Investing in real estate is all about the math, and one calculation investors use to figure out if a property is a smart buy is the total cost of ownership, or TCO. If you're wondering, "What is TCO?" -- you're in luck. We've taken the time to break down exactly what this calculation is, how it works, and how you can apply it to real estate. This article will help you understand why you need to consider the full picture of the expense in your cost accounting.
What is TCO: total cost of ownership?
In business, the acronym TCO stands for "total cost of ownership." This calculation is used to look at the overall cost of owning a particular asset, rather than just its initial purchase price. Sometimes also known as a "life cycle cost" or "cycle cost analysis," the total operating cost takes into account the purchase price, any operating costs, and, if applicable, the cost of eventually putting the item up for resale.
By and large, companies use a total operating cost calculation to get a fuller picture of an asset's total economic value and to protect themselves against unnecessary future losses. This calculation is especially helpful when comparing two potential assets before making a purchase, as it allows for a side-by-side comparison of which one will end up costing more in the long run.
How to calculate an asset's total cost of ownership
At its core, doing TCO calculations is a matter of simple addition. In order to find the total operating cost for an asset, you simply need to add up all the direct and indirect costs associated with that item. The more difficult part of doing an ownership TCO analysis is projecting the potential cost for expenses that aren't necessarily cut and dry.
However, there are ways around this. If you've been in business for a while, odds are, you may be able to use past expenses to give you a better idea of what you can expect to spend. If you're newer to the business, you may want to do some research into the average cost for your potential new acquisition.
Calculating TCO: A simple example
In order to give you a better idea of how calculating an item's total cost of ownership works, let's use the example of buying a new car. Here, you have the following expenses to consider:
- The purchase price plus financing costs.
- The insurance policy.
- Ongoing maintenance costs.
- Any repairs.
- The cost of fuel.
While those line items will give you a relatively full picture of the cost of ownership, you'll also want to remember to take into account any circumstances that are unique to your asset. In the above example, for instance, you would want to account for the fact that a car is a depreciating asset.
Using TCO in real estate investing
Now that you understand what an asset's life cycle cost is and how to calculate it, the next step is learning how to apply it to your real estate investments. In truth, the process is much the same as in the car example above, but since there are many different costs that go into owning and operating a home, the projections get more complicated.
Below is a list of the potential costs you might want to take into account if you're using TCO calculations to decide if an investment property is a smart buy.
This is the big one. If you're paying cash for the property, it's one fixed cost. If you're getting a loan, you'll also want to account for any associated costs like interest.
Though your down payment is essentially part of the purchase price, it's worth noting that while first-time buyers may not need to have a 20% down payment, those looking to finance an investment property are typically held to a higher standard. You'll want to be prepared to put at least 20% down upfront.
Closing costs typically amount to an additional 1% to 2% of the property's purchase price and are split between the buyer and the seller.