Hi BP Community,
I'm relatively new and I have a (what I believe should be) basic question: In calculating returns, should one include closing costs as cost basis when estimating cash-on-cash return and why / why not? This is solely for analyzing and comparing different properties, not for tax purposes or anything else.
Purchase price - $100k
Closing costs - $5k
Down payment @ 20% down - $20k
Down payment + closing costs - $25k
Annual cash flow - $3k
Cash-on-cash returns (w/o closing costs) - 15.0% [= 3 / 20]
Cash-on-cash returns (w/ closing costs) - 12.0% [= 3 / 25]
I have been including closing costs, because that's the cash out of my pocket on day 1 and also because it's a meaningful amount of the initial cash outlay (e.g. 5/25 = 20% in this example). But if I turn around and try to sell the property 1 day later, the property doesn't automatically appreciate by the $5k amount of the closing costs. That being said, if I think about looking at the cap rate (NOI / purchase price) instead of the cash-on-cash rate ([NOI - debt servicing costs] / cash invested), then I do feel like one should not include the closing costs to the purchase price in denominator of the cap rate calculation; which is the opposite of what I do with my cash-on-cash calculation. My main issue is that the closing costs is such a big amount vs the down payment (for properties I'm looking at), so I don't want to inflate my returns by not including them.
Please let me know if I'm over-complicating this, but I welcome all views. (Btw, I know the best solve for this is to find a rockstar deal, so this will just be a rounding error; but I'm a numbers guy, so please humor me).
Thanks in advance!
@Eviano I. If you are a numbers guy what number do you use when your IRA has a 1% fee. If it gained $10000 on a $100000, but had a $1000 fee. Are you using 10% or the more accurate number of 9%. There is an opportunity cost of the closing cost. Look at getting the cash flow and cash on cash that you want. Look at the BP calculators uder the tool section. You can use them for free up till 5 times or upgrade to pro and use them as much as you want.
@Tim Herman thanks for your response! I think I see your point re investment transaction fees vs opportunity cost of every dollar that leaves your account. I'll definitely run a scenario or 2 on the BP calculators to see the approach they take. Out of curiosity, do you include closing costs in your cash-on-cash calculations?
@Eviano I. The BP calculators use total dollars needed to calculate cash on cash. It might not be 100% accurate because prepay taxes and prepay insurance should be in operating expense vs cash outlay but they would be included in closing costs. I look at cash flow vs cash on cash, but it usually ends up over 10% cc.
@Eviano I. You include closing costs
Awesome. Thanks gents.
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