Closing costs in Rental Income?

Question

Hello Internet's Landlords! This is my first post on BiggerPockets, so please forgive any lingo spelling errors and the like.

I am interested in buying a rental property. I know the purchase price, approximate rental income, obvious expenses (taxes, ins, prop management, etc)..... but I want to know if anyone also budgets for possible future closing costs in their numbers? Or is that just a sad fact of life?

I am thinking to budget 10% of the purchase price (conservative estimate of closing costs with wiggle room) divided over 10yrs of income. Which amounts to 1%purchase-price-a-year set aside. Ex: A 2/1 SFH which costs $84,000 (cash, no mortgage). Set aside $840/year or $70/month for paying future closing costs (should the need or want to sell in 10years time come up.) If I don't sell in 10years then I have a useless saving acct with roughly $8,500 sitting there, doing nothing, BUT if I do sell then I won't lose out on basically all of the income/profit made over the last 10years?

Am I being too caustious or too parinoid? Is my math wrong? What about apperictaion on the house or inflation values? Am I over thinking this? (0_o)

Amanda Green · Answer

Hi all. Thank you for every ones input. Yeah my husband and I agree that it's silly to worry about closing costs, because we really aren't interested in selling suitable rental properties at any time in the future.

Plus I agree that the closing costs would technically be paid out of the appreciation   in the event I "needed" to sell the property. I was just over thinking it and being too conservative.

Alexander Felice · Answer

I wouldn't count it.

it's not an expense of the property, it's a transaction expense at the time of sale

you don't know when you'll sell. sure you say 10 years, but that is hard speculation to corroborate when you don't even have the first unit yet. What if you sell in 6 years, what about 25?

Can you negotiate different closing costs when you do sell, in 10 years?

You say if you sell this house in 10 years the only way you'll be profitable is if the tenant pays for closing costs of $8500??? If that's the case, there is no deal to be found here LOL

Those questions are sort of rhetorical to get to a larger point. The pool of gross rental income isn't subdivided into expense categories, it's just income. You build reserves as time goes on, and expenses go out as needed. In 10 years you may have 15 units and an $8500 is a nothing expense that just comes out of the business account. So you can set this money aside, but you're going to be setting aside that money anyway. If you don't have maintenance or capex or vacancy expenses for 3 years that doesn't mean you blow the cash. you can't change the market rent, and you shouldn't spend the money really anyway (except to redeploy). So you're analysis is slowing you down but doesn't change any real world profitability.

Should you account for EVERY possible future cost? Impossible! should you kill this deal because your analysis says it won't cash flow enough after setting aside potential future closing costs for a home sale in an unknown amount of time for an unknown sale price and complete dismissal of all appreciation.   it does seem overly cautious ;) ;)

You can't account for everything. Rather, there comes a point where it's not productive to. You count for the big stuff, but are you calculating the loss of buying power of your cash after inflation? Are you hedging this against potential state and income tax law changes over the next decade? What about potential changes to mortgage rates?  The variables to account for can be made staggering quite quickly, the reason people don't go overboard in analysis is because real estate is pretty damned lucrative when you get even CLOSE to doing it well.

I have a friend who far over analyzes deals. He misses deals all the time because he thinks they won't be homeruns, you don't need homeruns! do a shit ton of singles and you'll find some homeruns in between, promise.  Make sure your deal works on paper, ask a few people to double check, and get in the game.

Sorry for the long response, I didn't realize I had gotten so carried away  :D

Ben Raygor · Answer

People, usually, don't seem to think hard about closing costs before the purchase of a property, unless they are flipping it.  If the property is going to cash-flow well enough as a rental property, most people just plan on holding onto it until it appreciates enough to result in a nice long-term capital gain at the sale, if that is their strategy.  In that case, the taxable gain will be reduced by the amount of closing costs that you need to pay.

When properties are sold at a loss, closing costs that need to be paid could "wipe out your income/profit", sure.  But if the property cash flows for you, why would you sell it at a loss at all?  You would want to hold onto it and wait for a better market to sell it in UNLESS 1) selling it will relieve you of a massive headache and is worth the loss in cash, 2) selling it will allow you to invest funds in a bigger and better deal (happy scenario) or 3) some life circumstance happens and you just need cash bad, for medical or a home emergency (sad scenario) - people are selling stuff at a loss everyday because they really need/want the cash for something else.

You are making a conservative calculation by not assuming that any appreciation will happen.  If you purchase a property at $84,000, rent it out for 10 years, sell it for $84,000 plus pay $8,400 in closing costs, and if those closing costs exceed your rental profit totals for 10 years, then it would probably be considered a foolish investment.  All that work just to have less cash in your pocket in the end...people typically wager that their rental profits will exceed the difference between their purchase price and their sale price (after paying any closing costs).

10 years might be the problem with your calculation.  You, generally, wouldn't go through all the work of acquiring a rental property and being a landlord just to turn around and sell it the next year without some serious appreciation happening.  Just like 1 year, 10 years might be too short of a game plan for a rental with no appreciation assumed.

Doug Woodville · Answer

@Amanda Green I have never heard of accounting for this in any of the forum posts I've read. I suppose if you are doing a buy and hold for appreciation then that might be beneficial? But wouldn't it work better if you were to save the total amount in closing costs that you THINK it will sell for in the future? So in your example maybe it appreciates to $104,000- wouldn't you want to account for 10% of that versus the $84k?

I'm curious what others will say but off the top of my head I'm thinking you're "overthinking" it. I'd like to be proven wrong!

Closing costs in Rental Income?

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