What are some examples of carrying costs on real estate investments?
Real estate carrying costs are the recurring expenses a property owner needs to pay (usually each month) for as long as they hold the property. Typical real estate holding costs include:
- The mortgage payment
- Property taxes
- Homeowners association (HOA) dues
Real estate investors will encounter these and other holding costs, which can have a different impact on their return calculations depending on whether they're working on a short-term flip or holding a cash-flowing property for the longer term. Here's a breakdown of how carrying costs can impact these different investments.
Real estate holding costs for fix-and-flip projects
A buyer of a house or condo they intend to fix-and-flip must factor in the expenses of holding the property into their purchase costs. The costs of owning these investments can differ from others. Aside from the standard carrying cost of a property, like real estate taxes and HOA fees, additional holding costs can include:
- Financing costs, such as mortgage interest expenses. Most flippers obtain a hard money loan to finance the purchase and renovation costs of a property. A lender will charge a high interest rate for this type of loan, which adds up the longer it takes to complete the project.
- Vacant or unoccupied property insurance. Lenders usually require a flipper to insure the property, which often costs more than a typical policy on a primary residence because it's not occupied.
- Utilities. Most flippers forget to factor the cost of electricity, water, and gas into their budget. These costs can be high depending on the time of year, since the AC can be cranking to keep the humidity down even as contractors leave the doors and windows open while working on various aspects of construction.
Real estate carrying costs for long-term real estate holdings
Investors who buy and hold real estate also need to factor carrying costs into the equation. The investment expense will include the holding cost typical of most real estate, like the property tax, mortgage payments, utilities, and HOA fees. In addition to that, these investors will also encounter other carrying costs that they need to factor into their return calculation. These include:
- Rental property insurance. This policy will differ from a traditional homeowner plan by including things like loss of income, peril coverage, and liability.
- Routine maintenance. These expenses include recurring costs such as landscaping, painting, changing locks, and other regular upkeep.
- Property management costs. This fee goes to the property management company, which performs a variety of tasks like collecting rent, leasing units, and addressing routine maintenance items.
- Marketing costs. Short-term rentals, like a vacation property, will have to pay recurring subscription fees to vacation rental sites such as VBRO and HomeAway to advertise their properties.
Failure to account for carrying costs can prove disastrous
Real estate investing can be challenging. Unanticipated costs can eat into the expected return, especially on short-term projects like a fix-and-flip. If unforeseen issues delay the project for months, the expense of carrying the property, like the interest expense on the hard money loan, can eat away at the potential profit. Meanwhile, holding costs for longer-term investors can impact the investment income they expected the property to produce. That's why a savvy investor needs to factor these costs into their return calculations before purchasing a property so that they don't end up with a money-losing real estate investment.