First of all, the closing costs were higher than I expected. This was explained to me in a pretty logical way. For Property #1, I locked in an interest rate of 5.125%. I have been quoted the same rate for Property #2. However, the standard interest rates have risen. Back in the Spring, rates were a hair below 5.125% and now they are a hair above 5.125%. I was told that the banks make up for this discrepancy in closing costs, lowering them or raising them to cover the difference. This is commonly referred to as “paying for points”. I didn’t know I was “paying for points” at the time, but this is all part of the learning process.
Then, there was another issue. The HOA fees turned out to be higher than I imagined.
You saw the numbers I was working with in the last post. Add on an HOA fee of $125/month pretty much kills the deal regardless of the closing costs. So, I had to move on from this deal.
Let me take a step back for a moment. There are two common pitfalls in real estate investing that I have come across so far:
- Never getting started. People call the analysis paralysis. You continually research and learn and never take action (which, by the way, is where the real learning happens).
- Getting too attached to a deal. Letting yourself be sold on an opportunity and convincing yourself that it is still good, even as evidence piles up against it.
For this property, I was in danger of falling victim to pitfall #2. I had sunk a little bit of money already into ordering the appraisal (I promptly cancelled it, but still had to pay $125) and I very easily could have plowed forward thinking, “I have spent too much time and money to let this go now”. Of course, those of you who know about sunk costs are screaming at your computer screen right now! If the deal is bad, I might as well cut my time and money losses and move on. Otherwise, I could lose a WHOLE lot more!
So, I walked away from the deal. I was sad. However, those real estate guys know what they are doing. They don’t like giving you choices of houses to buy, even though they have inventory. They do this because psychologically, you are more likely to close if you focus just on one property. So, one day later, they had presented me with another property. Below are the numbers of the LATEST property:
Interest Rate: 4.75%
Estimated Rent: $850
Estimated Property Tax/Month: $125
Estimated Insurance/Month: $50
Property Management Fee/Month (8%): $68
Reserves for Maintenance and Vacancy/Month (20% combined): $170
Monthly Cash Flow: $137
Cash flow looks solid, even after accounting for vacancy and maintenance. I also confirmed that there is no HOA. The closing costs are STILL high though. I did a lot of digging on this and asked various sources, and the bank’s fee is definitely higher than normal, but not by a ton. Basically, they offered to cut $700 off the closing costs if I went with a 5.125% interest rate. I ran those numbers and it was NOT a good deal. I would be paying $216 MORE per year in interest. Since my strategy is to buy and hold for the duration of the loan (30 years), that would end up costing me $6,480 over the course of the loan! That’s obviously much more than the $700 I would save initially. Even if I wanted to pay the loan off early, I definitely won’t be paying it off within the next 3.5 years, which is what it would take to make this trade worth it.
So I counted my blessings that I was able to get such a great interest rate and decided to move forward with the property and the high closing costs. At the end of the day, my new ROI is almost 8.5% and I am building equity throughout the process! The numbers work out for me, and that’s all that matters.
The moral is, always review the numbers and if at any point in the process, they don’t work out, be prepared to move on to a different deal!
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