Whether you think about owning a house or you are a real estate investor, it’s important to make sure you understand the magnitude of this decision and how it can impact your future.
Most first-time buyers tend to think in short-term increments. When they buy a house, they only think about the down payment and the monthly mortgage payment. If the budget can support these expenses, most buyers would see it as a sustainable investment.
However, the true cost of owning property includes other important factors that regularly can’t be assessed by regular people. That’s why it’s best to have the property appraised by an expert in the real estate market.
In fact, successful investors hold appraisers in high regard because their expertise helps them understand the true cost of major investments that lack liquidity, such as real estate.
Investors always go for specialists who got the license of a good real estate school since they know their assessment will be accurate and thorough.
But what exactly does it mean to calculate the true economic cost of real estate property?
First of all, you need to make sure your budget also includes insurance fees, taxes, and maintenance costs.
These are some of the most common expenses associated with homeownership and they must be honored on a yearly basis. These expenses also need to be considered, if you plan on investing in rental properties to increase your capital.
Calculate the Cost of Ownership
Start by understanding that the price of the house (what you pay to become owner) is different from the cost of ownership.
Let’s say you bought a $500,000 house with a down payment of 20% and a $400,000 mortgage with a 2.5% mortgage rate that will be amortized over 25 years. The house also has a property that requires regular lawn maintenance and care.
In this scenario, your expenses would be as follows:
- Mortgage payment (around $2,000)
- Private mortgage insurance (~$100)
- Home insurance premiums (~$80)
- Property taxes (~$800)
- Utilities + communications (~$450)
- Property maintenance (~$400)
Up until now, your cost of ownership, per month, is around $3,800. However, you also need to include the expenses that come up before you can even buy the property such as the down payment, land transfer taxes, appraisal fees, title insurance, inspection fees, lawyer fees, and more.
Overall, before you even get to thinking about buying the property, you should have around $110,000 at the ready for the down payment and closing costs.
Plus, depending on the area and future developments, your monthly cost of ownership may increase. If you plan on turning the property into a rental, you must plan ahead and make sure the rent covers these expenses and turns a profit.
The Cost of Opportunity
As an investor, your main task is to find the best way to turn a profit. That’s why, before you start investing in real estate (which is a low liquidity market), it’s important to consider the cost of opportunity for the money you already have (the down payment and closing costs).
What does this mean? It’s simple – would you earn more if you were to invest this money into stocks or place it in a bank where they can earn interest? Compare the short-term and long-term results and draw your conclusions.
The real cost of homeownership can take you by surprise if you don’t plan ahead. However, due to new technologies (such as blockchain), the world of real estate is changing. This means that the future is difficult to predict even in a market that’s traditionally slow to advance.
Overall, when you make a major investment, it’s important to take into consideration all the costs it involves, now and in the future.
Ken Boyd is an accounting and finance expert at AIS-CPA. He is also the author of several books, including Cost Accounting For Dummies, Accounting All-In-One For Dummies, The CPA Exam For Dummies, and 1,001 Accounting Questions For Dummies.
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