Watch costs when buying real estate

Real estate is a popular topic for discussion when it comes to investments.   While real estate investments are appealing for their rental income and property value appreciation, most people seem to forget that their own personal residence can be another investment opportunity. 

We make decisions whether to rent or own, and we also make decisions whether to sell or hold.  Just like selling equities, before making the decision to sell your home, or even if you are looking to buy a new home, timing is everything if you hope to realize a gain.  If you feel real estate will decline in value, then it may be prudent to sell your home and rent until market conditions improve.

Another factor to consider in deciding whether to buy, sell or hold is to consider the transaction costs of buying and sell.  These costs are high and should always be factored in when looking at options.

You’ve heard the terms “good debt” and “bad debt.”   Bad debt would be credit cards and other debt associated with purchases of goods that are expected to immediately decline in value.  Good debt is the type of debt assumed on purchases that are expected to appreciate in value greater than the interest rate that you are paying on the debt.

Julie and Brent have saved up a little money and have also gone to the bank.  They have decided to purchase a home for $560,000 with a 10 per cent down payment.  In addition to the purchase price, they had other costs:

  • On a $560,000 home, the property transfer tax is one per cent of the fair market value up to $200,000, plus two per cent on the portion of the fair market value that is greater than $200,000.  The total property transfer tax is $9,200.
  • As Brent and Julie are only putting 10 per cent down (or $56,000) on the home, it is considered a high-ratio mortgage and they will have to cover the costs of Canada Mortgage and Housing Corp. insurance at two per cent of the loan amount.  The cost of the insurance is $10,080 ($504,000 x two percent).
  • The legal fee for buying the house is estimated at $800.
  • The building / house inspection is $500.
  • The bank also charged $400 for the house to be appraised for financing.
  • They will also have to purchase all the landscaping and gardening tools, including a lawn mower, weed-eater, garbage cans, hoses to name a few in order to maintain the yard.  They have set aside $840.
  • Household appliances are a significant cost.  Brent and Julie have estimated the cost of a fridge, stove, microwave, washer and dryer at $3,800.
  • The house Brent and Julie purchased was an older home that required some immediate basic repairs and maintenance.  They have set aside $800.
  • One of the additional costs for being a home owner is the insurance costs required for this significant asset.  The bank required home owners insurance which resulted in an initial cost of $800 for basic coverage.  Earthquake insurance was declined to reduce insurance costs.
  • Although Brent and Julie are only moving 19 kilometres from where they are renting, they’ll incur an additional expense to move their personal possessions.  They have hired professional movers for the day costing $690.
  • In addition to the initial cash outflow they needed funds to cover the upcoming annual property taxes of $2,480 and other utility bills.
  • Brent and Julie had to budget a further $1,150 to purchase curtains.

The total estimated costs incurred prior to moving in are $591,540.

Before even buying the home, Brent and Julie should budget for all of the initial costs.  They should also be aware of the breakeven number for some reason they wished to sell it.  The legal fee for selling the property is estimated at $660.  There can also be some harsh penalties for prepaying a mortgage early.  In the above case we will assume no early prepayment penalties.   Real estate fees are generally the biggest cost when selling.  As an estimate for Brent and Julie, a realtor could charge seven per cent on the first $100,000 of the sale price, plus 2.5 per cent on the remainder.   In this case, if Brent and Julie hoped to recover the total costs they initially put into the home ($591,540 they would have to list for $612,000 before commission.  The listing would include all appliances.  If they got the list selling price then the commission would be $19,800 which would be shared with their agent and the buyer’s agent.   If they subtract the real estate commissions and legal costs, the couple breaks even.

The above numbers highlight that to break even, the real estate market would have to increase 9.3 per cent or $52,000 ($612,000 – $560,000). Another factor that Brent and Julie should be aware of is that an increase in interest rates is typically negative for real estate in the short term.  After thirty years of declining interest rates, the best case scenario for Julie and Brent would be if rates stayed low for an extended period.

If interest rates rise then this typically results in fewer buyers being qualified to buy homes and a greater number of home owners defaulting on mortgages – both of which could cause real estate to decline rather than rise in price.   When it comes to selling or buying a home, use some caution, factoring in all transactional costs to ensure you’re able to protect your home as a good investment.