Operating Expenses

The costs to run and maintain an investment property. In apartment syndications, operating expense usually includes; payroll, maintenance, repairs, contractors, management fees, property taxes, insurance, marketing, admin, utilities, and capital reserves.

What are operating expenses?

Operating expenses are the recurring cost incurred to keep an establishment operating. In real estate, operating expenses are incurred by the owner who manages the real estate space which includes payroll, maintenance and repair costs, pest control, management fees, property taxes, utility, insurance, HOA fee, etc. 

These expenses are calculated to determine the cash flow and compare how much money is being spent with how much money comes in from rent. To maintain a positive cash flow, the owner needs to ensure that the rent he charges from his tenants is enough to cover the operating costs and any other expenses that he may incur. 

However, the owner must keep a fair rent as per the average rent of the area so that he does not end up asking for more and lose possible tenancy. 

What are the examples of operating expenses?‍

Examples of operating expenses for a multi family or single family home include the following:

• Advertising and promotional costs
• Costs incurred to run credit and background check of tenants. 
• Leasing fees paid to a property manager
• Repair and maintenance costs.
• Pest control.
• Property management fees. 
• Salary paid to people who manage the property (if applicable).
• Utilities bill.
• Insurance premium amount. 
• Homeowners Association fee (HOA).
• Fee paid to professionals such as accountants and lawyers. 
• Property taxes.

‍Which expenses are not included in the operating expenses?

There are certain expenses that investors do not include in the operating expenses as these expenses are not incurred for operating the rental property and are mandatory to be paid whether the property is generating any income or not. The expenses that are not included are:

• Mortgage payments for the property. 
• Tax paid by the investor annually. 
• Depreciation.
• Capital expenses. 

Why are operating expenses important?

It is important to calculate operating expenses of a property so that investors can determine the profitability of their investment. As these costs are mandatory to be incurred, it is important for investors to figure out a rent amount that will be enough to cover these expenses while being fair to the tenants. 

It also helps to predict the costs that the investors will incur other than the basic expenses he has kept in mind. When the operating expenses are calculated, if this expense exceeds the amount that comes in through rent, then the investor needs to take measures to improve this ratio. 

Operating expenses are also important to calculate for filing tax for a given financial year.

How can I calculate the operating expenses of a rental property?

To calculate the operating expenses of a rental property, you simply have to add all the expenses you are incurring for the property and then deduct this amount from the total rental income to determine the income. Let’s understand this with an example.

Suppose Mr. X has rented out an apartment building of 10 apartments for $500 rent each month. In this property, he has to incur a monthly expense of $200 in utilities, $100 in maintenance, $100 for insurance premium, $100 in taxes, $50 in HOA fees and $200 in other expenses. So, the operating expense will be:

OE = 200 + 100 + 100 + 100 + 50 + 200 = $750‍

Some investors use a 50% rule where the operating expenses should account for 50% of the total rent in order for it to be a profitable investment. For example, if the annual operating expense is $5000 and the annual rental income is $10,000, then this is a profitable investment as the operating expense accounts for 50% of the income generated. 

Conclusion ‍

A rental property is supposed to generate a passive income that will bring in positive cashflow. This amount is deduced by calculating the operating expenses of a property. If the expenses are continuously higher than the rent collected, the investor may choose to sell the property and pay off his debts. 

Operating expenses are important to be calculated for companies also to determine how well their company is performing. As such, investors and companies need to have a clear understanding of all the possible operating expenses they are going to incur and then set revenue goals.