The costs of owning

A friend describes an asset: costs 300,000, brings in 21,000 a year in rent. Seven percent, they say. Not bad.

Nothing they said is untrue. It is also not the return, because the sentence contains one of the four costs of owning and omits three of them, and the three omitted ones are usually larger than the one included.

The first one, drawn to scale

Debt service is the largest cost of owning for most people who own anything substantial, and it is the one that hides best, because it arrives as a monthly payment rather than as a total.

The monthly payment is the number everyone knows. The total is the number that decides things.

Property loan

≈ Hypothetical model, not a forecast

A long-dated secured loan: the payment, the interest bill, and what paying extra each month changes.

It assumes

• The rate is fixed for the whole twenty-five years, which long loans rarely are.
• Every payment is made in full and on time for three hundred consecutive months.
• Nothing is spent on repairs, insurance, taxes or fees anywhere in this model.
• The property is worth neither more nor less at the end than at the start.

It ignores

• Purchase taxes, legal costs, survey fees and lender fees
• Insurance, maintenance, and anything else the property costs to hold
• Any change in the value of the property itself
• Rate resets, which is how most long loans actually behave

Get the total interest to land between 300,000 and 320,000 — more than the purchase price of the whole property. You can do it by moving the rate, or by leaving the rate alone and stretching the term. Try both, and note how ordinary each looks.

Annual interest rate5%

Term25

Extra paid each month0

Paid on top of the scheduled payment, straight off the balance.

Amount borrowed

255,000

Deposit paid up front

45,000

Loan as a share of the price

0.85

Scheduled monthly payment

1,491

Total handed over, scheduled payments only

447,211

Total handed over, paying extra

447,211

Total interest, scheduled payments only

192,211

Total interest, paying extra

192,211

Months taken when paying extra

300

Months removed from the term

0

Interest avoided

0

• Balance outstanding
• Interest paid so far

◷ Not there yet — keep moving the controls.

Two ways to get there, and both are worth having found.

The rate route lands somewhere near seven and a bit percent — a rate that has been entirely ordinary in most places at most times. The term route gets there at an unremarkable 5%, on a loan stretched to something close to thirty-seven years. At either point the borrower has paid for the property twice: once to the seller and once to the lender.

Two observations that follow.

The first is that the term does at least as much damage as the rate, and gets discussed far less. Stretching a loan lowers the monthly payment, which is what the borrower is optimising, and raises the total interest substantially, which is what they are paying. Both facts are true at once and only one of them is on the offer sheet.

The second is what the chart shows. Interest accumulates fastest at the start, when the balance is largest. Early years are mostly rent on the money and barely reduce what is owed, which is why the balance after five years is so much higher than five years of payments would suggest.

Upkeep, which includes the part that is not repairs

Repairs are the visible half. The invisible half is depreciation: the value the asset loses by getting older, regardless of whether anything breaks.

A building does not stay the same building. Its systems age, its layout goes out of fashion, its energy performance falls behind what is now expected, and each of those quietly moves the price a buyer will pay. Spending on maintenance does not stop this; it slows it. The spending is the cost of slowing it, and it recurs forever.

For assets with moving parts or a technology component the effect is faster and more brutal. A machine bought this year competes, in five years, against a better machine bought next year by somebody else, and its earning power falls even though it still works.

Transfer and tax

Buying and selling most substantial assets costs a real percentage: fees to intermediaries, legal work, surveys, and in most places a transaction tax on the purchase, the sale, or the gain.

The mechanism worth carrying away is that these are charged on the whole value and earned back out of the return. A cost of a few percent of the price can be a year or two of the yield, which means an asset held for two years and an identical asset held for twenty are not the same investment at all. Turnover is expensive in a way that never appears in a yield figure.

Predict

Someone owns six small rental units and spends roughly six hours a week on them: viewings, repairs, chasing payments, paperwork. What is the honest way to account for those hours?

Choose one answer

They are free, because the owner would otherwise be watching televisionPrice them at what an agent would charge to do the same workPrice them at the owner's hourly rate at workIgnore them, since the work is not paid in cash

Lock in answer

What is left

Take the friend's 7%. Suppose two thirds of the price is borrowed at 5%, upkeep and depreciation run at 1% of the value each year, transaction costs amortise to a few tenths, and six hours a week is worth what an agent would charge.

The 21,000 does not become nothing. It becomes a much smaller number, sitting on a much smaller slice of capital that is genuinely yours, with a leveraged exposure to the price of the underlying. That is a completely legitimate position to hold, and it is a different position from the one described by "seven percent, not bad".

Check

Two assets both yield 6% gross. One is a building; the other is a claim on a diversified pool that requires no work and has near-zero holding costs. What does the gross yield tell you about which is better?

Choose one answer

Nothing useful — the yields are gross and the costs are the whole questionThey are equivalent, so pick on other groundsThe building is better, because you can borrow against itThe pool is better, because it has no costs

Check answer

Worth remembering

• Four costs sit between an asset and its return: debt service, upkeep, transfer and tax, and the owner's time.
• On a long property loan at ordinary rates, total interest can exceed the purchase price of the property itself.
• Lengthening a loan term lowers the monthly payment and raises the total paid, and only the first is on the offer sheet.
• Depreciation is the part of upkeep that is not repairs: value lost to age and obsolescence whatever you spend.
• Time spent on an asset is a cost, and pricing it at what an agent would charge separates the return from the wage.