How To Trim Real Estate Closing Costs For More Profit
By Paul Esajian on September 4, 2015
How can real estate investors trim down closing costs to increase net profits?
Closing costs make a massive difference in net profits for real estate investors. So how can they be reduced and kept in check?
How Much Your Closing Costs Matter
The impact of real estate closing costs are often underestimated when evaluating deals. This is incredible given how much of the numbers they represent. Closing costs can vary widely, but once you factor front and back end expenses they can run from a couple percent to over 12% of the purchase and sales price. Those are big numbers.
Forget the gross between what you think you can buy a property for, and what you can sell it for. That means little if the closing costs get out of control. So many real estate investors spend hours and even weeks deliberating and negotiating small numbers in the purchase price of a property. These can be miniscule compared to the potential savings to be had by getting better control of closing costs. If you are doing even 6 deals a month, and can save $2,000 per deal, that’s an extra $12,000 a month. If you even saved just $12,000 a year on closing costs, and compounded those returns at just a 10% return over the next 30 years, that’s around $2 million.
Closing costs make all the difference in your per deal profit, net annual profits, and in your lifetime achievements.
More than this, the profit margin difference directly impacts competitive advantage. The real estate investor with the best profit margins has the advantage at every single acquisition and sales opportunity. The can bid more, and sell for less, and still make the same or more money. Or they can buy more, advertise more, do more branding, and accomplish far more, all with the same amount of capital. This profit margin and competitive advantage snowballs over time. It puts more and more space between those rising and growing fast, and the rest.
Bait & Switch
What makes the closing cost issue worse is that they are virtually always more than quoted. It’s like building costs. You can almost guarantee that closing costs will be more at the closing than estimated when going into the transaction. In fact, the gap can be a lot wider than the typical 25% margin allowed for building and rehabbing costs. This can be due to literal bait and switch by a wide variety of vendors, or typical changes that arise during the transaction.
So real estate investors must allow for a cushion of error, and look for vendors they can trust.
Shopping for Deals
Shopping around for the best deals from related vendors is obviously one of the best ways to reduce closing costs. This can be tricky, and frustrating, but you’ll normally only have to deal with it once for each market you are working in. At least until you need to switch vendors. Do not try to cut out critical needs like title insurance, hazard insurance, and inspections. Shop them, but don’t risk going without them. That will cost you far more. Don’t just go for the lowest quote or promise of fastest service either. Get referrals. Find trustworthy companies and professionals that will deliver what they promise. It’ll be worse to be caught by bait and switch than going for the mid-range, but reliable quote. Be wary of pushing people too far too.
Negotiating Lower Closing Costs
What can you offer in exchange for lower rates? Can you pay more upfront for lower net costs? Roll some into financing? Can you offer a lot of volume business that will earn you a discount? It’s always worth asking for a discount. However, do note that if you push them too far you are going to risk inviting bait and switch, or eroding their margin so far that your deal will be the last thing on their list of priorities. Than can be worse than paying a little more. The deal that doesn’t close can be really expensive.
Strategies for Reducing Closing Costs
Keep your mind on strategies for reducing closing costs now and for the long term too. Can you eliminate one or two sets of closing costs on flips? Can you prolong and put off the hit with seller financing? Can 1031 exchanges put off the tax hit associated with selling? Can you own the vendors and pay yourself instead of a third party? Or can you balance and offset closing costs with outbound referrals?
Summary
Do not underestimate closing costs. They can make your break investors. Not just in terms of individual deals, but whole portfolios, and businesses. So shop smart, and look for ways to boost net profits and command the competitive edge.