How much money are your houses really costing you?

Most investors stop budgeting after adding up the downpayment and carrying costs, forgetting to include taxes, maintenance, improvements, and commissions when selling the home. If you add it all up, they’re not making nearly as much as they think they are.

Over at Consumerism Commentary, Flexo breaks down the costs of a typical home over a 30 year period. If you buy a house for $300,000 and sell it for $1 million 30 years later, are you really making good money? Not really. In his article, he breaks down $710,000 of fees over a 30 year period, meaning the homeowner is actually losing money.

The same type of thinking applies to your real estate investments.

Debunking the Famous 100% Return

Go to any real estate meeting and you’ll hear investors bragging about making over 100% on a recent investment. Now, I believe it’s possible to consistently make 100% on your money, especially with proper budgeting and leverage, but these investors are usually making much less than they think they are. They’re forgetting to add in all of the expenses.

Let’s break down a typical house deal.

Purchase Price: $95,000

Downpayment: $9,500 (10%)

Principal: $85,500

Closing Costs: $1500

Repairs: $10,000

Interest: $3,500

Taxes & Insurance: $1000

Sales Price: $125,000

Commission: $7,500 (6%)

Closing Costs: $500

Timeframe: 6 Months

Not really thinking about it, most investors use the following formula:

(Cash Back at Sale - Downpayment - Repairs) / Downpayment

In this case, it would look something like this:

($30,000 (Estimated) - $9,500 - $10,000) / $9,500 = 111% Return

But their formula is wrong. To simplify, it’s more like this:

(Cash Back at Sale - All Cash Invested) / All Cash Invested

You have to add up every dollar that came out of your pocket, including repairs, interest payments, taxes, closing costs at purchase, and your initial downpayment:

($30,000 (Estimated) - $25,500) / $25,500 = 18%

Now, 18% still beats your average six-month return anywhere else, right? Yes and no. If you factor in the amount of time that you spent on the investment and subtract an hourly rate, then you might have been better off working overtime at your job.

Develop a Detailed Budget before You Invest

If you’re only making that much money, should you take your money out of real estate and put it in something else? No, I still don’t think so. I just believe you need to develop a detailed budget before you invest in any property, so you can see how much you’re actually going to make. Factor in the time involved and see if it’s worth it to you.

For instance, I’d never invest in the above property. From start to finish, it’s safe to say it would take 40 hours of my time and if I billed the project my hourly rate ($500), then I would end up losing a lot of money on the deal. Even if I used a credit line and other people’s labor to better leverage the investment, nothing could justify the tiny return.

So, don’t get fooled by the large equity spread when you’re looking at the property. Put every dollar you expect to spend in a budget and make sure it’s still worth it.