The sale price catches up with the money paid in after a few years. The return never quite does, and the gap is larger than spreading the costs over the hold suggests.
There are two answers, and they differ by decades. On an illustrative 20,000,000 purchase at a 5.5 per cent yield, with 6.8 per cent purchaser's costs, 1.75 per cent sale costs and value growth of 2.0 per cent a year, the sale price covers everything paid in after 4.2 years. But the costs never stop showing in the return: the IRR is 5.63 per cent on a five-year hold and 6.48 on ten, against 7.50 per cent with no costs, and it takes 28 years to clear a 7.0 per cent target.
Worked in full in Commercial Real Estate Investing by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Purchaser's costs are paid on day one and sale costs on the last day, so they are a fixed toll on the round trip. A longer hold spreads the toll over more years, which is why "how long do I need to hold" is a reasonable question. The mistake is to think the toll is ever fully paid off. It shrinks with time; it does not reach zero.
| Input | Value |
|---|---|
| Net purchase price | 20,000,000 |
| Purchaser's costs (transfer tax, agents, legal, survey) | 6.8% |
| Net operating income, year 1 | 1,100,000 |
| Initial yield on the net price | 5.5% |
| Growth in income and value | 2.0% a year |
| Exit yield | 5.5%, unchanged |
| Sale costs | 1.75% of the sale price |
| Target unlevered IRR | 7.0% |
The yield and the growth are held constant on purpose. With the exit yield equal to the entry yield and income growing at a steady 2.0 per cent, the property's return before costs is exactly the yield plus growth, 7.50 per cent, whatever the holding period. Any shortfall below 7.50 is the cost of buying and selling, and nothing else.
The buyer pays 20,000,000 plus 1,360,000 of costs, 21,360,000 in all. The sale returns the gross price less 1.75 per cent. Capital is recovered when:
Value today × (1 + g)T × (1 − sale costs) = Value today × (1 + purchase costs)
(1.02)T = 1.068 ÷ 0.9825, so value must rise 8.70 per cent
T = ln(1.068 ÷ 0.9825) ÷ ln(1.02) = 4.21 years
In Excel: =LN((1+B2)/(1-B3))/LN(1+B4) with purchase costs in B2, sale costs in B3 and growth in B4.
This is the number most people mean by "recovering the costs": the round trip costs 8.55 per cent of today's value, and at 2.0 per cent a year it takes a little over four years of growth before a sale returns more than the cheque written on day one. It ignores the income, and it ignores the time value of the money. A hold of 4.21 years has not made the investor whole in any sense a fund would recognise; it has merely avoided a nominal capital loss.
Take the five-year hold. Income grows from 1,100,000 to 1,190,675; the property is sold at the end of year five for 22,081,616, and 386,428 of sale costs leave 21,695,188.
| Year | 0 | 1 | 2 | 3 | 4 | 5 |
|---|---|---|---|---|---|---|
| Cash flow | −21,360,000 | 1,100,000 | 1,122,000 | 1,144,440 | 1,167,329 | 22,885,863 |
The IRR of that series is 5.63 per cent, 1.87 points below the 7.50 per cent the same building earns with no transaction costs. Repeat for other holds:
| Hold (years) | IRR | Drag from costs (bp) |
|---|---|---|
| 1 | −1.02% | 852 |
| 2 | 3.09% | 441 |
| 3 | 4.49% | 301 |
| 5 | 5.63% | 187 |
| 7 | 6.12% | 138 |
| 10 | 6.48% | 102 |
| 15 | 6.76% | 74 |
| 20 | 6.90% | 60 |
The drag falls steeply over the first five years and slowly after that. Against a 7.0 per cent target the deal needs a 28-year hold; at 27 years it is still a fraction of a basis point short. A building bought on these terms to clear 7.0 per cent unlevered has to be bought cheaper, grow faster or be sold at a lower yield, because time alone will not do it.
The two answers move differently. Faster growth shortens the capital recovery period sharply but leaves the IRR drag much as it was, because it raises the frictionless return by the same amount.
| Growth | IRR, no costs | IRR, 3 years | IRR, 5 years | IRR, 10 years | Capital recovered after |
|---|---|---|---|---|---|
| 0.0% | 5.50% | 2.55% | 3.66% | 4.50% | never |
| 1.0% | 6.50% | 3.52% | 4.65% | 5.49% | 8.4 years |
| 2.0% | 7.50% | 4.49% | 5.63% | 6.48% | 4.2 years |
| 3.0% | 8.50% | 5.47% | 6.61% | 7.47% | 2.8 years |
| Purchase costs | IRR, 3 years | IRR, 5 years | IRR, 10 years | Capital recovered after |
|---|---|---|---|---|
| 2.0% | 6.19% | 6.71% | 7.09% | 1.9 years |
| 4.0% | 5.47% | 6.25% | 6.83% | 2.9 years |
| 6.8% | 4.49% | 5.63% | 6.48% | 4.2 years |
The cost level matters most for short holds: moving from 6.8 to 2.0 per cent of costs adds 1.70 points to a three-year IRR (from 4.49 to 6.19) but only 0.61 to a ten-year one. That is the arithmetic behind buying short-hold, value-add assets through corporate vehicles where the structure allows it.
Spreading the round-trip cost evenly over the hold. 8.55 per cent over five years looks like 1.71 points a year, over ten like 0.85. The true drag is larger, 1.87 and 1.02 points, because the purchase costs are paid at the start and earn nothing for the whole hold, while the yield is earned only on the net price: the net initial yield on the 21,360,000 actually paid is 5.15 per cent, not 5.5. The straight-line shortcut understates the cost for every hold beyond the first year, and by most for the longest ones in relative terms. It also invites the conclusion that the costs are "paid off" after so many years, which, as the table shows, they never are.
The second mistake is to compare yields struck on different bases. The 5.5 per cent here is earned on the net price, while the net initial yield on the 21,360,000 actually paid is 5.15 per cent; entry and exit yields only compare when costs are treated the same way at both ends, as set out in how to calculate net initial yield with purchaser's costs.
Answer the question in IRR, not in years to break even on capital. Purchase and sale costs of about 8.6 per cent cost an unlevered investor about 3 points a year on a three-year hold, nearly 2 on five and about 1 on ten, and the drag never reaches zero. The same building can then be tested for whether to keep it, using today's net sale price as the reinvestment, as in the hold vs sell analysis. The cash flows above, with the hold, the costs and the growth as inputs, sit in the free workbook for this case.
It depends on the hold. On an illustrative building yielding 5.5 per cent with 2.0 per cent growth, 6.8 per cent purchaser's costs and 1.75 per cent sale costs cut the unlevered IRR from 7.50 to 4.49 per cent over three years, to 5.63 over five and to 6.48 over ten. The drag is 301, 187 and 102 basis points: steep at first, then falling slowly, and never zero.
Not on a sale at the same yield. With no growth the value never rises above the net price, so the 8.70 per cent increase needed to cover 6.8 per cent purchase costs and 1.75 per cent sale costs never arrives. The return is still positive because of the income, but the five-year IRR is 3.66 per cent against a frictionless 5.50, and the ten-year one only 4.50.
It understates their cost. A round trip of 8.55 per cent spread over five years suggests 1.71 points a year, but the true IRR drag in the illustrative case is 1.87, and over ten years 1.02 rather than 0.85. Costs paid on day one earn nothing for the whole hold, and the yield is earned on the net price, not on the 21,360,000 actually paid.
This article is one calculation from Commercial Real Estate Investing. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
Get the book on Amazon →Free companion files
Also on Amazon UK · Amazon Germany · Amazon France · Amazon Canada
Reading guide: real estate investing, finance and fund management → · All 1523 articles →
If this book helped, or didn’t, a few lines on Amazon are worth more than they look: they are what the next reader goes on. Write a review. The workbook stays free either way.