Reality Check Lots of us have heard about seemingly fantastic real estate deals. Someone who’s able to purchase a $300K property for $180K: that must be a real Donald-Trump style negotiator right? That’s somebody who’s making the mad cash, right? I mean, after all, that’s $120K in profit, free and clear, just like that. Not exactly.
What most people outside the real estate investing business don’t realize is that it costs money to buy, over and above the principal paid for the property. Let’s take the example above. What will an investor pay to purchase a $300K propertyfor $180K? First we’ll assume that our investor is buying the house to sell. The property will not be held for rental, but sold, most likely to an end user. Chances are, the investor is not independently wealthy. Which means he’s getting his cash from a source, and that source wants points.
That’s how lenders make money on short term financial transactions. The number of points will vary based on the risk associated with the deal, but something between five and ten is standard. We’ll go with the low number and say the lender wants five points. Five percent of $180K is $9K. Now you have to calculate closing costs, everything from processing fees to delivery fees, all of which averages around 3% of the sale. So on $180K, you can figure on paying $5,400 for closing. $9K and $5,400 add up to $14,400, the cost of buying the property. But that doesn’t even touch repair costs or the time it takes to move the investment.
Let’s say you forego the rehab and decide to wholesale the property. Even then, there’s obviously a time differential built into the transaction. If there weren’t, the wholesaler would have just bought it himself and paid you a referral fee. So you have to figure principal and interest for the number of months you end up owning the property, and that’s going to be pricey because you’ve bought at the higher interest rate of hard money instead of going with traditional financing. On $180K, you might have to go $1,500 a month. If you have to hold onto the property for 5 months, which is by no means unusual, you’ve put $7,500 just into the cost of holding the inventory. And what about taxes and insurance? You have to get insurance to cover your investment, and you will most definitely have to pay taxes on it as long as you own it.