Hidden Costs in Real Estate?

5 Replies

Hey everyone

I just wrote an article on BP about owning real estate and hidden costs >>> https://www.biggerpockets.com/renewsblog/hidden-co...

I know there are countless other hidden costs out there?  Can you think of any other hidden costs and mention them here?  I would like to write a follow up article for any new investors

Thanks

Gino

Reserves.

Let's say I have a $100,000 house that generates $10,000 a year.  It makes 10% return right?

What If I need to hold $10,000 in reserve account in case of emergencies that can't be invested elsewhere?  This $10,000 has to be held as working capital and can't be removed before end of project, meaning time value of money is working against it.

- IRR IRR
- 10.0% 9.1%
Year No Reserve With Reserve
0 $ (100,000.00) $ (110,000.00)
1 $ 10,000.00 $ 10,000.00
2 $ 10,000.00 $ 10,000.00
3 $ 10,000.00 $ 10,000.00
4 $ 10,000.00 $ 10,000.00
5 $ 10,000.00 $ 10,000.00
6 $ 10,000.00 $ 10,000.00
7 $ 10,000.00 $ 10,000.00
8 $ 10,000.00 $ 10,000.00
9 $ 10,000.00 $ 10,000.00
10 $ 110,000.00 $ 120,000.00 

Including calculation for reserve reduces IRR by an entire percentage point.

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With your example showing a 10,000 return is that a return generated by the property, by the equity (100,000) or a combined return.

If as you state the "house" generates the return you are losing the return that equity should generate. Based on a low return of say 5% your $100,000 is losing $5000/year.

Return on equity is a "hidden" expense that most investors conveniently ignore.   

@Thomas S.

Yes, the example shows buying a house for $100,000 cash, having it generate 10k annual profit and selling it for same value as purchase 10 years later.

Obviously, if you have other projects that have a higher IRR, you wouldn't commit your equity to this sort of project in the first place or you would refinance out the equity you have in order to commit it to a higher IRR project. Failure to do so is a lost opportunity.

The example is just to show what effect keeping a cash reserve account does to your total portfolio IRR.

increase in property taxes upon reassessment from property sale

underestimating loan closing costs and/or excluding them from CoC and IRR

off site management can be costly in tenant attraction and retention

hiring the wrong 3rd party manager...cost both $s and time

dip down to too low of a tenant class or market and underestimate turnover and repairs

lack of lender connections - end up with poor terms

lack of proper debt structure knowledge - can end up without sufficient capital to properly operate the property, pay unwarranted prepay penalties, early balloons