Many consumers believe that real estate transaction costs are simply the 5 percent to 6 percent of the sales price that the real estate agent earns as commission. But the real costs of selling property are much higher -- especially when viewed as a percentage of earned equity. Avoiding recurring transaction costs is the reason experienced financial individuals believe that real estate should really be kept as an asset for the buyer's lifetime.
Let's use a $200,000 property as an example: Imagine you purchased this home five years ago by putting 10 percent -- $20,000 -- down, leaving you with a $180,000 mortgage. Now, you are selling this property for $235,000.
Here is an estimate of transaction costs you might incur upon sale:
Sales agent commission -- 5 percent to 6 percent or about $13,000.
Escrow costs and recording costs upon sale -- $1,000.
Title insurance costs -- $600.
Repairs to prep property for sale -- $2,000.
Credits to buyer for home inspection issues -- 1 percent or $2,500.
Housing overlap -- $1,500 since you will not likely close escrow selling your property and close escrow or rent a new property one day apart. There will probably be some overlap; one and a half months is our estimate. The added cost of paying rent or mortgage on two residences for six weeks.
Last five years' improvements of $5,000 estimated -- You will only recoup of fraction of the money you have spent on that new refrigerator, new flooring, paint and landscaping purchased in recent years. Maybe you will recoup 50 percent of your investment in a higher sales price, so losses of $2,500 are likely.
Total transaction costs: $23,100 or about 10 percent of your sales price. That's a lot of money.
Now consider this: Your current equity in the property is the difference between the $235,000 value and the $165,000 current mortgage balance, or $70,000. If you are paying $23,100 in transaction costs, you're wiping out 33 percent of the equity you had in the property.
This is why it makes sense to hold real estate for long periods of time. In fact, forever is the optimal holding period.
More about owning real estate:
What Is 'Risk' in Real Estate?
Offer Accepted: What Happens During Escrow?
Are You Properly Insured for Your Real Estate?
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Leonard Baron, MBA, is America's Real Estate Professor®. His unbiased, neutral and inexpensive "Real Estate Ownership, Investment and Due Diligence 101" textbook teaches real estate owners how to make smart and safe purchase decisions. He is a past lecturer at San Diego State University and teaches continuing education to California real estate agents at The Career Compass.
Note: The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinion or position of Zillow.