How much do you subtract from your net worth for transaction cost

Question

How much as a percentage of asset value do you subtract to come up with your true net worth assuming any real estate sold will be 1031 exchanged? I know this number will vary by state, property type, and for various other reasons, but I am wondering what a good average percentage would be in the single family and condo space so that I can have a more realistic net worth picture on my mint.com account.

I know this is somewhat trivial because cash flow is more important to me in the end, but I want to have a healthy picture of my financial well-being and future.

Another question I wonder about is how you factor taxes into it if at all?

I know this is somewhat trivial because cash flow is more important to me in the end, but I want to have a healthy picture of my financial well-being and future.

Another question I wonder about is how you factor taxes into it if at all?

Andrew Kerr · Answer

@Brian Maida you can always figure that 5-8% cost to sell a property. Then figure 15-20% on capital gains.

Relating to strategy about paying down or buying more, my focus in 2018 is to build up a cash war chest and deleverage. I am choosing this route as I feel we are way closer to the top then the bottom. As an example, I have three college rental properties in Raleigh with a blanket loan on them. I am selling two of them and will be left with the third free and clear. My cash flow will be pretty close to the same. To me, where I feel we are at in the cycle, this seems safer. It gives me a free and clear property, and lowers the overall LTV in my portfolio. My target with debt servicing is that my whole portfolio will be able to sustain itself at 50% - 60% occupancy. I feel this will still let me get appreciation, along with cash flow but protect me from any recession. But, this is really my personal preference.

Dave Foster · Answer

@Brian Maida, selling costs in a garden variety transaction usually run between 6-10%.  There's still room for lots of variance above and below that but estimate 10% and you'll be on the high side of hand grenade math and that will work.

But I think you've already figured out that other than the snapshot of time right now that current net worth number doesn't mean much.  Far more important are the relative rates of return in figuring your end game calendar.  5.9% seems to be your assumption.  And from there it sounds like you're backing into your cash flow - which is fine to do.  But then take it one step further.

Play with returns above that and below that and look at other sectors current performance.  Then take a look at your other question which is leverage and not and do the same thing:  leave the return constant and manipulate the leverage.  Then place the two variables into play with a constant amount of cash (now use your current net worth).  I think that will give you a grouping of data to begin forecasting a strategy.

I always  found it interesting that Wall street companies love to give you an expectation number (4% was one I saw a lot) rate of return for your retirement investments.  Plan your retirement around a 4% rate of return.  So the only answer to have more for retirement was to save more.  OK plan but only half the equation.  All that kind of marketing serves to do is to set/lower your expectations of your fund manager and incentivize you to place more money with them that they can manage to a mediocre eternity!

The principle of target fixation tells us that we hit what we are looking at -even if it is the wrong target.  To make sure you're not missing the "right" target that gets you to your dreams the quickest safest way.  Look at the entirety of rate time interest and quantity all from a risk perspective.  from all directions.

Andrew Kerr · Answer

@Brian Maida - I really like Mint, and use to use it exclusively. Now I use Mint to manage the day to say so to speak of my personal finances. Things like budgeting and short term financial goals. Then I started using Personal Capital last year for tracking net worth and future growth. I like their platform a lot better.

And unless I know I plan to sell an asset, I don't worry about estimating transaction costs. Costs to sell an asset, taxes, along with what  exit strategy might be used could vary or change drastically over the years. With that in mind, I just don't worry about it.

Andrew Kerr · Answer

@Patrick Kendrick - I think a blend in between works best. Then build firewalls between properties and businesses. And as you mentioned, use good legal counsel with insurance to help prevent loss.

Joseph M. · Answer

Thanks @Andrew Kerr and @Dave Foster

Joseph M. · Answer

@Paul Allen Being a relatively new investor (7 years), I have never sold a property. Not having the data makes it harder. It is possible that I would keep the properties for the very long term as I would like to keep a relatively small portfolio $1.5-$2 Million while creating between $75 - $100K in yearly profit to live off of.

With my current portfolio, if I paid off the mortgages and managed them well, I would bring in about $60 - $70K on $1.23 Million in assets (in today's dollars).

I know this conversation has shifted away from net worth to overall strategy, which may be the question after all @Andrew Kerr  @Max Tanenbaum. I am stuck asking myself, "do I work hard to pay down my current mortgages and acquire one more property" or "do I continue to leverage myself using my current strategy to the cash flow I am looking for? (my net worth sure would be higher, but so would my time and energy commitment)"

I could probably meet my goal (yearly profit of $75-100K) in 10-20 years with about $1.7 million in assets (today's dollars) and less risk or I could use the same strategy I have been using (high leverage) and need about $9.84 million in assets (today's dollars) with considerably more risk. I don't know how long that strategy would take, but I know I don't want to have a burdensome business and I likely won't move into real estate investing full time, so maybe that is not the answer. I can manage my current portfolio in about 120 hours per year.

The other consideration I have is "would I want to consolidate to just 1 complex in the future or would I just keep my 5 current properties (and 1 more acquisition)?" I know a 1031 exchange to sell all 5 properties and buy 1 apartment building wouldn't likely be successful.

I also know that the other variables, such as rental rate appreciation, property price appreciation, tax appreciation, and deferred maintenance would affect all of the scenarios. For my basic modeling, I am just assuming everything goes up at the same rate of inflation, which I guess over time would actually improve my profit being that rental rate is the highest number being adjusted and P&I are locked in already.

Would love to hear all of your thoughts on this.

Paul Allen · Answer

Interesting concept. You're more or less establishing an accounts payable for future transaction costs so that you have a current liability to subtract from your net equity. How do you know there will be future transaction costs on your current properties? What if you keep them forever?

If I were doing it I would look at past transaction costs, figure out what percentage they were of the asset value, and apply that to future transactions. You'd also have to know how many transactions per unit time. Are you going to 1031 an asset every 2 years? Every 5? Every 10?

I like numbers. Let me know what you come up with.

How much do you subtract from your net worth for transaction cost

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