The cost of holding

By: J. David Chapman/May 13, 2021

Land investors have long understood the cost of “holding” real estate assets that produce no income. The game for most land investors is to hold the asset for the hope that it will appreciate while paying reoccurring expenses.

During COVID-19 and the ramifications that have followed, real estate developers have learned, if they didn’t already know, the effects of holding costs as well. Maybe I am a bit sensitive to holding costs right now because I have been affected the last year more than ever. Every developer I know is behind on projects and most are absorbing these holding costs. So, what are these holding costs, and why are they so damaging right now?

Real estate carrying costs are the recurring costs that the property owner is responsible for during the duration of owning the property. Real estate holding costs are typically paid monthly and are important because they affect the investor’s bottom line. They are part of the monthly budget as well as a factor when deciding on a property acquisition budget.

Many investors who purchase an investment property forget to include all of their carrying costs and only include the acquisition and rehab costs. It’s important to include other real estate carrying costs like utilities and management fees because they affect everything from your budget, return on investment to your cash flow, and your cap rate. They also help determine what amount of rent you need to charge if the property will be a rental upon completion.

Unlike operating expenses, carrying costs include your mortgage payments. Think of them as the cost of doing business. You pay these holding costs while you own the investment property. Standard real estate carrying costs include: your mortgage payments, insurance, property taxes, utilities, maintenance, and homeowners’ association dues.

At the start of the pandemic most construction stopped for a period of time. Although eventually declared an “essential” business, that did not mean that all of us had confidence that we should be proceeding with our projects. Many of us took a break and continued to incur these holding costs. Then once we started back with construction, many were shut down because entire crews were ill with the virus or the materials were back-ordered and not available. Holding costs have made this a particularly challenging time for developers.

J. David Chapman is an associate professor of finance and real estate at the University of Central Oklahoma (jchapman7@uco.edu).