Hidden Costs of Real Estate Investing (That New Investors Overlook)

Real estate investing is a proven strategy for building wealth and increasing capital, with lucrative opportunities available in every market.You’ve got to be ambitious as a real estate investor and there are potentially lucrative opportunities in every market. If you’re a first-time investor, you’re probably focusing on the headline figures: primarily the purchase price and mortgage costs.

New investors often overlook hidden costs that traditional homeowners don’t encounter, such as maintenance reserves, vacancy expenses, and investor-specific tax liabilities.Overlooking these costs, like property taxes, insurance, and tenant turnover, can put you in a difficult financial situation. 

When you’re learning the basics of real estate investing, you’ll want to familiarize yourself with these hidden costs to guarantee long-term success and better financial planning. We’re breaking down the hidden costs that new investors overlook with advice on how to avoid these.

What are Hidden Costs in Real Estate Investing?

Real estate investing can help you build wealth and generate passive income, but it’s not without risks and challenges. Hidden costs in real estate aren’t included in the upfront purchase price and that investors may not consider when they first enter a deal. These costs aren’t immediately apparent and can negatively impact your cash flow if they’re not accounted for.

Failing to account for hidden costs can strain your cash flow and limit future investment opportunities. For example, failing to account for capital gains taxes could leave you out of pocket if you’ve not planned for these within your investment and financial strategies. 

9 Common Hidden Costs in Real Estate Investing

Real estate investment is all about balancing risk and reward. Before you sign on the dotted line for an investment property, you need to account for the full picture. While it’s important to account for property appreciation and its impact on cash flow, hidden costs can have a more immediate impact on your finances. 

Here are 9 hidden costs commonly overlooked by new investors:

1. Taxes for Real Estate Investors

As an investor, you’ll be expected to pay property taxes on all investment properties. However, these are considered an operational expense and are deductible against the income generated by your rental property. You’ll still need to have the capital available to pay these and they typically increase annually. 

There are three other types of taxes you’ll be liable for as a real estate investor:

• Income Tax

You’ll pay taxes on the income you generate from rental properties, calculated by deducting allowable expenses from the rental capital generated to determine your net rental income. 

• Capital Gains Tax

Short-term capital gains tax applies to properties held for less than a year—critical for fix-and-flip investors, as these rates are typically higher than long-term capital gains tax.. Properties held for over a year are charged a reduced long-term capital gains tax rate. You’ll pay capital gains tax on the profit of the property sale, so account for this in the final price.

• FICA Taxes

Although not always relevant for new investors, it’s important to consider hidden costs that you might occur in the future. If you register your properties as part of a real estate business, you’ll be liable for FICA taxes, including Social Security and Medicare. 

Even as a first-time investor, it’s important to create a tax strategy that maximizes cash flow. If you’re unfamiliar with property taxes, working with a specialist accountant can help streamline the process. 

2. Insurance Premiums 

If you’re planning to rent out your investment property, you’ll need to purchase landlord insurance, which is typically more expensive than standard homeowner insurance. You’ll want to consider insurance premiums when choosing where to invest as properties in areas at a high risk of flooding and natural disasters will face larger premiums. 

There are different types of insurance that you might want as a real estate investor. General liability insurance is a preference for most investors as it provides broad coverage, protecting your real estate investment against potential risks including legal costs from third-party claims. 

If you’re focusing on commercial property, explore the option of commercial property insurance to protect your building against vandalism, fire, theft, or other structural damage. While insurance is often considered a hidden cost, it can help offset future costs if repair work is required. 

Most standard insurance policies exclude natural disasters like earthquakes and floods, making additional coverage essential for properties in high-risk areas. If your property is in an area likely to be impacted by natural disasters and extreme weather, it’s a good idea to invest in specific coverage. 

3. Maintenance and Repairs

As a real estate investor, you’ll be liable for maintenance and repair costs for your property. These are often the most common hidden costs as they can be difficult to predict. The age and condition of your property will directly impact your future repair costs, but you’ll also need to consider routine maintenance, such as HVAC servicing and plumbing. 

A common rule of thumb is to set aside at least 1% of the property’s value annually for maintenance and repairs, though older properties may require more. If your property is valued at $500,000 or more, budget at least $5,000 annually for maintenance and repairs. Having an emergency fund or additional capital set aside for unexpected repairs can help offset these hidden costs. 

Electrical issues, roof leaks, and other emergencies can happen out of the blue and you’ll be responsible for paying for these repairs as the property owner. When you’re determining the return on investment (ROI) of a property, always consider its potential maintenance costs against its expected rental income. You’ll want to consider the property’s location, including the likelihood of weather-related damage, and the property type, including its age and condition. 

4. Property Management Fees

Property management fees are one of the most common hidden costs of real estate investing, especially if you intend to be a passive investor and outsource your management to a third party. Typically, these fees account for 8-12% of monthly rent but may be charged as a flat fee, depending on your chosen property management company. 

Even if you manage your property yourself, you can expect to face hidden costs like leasing fees, marketing expenses, and costs associated with evictions. Property management fees will be higher for commercial and multi-family properties, as well as larger properties. Higher-rent markets typically have higher property management fees, while newer properties often incur lower costs due to fewer maintenance needs.

If you choose to work with a property management company, you can expect to be charged a standard monthly fee, along with additional costs for advertising, leasing, and the initial setup. 

5. Vacancy and Tenant Turnover

One of the most unexpected hidden costs is vacancy and tenant turnover. If your property sits empty, you’re losing out on valuable rental income. However, you’ll still be accumulating costs during this vacancy period, including advertising your property, re-leasing it, and cleaning it regularly. 

You may need to account for making minor repairs between tenants, such as replacing carpets, upgrading fixtures, and repainting. Tenant turnover costs will be impacted by the age, condition, and location of your property. If your property has a high turnover rate, it can quickly start to negatively impact your earnings. 

6. Closing Costs

The price you’ll pay to get the keys to your property is more than just the sticker price. There are common closing costs that are often overlooked, including attorney fees, title insurance, and inspection fees. 

Closing costs typically range from 2% to 6% of the purchase price. Partnering with an investor-savvy agent ensures you accurately budget for these expenses.

7. Utilities and Operating Expenses

If you’re renting out your investment property, you’ll likely be responsible for utilities and operating expenses. While long-term tenants may take on these utility costs, you’ll still be responsible for other operating expenses, such as property taxes, landscaping, and HOA fees. 

You can account for these hidden costs by using the 50% rule, which stipulates that utilities and operating expenses are typically half of the annual gross rental income. Talking to other investors and landlords in the local area can give you an insight into these potential costs to help prepare your cash flow strategy.

8. HOA Fees

Don’t overlook HOA fees. While they average between $200 and $400 monthly, they can range up to $1,000 for luxury properties. The number of properties with HOA fees is steadily increasing in the USA, but these costs translate to amenities and services offered by the HOA, which may enable you to charge a higher rental cost.

9. Capital Expenditures

One hidden cost that you can budget for is capital expenditures. These major repairs or replacements are larger expenditures. While they won’t happen regularly, they are expensive and should be considered in your cash flow and budget. Prioritizing capital expenditure can help boost the long-term value of your property and make it more attractive to potential tenants or buyers.

It’s recommended to set aside at least 1% of the property’s value annually for future capital expenditures. You can predict potential expenditures by estimating the remaining life of major appliances, like the HVAC system, and the potential replacement cost.

Potential capital expenditures include replacing your HVAC system, installing automation systems, and adding new equipment or appliances. It’s best practice to account for capital expenditure on your balance sheet, including tracking the depreciating of an asset over its useful life.

There are multiple financing options for capital expenditures if these pop up unexpectedly, including traditional bank loans and private financing. Although a hidden cost, every investor should plan for capital expenditures to improve their property’s value and revenue potential. 

The Impact of Hidden Costs on Cash Flow

Hidden costs can be expensive and have a negative impact on your cash flow, especially as a first-time investor if you have limited resources. These hidden costs can reduce the profitability of your investment and may put you in a negative financial situation, including having to cover costs out of pocket. 

Unexpected expenses can disrupt cash flow and erode projected ROI. It’s important to account for the hidden costs listed above to better calculate the potential profitability of your investment.

Failing to account for these hidden costs can make it difficult to grow your portfolio or generate the passive income you expect to receive. 

How New Investors Can Avoid Being Caught Out by Hidden Costs

Hidden costs aren’t always unexpected. Many of the hidden costs in our lists are well-known to seasoned investors and those who are more familiar with the real estate market. 

If you’re a new investor, you’re already doing your due diligence by researching these hidden costs. Due diligence is your best way of avoiding the unexpected, from doing your research on the local property market to investing in a property appraisal or inspection.  

You can avoid being caught out by hidden costs by creating a realistic budget that accounts for the average costs listed above. Your budget as a real estate investor should account for both expected and unexpected costs by setting aside a portion of your rental income to cover future maintenance repairs and capital expenditures. 

A contingency fund is your best defense against hidden costs. Be proactive and budget at least 40% of your rental income for expenses and utilize home warranties and insurance for larger repairs. As a first-time investor, you might decide to focus on properties with lower maintenance needs to reduce the risk of unexpected repairs.

There are proactive steps first-time investors can take to reduce hidden costs, including screening potential tenants to minimize turnover and unexpected vacancies. You don’t have to do everything by yourself. Reach out to professionals for help and advice, including accountants, contractors, investor-focused real estate agents, and property managers. 

Routine inspections and preventive maintenance help minimize unexpected repair costs and prolong property value. Always have an emergency fund as a real estate investor and ensure your cash flow accounts for predictable expenses, such as utilities, taxes, and insurance.