Friction Costs

Friction costs are the direct and indirect expenses incurred for the buying and selling of a financial instrument.

In the equity market, friction costs (FC) are the broker's fees and taxes paid to the government. For stocks, this equates to approximately 1.19% of the purchase price of the stock. That is to say, the stock price has to increase by 1.19% to break even from purchasing a stock.

Even time deposit accounts have friction costs. It's a 20% withholding tax on the interest earned.

In the RE world, friction costs are typically the capital gains tax, doc. stamp tax (DST), registration fee (RF), transfer tax (TF), and broker's fees, which equate to approximately 12% (or 14% if the broker's fee is 5%) of the gross selling price. That is to say, RE prices have to increase by at least 12% to break even.

(For preselling properties, the DST, RF, and TT are charged by the developer and called "Handover Costs" or "Other Charges.")

The significantly higher RE friction costs make these assets less liquid. Assuming a property was bought at market price and RE prices grow by 5% annually, it would take more than two years to break even.

RE friction cost has likewise evolved recently as the BIR has begun chasing after property flipping and rental businesses. Depending on how the BIR classifies the seller (i.e., someone who is registered to be in the RE business vs. someone who is not), RE friction costs may quickly jump to 53% (12% VAT, 35% Income Tax, and 3% Broker's Fee as well as fees associated from the original purchase–1.5% DST, 0.75% RF, and 0.75% TT) of the GROSS amount.

This ridiculously high friction cost would make any investor think twice before purchasing RE. Thus, investors and brokers must understand this concept in RE investments.