Question about closing costs?

Question

Hi, new Pro member and have a question about the rental property calculator. I'm trying to figure out what needs to be included in closing costs. I see a lot of people use a low % (2-3%) for closing costs but shouldn't it be your first year taxes + closing costs? Example: I'm looking at duplex's in the 100,000 range. Taxes on the properties are around $4,000, and the typical closing costs + points are around $6,000. That's around $10,000 in closing costs, which is 10% of the purchase price. Obviously very different than the 2-3%.

Any insight would be greatly appreciated...thanks!

Mitch Messer · Answer

Hi @Patrick McCracken and welcome to BiggerPockets!

Yes, this is the great weakness of using anyone else's rental property calculator: It's far too easy to be fooled into believing that the assumptions encoded within will apply in every case and market. They won't!

It's true that, at closing, a buyer is typically required to pay their prorated share of property taxes. So, those costs might vary a bit depending on when in the year the sale takes place. But, while these taxes may be paid at closing, they're not really considered closing costs for the purposes of deal analysis. Rather, they are part of operating expenses.

All good rental analysis calculators should already have a line item for annual property taxes, for the purpose of calculating key financial indicators like net operating income, cash flow, and cash-on-cash return.

For items like closing costs, you will absolutely need to calibrate and adjust your analysis tool to reflect your actual market.

Simon W. · Answer

@Patrick McCracken I was actually in the middle of typing something, but something came up. Glad someone was able to respond to you.

Taxes shouldn't be part of the closing cost, but typically a year's worth is required during the CLOSING. Just not part of the closing cost. So definitely make sure you have enough to cover the required escrow amount that the lender is asking for. Otherwise, the deal will fall through.

Accounting purposes, taxes are just classified as an asset/escrow account and closing cost is something that should be capitalized.

Aaron Montague · Answer

No to the taxes.  They are not a closing cost.  They ARE cash you need to bring to closing.  Taxes are part of your operations as  @Mitch pointed out.

Therefore taxes are part of your monthly cash flow OUT.  So hopefully your tenants are actually paying for this line item, albeit indirectly.

On my books the closing cost are mostly Down Payment + Fees. So your CoC return will be an estimate initially, then an exact number once you close. Example: On a duplex we bought, we estimated 28k in closing costs.  The actual number ended up being $28,404.02.

Aaron Montague · Answer

@Patrick McCracken it depends slightly on how you define "closing costs."

At M&A we define them as the expenses that we incur at closing.  This is a different amount than the amount of cash we need to bring.

The list of items we define as closing costs are the items on HUD-1 form that do not recur.  Bank fees, points, wire fees, appraisal, inspection (this isn't actually on the HUD-1 form), and the like are what we define as closing costs.  The items that we are going to escrow, namely taxes and insurance, are not "closing costs" on our books.

We do this for accounting reasons.

My initial number for closing costs is $5500 + points.  This $5500 number is fairly consistent whether we are looking at 90k properties or 340k properties.  Many things in real estate are not accurately portrayed by %.

Hope this helps.

John Teachout · Answer

The amount of cash you need to bring to close and the "closing costs" are usually two different things but the amount of cash to close can be significant depending on how much "prepaids" are required by the lender to be put into escrow. A lot of it is semantics but it does need to get categorized properly to accurately calculate your basis in the property.

Patrick McCracken · Answer

@Mitch Messer makes sense. I did already include property taxes separately so including them would be “double dipping”. Appreciate the insight!!

Victor S. · Answer

since this is a rental, i assume you're already bringing 20% to the table. see if they'll wave escrow, unless you need a nanny to make those tax/insurance payments for you.

Patrick McCracken · Answer

I'm with you guys now...thanks!

Patrick McCracken · Answer

@Aaron Montague thanks! So for the sake of analyzing the deal using the calculator to get an accurate COC and cash flow, would you include first year taxes in there, or just the typical costs incurred with taking on a mortgage?

Question about closing costs?

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