The costs associated with buying and selling real estate are way different than so many other purchases and investments people make. With stock, you can buy and sell with just one click. It’s easy to make an emotional decision and end up buying and selling based on fear. Real estate is illiquid; it takes 6+ months to buy and sell. Some people say this is a negative of real estate, but I see it as a feature instead of a bug. Not being able to buy and sell immediately makes me take a long-term view on my investments, and not react to markets and fear. If I could have clicked and sold all my real estate in an instant in March of 2020 when the world started to melt, I probably would have. But the market roared back, and values are at an all-time high, and the fact that I couldn’t have sold in a panic proved to be beneficial.
A lot of people underestimate the cost of a real estate transaction. People think too concretely about the buy and sell price and assume that there’s profit in between, but there are a ton of steps in the transaction that eat into your financials. The timeline for any transaction is often 6-12+ months and involves a broker preparing an offering memorandum, P&Ls, due diligence materials, tax returns, property tax info, and maintenance records all in order. As a seller, you need to go to market, solicit bids, go under contract, and take the time to close.
People who do real estate deals can go hungry for a long time. If we’re not buying and selling, it’s hard to make a lot of money. Real estate private equity encourages transactions, sales, and locking in gains, and that’s one of the few gripes I have with the industry. A lot of real estate pros are living on the value of transactions, but not making passive income, which makes it hard for them when the market runs dry.
There are hidden costs in selling a property. I’m looking at a property right now that makes $375K annually in net operating income, and I’m making an offer at $5.75M, which would be a 6.5% cap rate. We have to add in legal fees, title insurance, appraisals, mortgage tax, financing fees, and transfer fees, among others just to make the deal go through. On top of that, we need to have $75K in working capital prepared for the deal, expect to spend $150K in new capital expenses like signs, gates, and security, and need to pay out my acquisition team a total of over $150K. This brings the all-in cost of the deal to $6.35M, a whopping $600K on top of my offer price.
It doesn’t end when you buy the property, you shouldn’t be surprised to know that there are fees associated with selling. In that same $5.75M acquisition, a mom-and-pop seller probably pays a broker 5% ($287K) to list, market, and help close the deal. Adding on a 1% ($57.5K) transfer tax and $25K in legal fees, the seller ends up paying $370K and netting $5.38M from the deal, only to then be left with $4.4M after paying capital gains tax. So I paid $6.3M to buy the property all-in, and the seller gets $4.4M when all is said and done, meaning $1.9M has evaporated on this deal just to get it done.
All these extra costs can make things complicated for investors. As a buyer, I can’t just find a well-priced deal, I have to find a way to extract value and make the deal work for me. This often includes raising rents, cutting costs, or speculating that the property will appreciate over time with market conditions. A significant chunk of value is evaporated between the buyer and seller when transacting on any real estate deal, meaning you can’t act on anything that you feel uncertain about.
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