Closing Costs to Consider in a Real Estate Investment Transaction
In contrast to buying a home, real estate investors enjoy the advantage of offsetting rental income with closing costs, as permitted by the IRS. When selling an investment property, certain costs can be immediately written off, while others are added to the property’s inventory and accounted for through depreciation over time.
The closing costs involved in selling an investment property resemble those of an owner-occupied property, with a few noteworthy exceptions. Let’s delve into the various final costs that might arise when purchasing property: Customs duty, registration fee, transfer fee (depending on the purchase), taxes, interest, accommodation fee, pledge, and confiscation, loan fees (such as application, loan processing, and loan management), mortgage insurance (often in the form of a finance fee when the down payment is less than 20% or when using an FHA mortgage or VA loan), comprehensive inspection costs (including property appraisals, inspections, termite/pest control, and surveys). Additionally, there are costs for external professionals such as lawyers, financial advisors, and qualified real estate agents in Fairfax, whose services you can read about here.
Closing costs for a typical buyer and seller
While each transaction is different, buyers are generally expected to pay 3-4% of the contract value, while closing costs for the seller often exceed 8%. Although buyers and sellers can typically negotiate who pays which fees, the following are common closing costs that real estate investors can expect from buyers and sellers:
For buyers:
Pledge or deposit, loan fees (such as loan processing), credit reports, various court costs, real estate appraisal commissions, property inspection fees, insurance, and property search fee.
For sellers:
Debt, guarantee, repayment of the mortgage of the outstanding loan, admission fee, transfer fee, relative credit of the buyer, and realtor’s commission on both sides of the deal.
Types of acquisition costs for real estate investments
Let’s take a closer look at some of the closing costs for real estate investments.
Credit Report Fee: Checked by multiple lenders to determine credit reports and creditworthiness.
Appraisal: Performed by an independent third party to verify that the value of the purchased property equals or exceeds the contract purchase price.
Commitment fee: Covers the lender’s costs related to the issuance, preparation of loan documents, and assessment of the risk of default.
Discount points: Paid in advance to reduce interest rates on loans. Each point is equal to 1% of the loan amount, which often reduces the mortgage interest rate by 0.25%.
Mortgage Insurance: Also known as PMI or Personal Mortgage Insurance, this protects the lender against borrower default. Usually required when the down payment is less than 20% on a conventional loan or when using an FHA or VA loan.
Lender’s Title Insurance: Protects the lender from a loss if there is an error in the title that cannot be discovered through a traditional search.
Prepaid Interest: An account that pays interest on a loan from the time the transaction is completed until the first loan payment is due.
Prorated Tax: If the seller pays the price of the property after the mortgage expires and the property tax is due but not paid, it will show as a credit to the seller and a debit (received) to the owner.
Repayment of existing loans:
Release of the seller from the creditor’s mortgage and a guarantee of clear and free delivery of the goods to the buyer.
Property Inspection:
To verify the condition of the property held, most buyers also perform an inspection as part of their regular due diligence process.
Property Investigation:
Examine property boundaries, and determine the condition of utilities or encroachments on neighboring properties, such as fences or sidewalks built outside the property.
Experts’ fees:
Real estate companies in Virginia offer a range of valuable services that are widely utilized by real estate investors in Virginia and beyond. One essential service provided by a realtor in Virginia is their expertise in facilitating property closings and reviewing crucial documents such as sales contracts, deeds, and other closing-related paperwork. These professionals play a pivotal role in ensuring smooth and efficient transactions.
Additionally, real estate investors with substantial portfolios of rental properties can benefit from the guidance of financial advisors. These advisors specialize in assisting investors with their long-term financial goals, strategizing how each property purchase can contribute to their overall financial growth and success.
By leveraging the services of reputable real estate companies in Virginia, investors can tap into a wealth of knowledge and support, empowering them to make informed decisions and achieve their investment objectives.
Expenses related to the tenant
Prorated Rent:
The rent charged to the seller after the escrow account closes will be charged to the seller and credited to the buyer.
Deposit:
Collected by the seller and credited to the buyer as proof of the transfer of the tenant’s deposit to the new owner.
Seller Accounts:
Fee to seller and credit to buyer for unpaid bills while the seller owns the property.
Other related fees
Escrow Accounts:
Issued to the buyer as an “honest” escrow loan if the seller accepts the purchase offer.
Deed Search Commission:
Responsible for conducting deed searches to verify the history of claims and complaints filed against the property.
Registration:
There is usually a flat fee for issuing and registering new title deeds in the country where the property is located.
Title Insurance Premium:
The buyer purchases insurance to protect the lender, and the seller purchases insurance to protect the buyer in case title issues or unrecorded claims arise after escrow closes.
Other:
Includes fees for services such as notaries, filing, certificates, and other transaction fees.
How to reduce closing costs on a real estate investment?
While it is true that the fees can be high, new real estate investors are often surprised at how quickly closing costs on an investment property can add up. Seller discounts can lower the final cost for buyers. When the real estate market is in a downturn, sellers may make concessions to encourage buyers.
Additionally, sellers can balance their investment portfolios by exchanging property for a more profitable rental property on the cheaper secondary market, saving thousands of dollars in the process.
More effective ways to reduce investment property closing costs
There are a few key ways that buyers and sellers can reduce the bottom line of their real estate investment. Don’t forget to ask your manager for an investor’s discount on the ownership company’s share. By closing the deal at the end of the month, you can reduce costs that are shared equally between tenants, such as the same rent and initial interest. If your property has changed hands in recent years, apply for a new owner’s “policy renewal.”
Can I write off closing costs?
Some acquisition costs of capital assets can be immediately written off or expense, while other acquisition costs must be added to the basis of the property and included in depreciation. Closing costs that can be charged to the income statement include:
● Mortgage interest (including initial and monthly interest)
● Most property taxes
● Apartment rent must be amortized over a certain period, plus other acquisition costs.
● Various court costs
● Realtor’s commission
● Property insurance
● Commission for the sale of real estate
The types of acquisition costs that can be expensed or amortized with investment property are regulated by law and vary. Investment property closing costs are an integral part of running a business, so don’t let these fees and costs keep you from investing in real estate. However, understanding how lease closing costs work can give you an edge in negotiating the best possible lease to save costs and maximize your overall investment.
Diversification of the investment portfolio by investing in real estate
Today’s real estate investments, if done right, can pay off despite higher interest rates. Investing in real estate can also help diversify your current investment portfolio and ultimately create a stream of passive income. However, it’s suitable to note that not all investment properties are suitable for every buyer.
REITs allow you to invest in real estate without owning physical real estate. Mutual funds are often compared to companies that own commercial real estate, such as office buildings, retail space, apartments, and hotels.
REITs are popular as retirement investments because they pay high dividends. Investors who don’t need or want steady income can automatically reinvest those dividends to grow their investments. Are REITs a good investment? Yes, but they can be diverse and complex. Some transactions take place on the stock exchange, such as shares. The type of REIT you buy can significantly affect your level of risk, as non-trading REITs are not easy to sell and difficult to value.
In general, new investors should choose listed REITs that can be purchased through a brokerage firm. For this, you need a brokerage account. By buying a fund that has multiple REIT interests, you also get a variety of real estate investment opportunities. The real estate investment platform connects real estate developers with investors who want to finance their projects through debt or equity funds. Investors are willing to take a big risk and make monthly or quarterly distributions instead of paying platform fees. Like many other real estate investments, they are speculative, illiquid, and may not pay off as easily as stock trades.
Invest in your home.
A primary residence is the most common way to invest in real estate. Apply for a mortgage, make monthly payments, and gradually build equity in your home; you can potentially benefit from selling it at a high market price in a high-demand market. Investing in your home can yield long-term financial gains, although the average annual return may be lower than expected. For example, according to a report by industry analysts, home values grew by just 3.9% per year between 1994 and 2019.
Investments in rental real estate
If you want to invest in real estate, you should consider buying a property for profitable rental. Renting provides a constant cash flow and can increase over time, but it is one of the most time-consuming ways to invest in real estate. There are two key ways to earn money from rentals.
Long-term lease.
These properties usually have a minimum term of one year and theoretically offer stable cash flow each month, although this depends on the reliability of the tenants. You can buy an apartment or a family home and rent it out to other people.
Short-term rental.
Like Airbnb, this property is designed to change tenants for about one night. You can offer an entire house or apartment in one go or even invest in one property just for short-term rental.
Investing in rental properties offers great income potential but also requires significant commitment. As a landlord, you have to find and select tenants, pay for ongoing maintenance, make repairs, and solve any other problems that arise during the use of the property. Working with a property management company can solve some of these problems but will result in lower profits.
When it comes to financing a rental home, a primary home can have low equity and low-interest rates. This can increase the rental value of the property. You don’t have to buy a rental property to get the best return on your real estate investment. Buying and selling real estate is a common strategy, but like renting real estate, selling it takes a lot of effort.