Do Future Sell-Side Commissions Affect Buy Price?

Question

My question is in regards to how commissions and vacancy affect the buy price. I understand when flipping a house, most calculations take into consideration how much you'll have to pay in commissions when you sell the house. My questions is focused on the buy and hold strategy. First - how many years do most investors consider a "hold" for? Let's assume I buy a property for $100,000 and it cash flows $200/mo and brings in $1,000 in rental income/month. Eventually, when I sell the property I'll have to pay $6,000 in commissions (not considering any appreciation). This would take 30 months to break even on if I had absolutely zero months of vacancy. I understand you calculate a percentage of vacancy in the buy-side formula but that doesn't seem to account for an absolute true vacancy for a month.

Bottom line - I seem to understand the general "rule of thumbs" when it comes to cash-flowing the house and making sure you buy it right so that you can accomplish that. I'm not understanding where future expenses are considered that will dramatically eat away all the cash flow.

Doug McLeod · Answer

Brad, you are thinking smart. Yes, you have not only the 6% commission but usually some other items when you sell. My mentor says to plan to have 8% selling cost all together. In calculating return, this simply nets out of the sales price. Don't forget you are getting some equity pay down along the way and in many/most cases there will be some appreciation over the hold period. So with high appreciation, you can seller sooner without the transaction cost eating all your profits. For average appreciation markets it might take 3-7 years before selling make sense. In low/no appreciation markets, you want higher cash on cash returns that will offset the lack of appreciation and so you can at least exit the market in 7-10 years if you need to without losing money or you will have been able to save some of the cash flow to make capital improvements and continue to hold the property.

Also, you want to buy at a discount so that much of the equity margin you need to avoid selling costs eating up all your aggregate cash flows is captured at purchase (and perhaps some significant gain above that).

Brad Meyer · Answer

Thanks Doug!

Doug McLeod · Answer

@Brad Meyer - also, vacancy is a hole is the incoming cash flow. Often the number used for calculating returns represents less than a full month rent because it is very possible in good rental markets to have less than a month vacancy. Tenants who have been screened properly generally will not destroy your property and will usually give you notice, allowing you to market the property while still occupied, have a new tenant lined up ready to go, and move them in very soon after the prior tenant leaves. I've turned one over as fast as 3 days when the only work to be done was a good cleaning. But that's not always possible.

Do Future Sell-Side Commissions Affect Buy Price?

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