As investors, we do not want surprises at the closing table. Knowing how line items are pro-rated on the closing statement is quite important. It’s probably a bit of an over-statement to say that the surprise will happen at the closing table, as the investor buyer will realize they have problems before that point. However, it may not be long before closing, and it’s usually very much too late to do anything about it. That is, anything except bring a bigger check with you.
The first thing to know about pro-rating rents, taxes and other items, is to know if they are paid in advance or in arrears. If they are paid in advance, then generally the seller may be owed a credit for sums they have paid for periods of time after the closing. If paid in arrears, the buyer should get a credit, as they will need to pay for obligations prior to closing.
So, once we know how an item is being paid, in advance or arrears, we can calculate who owes who, and how much. There are a couple of more wrinkles before we can jump to the calculations:
· Are we pro-rating “to” or “through” the date of closing? The purchase contract should spell this out. If “to”, then the buyer is picking up the tab for closing day. The seller is paying if it’s “through.”
· Are we using a banker’s or calendar year? As we’re bringing our calculation down to a certain date, with an obligation for a number of days payment by one of the parties, we need to know how many days in a month. Bankers use a 12 month year with 30 days in each month, or 360 days for the year. A calendar year is, of course, either 365 or 366 days. Though the difference is usually small, it isn’t insignificant.
OK, we now know what type of year we’re using, whether it’s “to” or “through” closing day, as well as which items are paid in advance and which are paid in arrears. Now it’s just a matter of doing the math.
· Rents are a major consideration. As they are generally paid in advance, the seller will get to keep the amounts “to” or “through” closing, while the buyer will receive a credit for the pre-paid rents through the end of the month of closing.
· Property insurance is also normally paid in advance, and either for six months, or more likely a year in advance. The buyer will owe the seller a credit for the amount from closing through the end of the policy period.
· Taxes could go either way, depending on when property tax bills are issued. However, they are usually paid in arrears, so the seller would normally owe the buyer a credit for taxes they’ll be billed for periods before closing.
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