Rental Return on Investment (ROI) Question

5 Replies

For calculating ROI on a rental property, I assume my closing cost to be part of my initial investment number. On my closing costs, I paid 1 year's insurance, 1/2 year taxes, and some HOA. Normally those are part of the operating expenses, thus impacting the cash flow numbers.

So do I not include those in my cash flow numbers for the first year of operations since they were paid upfront?  

For that year, I ended up booking those expenses on their respective line items in my P&L.... should I have not done that and left them off operating expenses all together since they were paid at closing?

Thanks

A few thoughts: 

I would book them on those respective lines. Although they are paid at closing, I wouldn't consider them as closing costs -- it just happens that some operational costs were paid at closing. This will be very helpful in analyzing actuals year over year and updating your proforma. Capturing these costs accurately will also help if evaluating operational costs (such as insurance) down the line to see if you can shed some of those costs and increase the value of the investment or improve cash flow. Good Luck!

Originally posted by @Joseph Gamatoria:

A few thoughts: 

I would book them on those respective lines. Although they are paid at closing, I wouldn't consider them as closing costs -- it just happens that some operational costs were paid at closing. This will be very helpful in analyzing actuals year over year and updating your proforma. Capturing these costs accurately will also help if evaluating operational costs (such as insurance) down the line to see if you can shed some of those costs and increase the value of the investment or improve cash flow. Good Luck!

 Thanks.  Yeah I would feel odd not having those operational expenses off the books for the first year, making things lopsided going forward.  Unless I hear differently, I will remove that cost out of my closing amount, and ultimately have them reflected in my first year's cash flow figures

@Ryan Moore Also, don't forget that tax treatment of closing costs and business expenses are different. 

"Generally, deductible closing costs are those for interest, certain mortgage points, and deductible real estate taxes. Many other settlement fees and closing costs for buying the property become additions to your basis in the property and part of your depreciation deduction, including: Abstract fees."

Source: https://www.irs.gov/faqs/sale-or-trade-of-business...

@Ryan Moore

Good question. The way I see it this way, the closing cost is paid when you have not rented the property. You analyze the money you have put in the deal to begin with, so I usually put the entire closing cost as of upfront cash investment. 

Also, when you actually run numbers to analyze the deal, you are factoring in the insurance and taxes that you will owe each year. it's not that you would not factor in insurance and taxes that you paid at closing to analyze the deal, as you are paying upfront.  

Bottomline: 

Tax/P&L  treatment is different compared to the numbers when you analyze the deal.

Although you are treating the closing cost as an initial investment(same as equity), for the P&L purpose and eventually tax purpose, you get to deduct some of the closing cost, such as insurance and taxes, and some get added to the basis of the property. 

Originally posted by : @Ashish Acharya

Bottomline: 

Tax/P&L  treatment is different compared to the numbers when you analyze the deal.

Although you are treating the closing cost as an initial investment(same as equity), for the P&L purpose and eventually tax purpose, you get to deduct some of the closing cost, such as insurance and taxes, and some get added to the basis of the property.

Yup, that makes sense.... treat it as upfront for analyzing the deal/RIO, and in the P&L/taxes.  

How would you classify the following scenario in terms of upfront cost vs cash flow:  When I closed on my 4-plex, 2 of the units were unexpectedly vacant and over the course of 3 months, I had to put ~$10k into fixing them.  Now, I wasn't planning on putting any extra upfront money at the time of purchase, and 2 other units were occupied from Day 1, so I was bringing in revenue on top of contributing  extra cash into the property for those repairs/reno

Would you classify all funds used to fix up the 2 vacant units as upfront cost for purposes of ROI calculation? Or should the funds just fall strictly under cash flow since the property was not fully vacant and was bringing in revenue?