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6 Holding Cost Items Associated With Real Estate
Some real estate investors fully advocate the buy-and-hold approach to investing while others feel that the longer you hold onto the asset, it can quickly turn into a liability.
Because real estate value generally rise with time due to several factors including inflation, many homeowners feel that holding onto a home only has gains with little drawbacks.
However that is not always the case.
Because the costs of holding onto a property can sometimes outpace the rise in appreciation.
On top of that, people are prone to making the mistake of only looking at the value of a house at the beginning of the year, and comparing it with the value at the end of the year…
… leaving out accounting for the expenses spent during the year just to keep the house.
Here are some holding cost items that you will typically incur when holding onto real estate.
The mortgage is usually the biggest cost item that you have to factor in when working out your sums.
While payments made towards the mortgage can be seen as building up the equity in the house, don’t forget that installments are made up of loan principal and interest.
This means that portion is used to pay interest while the remaining portion theoretically goes into home equity.
So let’s say when you paid $500,000 for a property and it appreciates to a value of $550,000, it’s not exactly correct to book a 10% increase in gains. Because when you factor in the interest you have paid to finance the purchase, you are going to end up with a lesser percentage.
On top of the mortgage, more and more homeowners are taking up renovation loans and personal loans to beautify their homes.
All these will come with monthly obligations as well.
Depending on your requirements for coverage, the type of insurance policies you buy will vary.
But typically, homeowners insurance would be the first to come to mind when homeowners buy insurance for the house.
Investors might come up with a totally different set of policies to purchase.
As long as you are holding onto the property, you are going to have to continually meet the premium payments or suffer from no coverage.
Property taxes is another significant cost to list down.
The amount of tax you pay will depend on the method of calculation the tax authorities used.
It is typically calculated as a percentage of the value of the property.
The method of valuing the property is another manner altogether. And you might totally disagree with how it is worked out.
The tax man is definitely someone you don’t want to mess with.
If the property is not occupied, this figure will be minute.
But why would you ever get into that situation in the first place?
Are you buying a house for the fun of it? Are you not getting tenants in? Are you not able to sell it?
Landlords often include terms in the tenancy agreement about how to settle utility bills.
The most common arrangements are:
- Tenants will pay
- Landlord and tenants will split the bill
- Tenants will pay but landlord will offer a rebate towards the rental
The gist is that if they are occupants in the property, they would usually feel that it is fair that they either fully pay or partially pay for the utility usage.
So if you are renting out the place, don’t take on the utility bills yourself unless you are already charging premium rentals way above market rate.
5) Services fees
People who make it their job to upkeep the neighborhood don’t do it for free.
You can often see workers loading the trash up to the trucks, trimming overgrown shrubs, or cutting down hazardous tree branches all over the place.
These services are provided by the local authorities and you would have to pay a fee for them.
As long as your property is in the neighborhood, you are going to have to pay for these general maintenance and repairs.
6) Management fees
Someone has to mow the lawn, see over the house, and even provide access to potential tenants and buyers.
Unless you are going to take on these tasks yourself, you are going to have to hire people to do it on your behalf.
Remember that you are taking on too much risks if your finances only allow you to hold onto the house for a maximum of one month.
That is cutting it too close for comfort.
What if you are unable to secure tenants? What if your fixer-upper doesn’t sell? What if tenants default on rental?
For better peace of mind when holding onto real estate, you should keep at least 6 months worth of holding costs so that a shortage of cash flow does not push you towards decisions that you cannot live with.