your budget, remember that if you are listing the house on the MLS (which you should be doing), you are going to have to pay your agent or broker a commission. In most markets, six percent is the norm.
Don’t forget that another agent or broker will show the property and try to negotiate a commission with your agent/broker. Don’t get flustered when your agent asks you to pay a portion of the other agent’s commission. This is normal in almost 99% of real estate transactions today. Even though it feels like both agents are getting paid a lot of money for little work, remember that marketing your listing is a full-time job in itself.
Prorated Property Taxes:
You will have to prorate property taxes for the term you own a home. At the closing, sellers are required to credit the buyer for the current year’s prorated property taxes. This means that if you sell a home on May 31st, you’ll credit five months of property taxes to the buyer at closing. Typically, this is supposed to be done by your agent and attorney.
Understanding your real estate investing costs is a key component of evaluating any potential deal. Many new investors overlook these expenses and find themselves in the red at closing because they didn’t properly account for their costs. Keep the overhead costs in mind when deciding to buy a deal you are planning on flipping so you know what to expect at closing. Remember, these numbers will vary based on the value of your deal and how long you own it before it sells.
