Factoring Closing Costs into ROI's

[hammer12]

Wondering how everyone factors the selling costs of a property into the ROI.  I think of the purchasing closing costs as an additional cash laydown when combined with the down payment, but I’m not sure how to account for the selling costs.  I tend to take more of a life-cycle approach to my investment analysis, and being able to get out of an investment is important in my view.

To give an example, suppose I purchased a $100k house, with 5% down and $3k of closing costs.  Let’s assume that the property never appreciates in value through my ownership period (I’m not generally comfortable making appreciation assumptions), and I make a sale “x” years later, again at $100k, but this time, with closing costs equal to about 7.5% total (with realtor commission being the lion’s share).  In transactional fees alone, I’m in the hole by $10,500.  Does this mean that I have to have made cash and equity returns of at least $10,500 to break-even?  Seems like the break-even time frame would be around 5 years for the average property in my area.

With this view, it’s putting somewhat of a damper on my hopes of RE investment.  Am I looking at it the wrong way?  Help!

[arebelspy]

Absolutely closing costs need to be factored in.

And yes, I've heard similar break even times.  It really depends on what you want the property for, why you are buying, and why selling.

I'm not planning on selling any properties anytime soon (flips aside.. From my long term buy and hold properties I have no sale plans).  When I calculate ROI I use something I call "initial costs" which is all cash outlay from offer to first renter.  That means inspections, appraisals, purchase price, closing fees, and any rehab costs (sometimes major, other times as simple as paint/carpet).  Those are my "all in/initial costs" and I calculate my cash on cash return based off of income in a given year (minus all expenses and a maintenance/vacancy reserve) over that number.  Total return could also include equity gain (if leveraged), appreciation, tax benefits, etc.

[Another Reader]

There are two components to your return on investment.  One is net cash flow over your holding period.  The other is net profit (or loss) on sale.  If you buy a house for $100,000 plus closing costs, receive $15,000 in net cash flow every year and sell it for $100,000 less closing costs after 10 years, you took a capital loss.  However, you have a substantial return on your investment in the form of net income over your holding period.  You can do a discounted cash flow analysis to find that rate of return.

[arebelspy]

If you want to find your return, use IRR (internal rate of return) and play around with it.  If you aren't sure how, download an excel template of IRR and just change the numbers.