Flipping properties may sound like a good idea to the novice real estate investor. However, anyone who has even engaged in real estate transactions even once or twice knows that there are significant costs associated with real estate transactions. These costs are called “transaction costs” because they are triggered when a real estate transaction takes place.
These costs tend to be significant and have the potential to burn a hole in your budget if they are not accounted for well in advance. In this article, we have listed down some of the common transaction costs. This list is not exhaustive as transaction costs can vary depending on when and where the transaction is taking place. However, they do provide a good understanding of the types of costs that one can expect to incur.
Brokerage is one of the most known costs associated with real estate transactions. This cost is typically a charge by a broker. The job of the broker is to make the buyer and the seller meet. The broker also has to assist during the period of negotiations and convey the offers and counter offers between the buyers and sellers. The broker has to ensure that both the buyer and the seller are on the same page. To do so, they charge a fixed percentage of the transaction value from both the parties.
This model of charging a percentage value from both the parties has come under criticism. This is because this model creates a misalignment between the incentives of the principals to the party and the agent. Since the broker’s compensation is a percentage of the transaction value, the broker has an incentive to maximize the transaction value to maximize their gain!
Search costs are another commonly known cost that are associated with real estate investing. These costs include money paid to newspapers and magazines to advertise the property. Nowadays, online portals allow sellers to advertise their properties for free. However, serious sellers use the premium paid services offered by these websites. Hence, there may be a cost attached with that too. Apart from that if the owner of the house wants to rent the property instead of selling it, there may be costs associated with conducting a credit check of the potential tenant to determine the credit worthiness of the potential tenant.
Apart from that, from the buyer’s point of view, visits have to be scheduled to various houses. These visits cost time as well as money and add to the search costs from the buyer’s point of view.
Legal and Administrative Costs
The real estate business requires extensive paperwork. This is because the costs of real estate are extremely high. Therefore when any person transacts i.e. buys or sells real estate, they want to ensure that the deal which has been agreed on in person also finds its way to an agreement in black and white. As such, attorneys and lawyers have to be engaged in the process. In fact, real estate transactions tend to be complicated. This is the reason that there are attorneys that specialize in real estate laws.
Also, there are administrative costs involved with the transfer of title for utilities such as water, electricity, cable etc. These transfers take a small but significant amount of time and money too!
Across the world, whenever real estate transactions take place, the government usually adds to the transaction costs by taking a portion of the sale proceeds. Across the United Kingdom, Australia, India and in some states in the United States, a stamp duty is levied on the transaction value. Thus, if the transaction was completed for $100, then $3 is owed to the government for the transaction to be considered legally valid! This often results in people undervaluing their transactions on paper and offering black money to the seller, thereby reducing the amount of stamp duty payable.
In many other countries, conveyance of the property title needs to be done by the government. As such, the government charges a hefty conveyance fee. Also many jurisdictions charge another tax called the ad-valorem tax when real estate transactions take place. This obviously is another form of transaction costs being charged by the government.
The statutory costs of real estate transactions are huge and the most visible component of the expenses incurred during the period. As such, they are also the biggest deterrent to buyers and sellers as they make flipping properties difficult as well as expensive.
Most of the housing transactions that are conducted nowadays are financed using borrowed money. As a result, there are some transaction charges that need to be paid to the lender as well. Consider for instance, the processing fee that is charged by most lenders to process the mortgage agreement. This charge is also a substantial sum usually accounting for 0.15% to 0.25% of the property value. This is the fee charged by lenders for the cost of collecting your documents and running a credit check on them to determine your creditworthiness. Also, this covers the charge of the procedure of loan disbursement that needs to be followed. Apart from the lenders also charge various fees to verify the title of the property in question and for a variety of other services that they provide.
The costs of transacting in real estate are many and varied. This is what makes real estate investment a long term game. Flipping houses like one can flip stocks or bonds is simply not possible because of the complexity of the transaction costs involved.