In Defense of the Landlord
The Hidden Costs of Real Estate Deals: Why the Owner Doesn't Get All the Money
Real estate transactions have many layers and there are a lot of hands that need to be fed. In our previous article we explained how 51 People Get Paid in a single renovation. Fast forwarding from the purchase, through the rehab, and landing at the rental stage of a deal, the same concepts apply. Although there are plenty of other benefits with owning real estate, a word to the newbie investor; if you plan on quitting your job to buy, renovate, and rent out a single house (which can very well cost you an entire year’s salary) in order to break free from the rat race - consider this.
As the face of the operation, the investor (or owner) of a piece of property, you don’t make ALL the money. There are many hands that grab at your cookie jar, and when all is said and done, you actually don’t make even a quarter of all the money.
Take this example from a property in South Bend, Indiana. Just an average property, this house was renovated and turned into a rental during the winter. Here are the numbers:
$1,300 Rental Income (100%)
$715 - Mortgage (55%) (48% Interest AKA the Bank & 7% to Principal)
$100 - Property Tax (7.7%)
$50 - Insurance (3.8%)
$130 - Property Management (10%)
$65 - Maintenance Reserves (5%)
$65 - Vacancy Reserves (5%)
$1,125 - Total Expenses (86.6%)
$42 - Income Tax
$133 - After Tax Profit for Investor (13.4%)
It might not surprise you to see that the BANK actually makes the highest percentage of the pie. In this example, this $108,000 loan to your name leaves you with $175 in profit minus of course income tax, let’s say at 24%, which puts $133 in your pocket each month. When it comes to the cash flow, it’s not a life changing amount.
Hidden Costs
This becomes most important when analyzing a property. Most non-experienced investors will consider the selling price of the property and the loan. What’s the term lenth, interest rate, and monthly cost but there are a LOT more line items in a purchase. To name a few:
Appraisal
Inspection
Title Deep Prep
Title Wire Fee
Insurance Pre-payment
Government recording fees
In this same transaction the Finance cost, meaning the cost of prepaid interest can come due at the time of closing addding in another $5,000-$10,000.
When you look at your personal bank statement and realize you’ve spent $1,500 over the course of the month, it’s not typically from major purchases but rather many small consistent charges. A coffee here and a burger there really add up.
In this scenario the house was also purchased with a significant amount of cash! There were closing costs, title fees, Realtor commissions, surveys, appraisals, and plenty more that adds up. Our last deal cost us over 10% of the loan amount in financing and title costs.
If you see an investor doing well it means he has been at it a long while. Nobody in the investment game preaches getting rich quick. Investment is a phenomenon of compound interest and snowballing assets into extreme wealth. After time, yes it’s easy to flaunt the massive gains that may come monthly or yearly, but getting there is no cake walk.