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A Brief Introduction To Operating Expense In A Commercial Rental Property

Thoughtful investment in a real estate property is always a smart investment. Real estate is not a depreciating asset like a car. Whether it is a residential property or commercial property, its value is going to increase.

When you are buying a commercial property to become a landlord, you have to keep in mind that operating expenses of commercial property are more as compared to the operating expenses of a residential property. You can make use of commercial property management software to keep track of your operating expenses. However, you have to be aware of these expenses before you invest in a commercial property. These expenses are going to impact the cost your tenants have to pay and your income. Operating expenses include out-of-pocket costs on maintenance, space and keeping things legal. 

What Is Included In Operating Expenses? 

Think about the following operating expenses before investing in a property:  

  • Property expenses 
  • Property insurance 
  • Administration/management fees 
  • HVAC, electricity and other utilities 
  • Supply costs and contracted services 
  • Common area maintenance

What Is Not Included In Operating Expenses? 

Not all major costs are included in these expenses. Following are the important expenses not included operating expenses: 

  • Advertising and marketing costs 
  • Market study fees and consultant fees 
  • Refinancing of the property 
  • Tenant improvements 
  • Structural repairs/capital improvements 

How To Calculate Operating Expenses? 

These costs are calculated per square foot of space. Calculate the total cost and then divide per square foot of space passed to the tenant. Also consider the percentage of shared space. As the property tax and insurance rates increase, also increase the operating expenses your tenants are paying. 

Operating Expenses And Net Operating Income 

Calculate your gross operating income and deduct operating expenses from it. When it comes to buying a commercial property in a neighborhood, start with operating expense ratio: operating expenses divided by gross operating income. A low operating expenses ratio indicates higher profit margins and minimizes expenses. 

Who Pays Operating Expenses Of A Commercial Real Estate?   

The financial burden of these expenses of shared space is split. The tenants pay for the dedicated space they are using. The landlord has to cover the vacant space. So, a landlord should make sure that the maximum of the space is rented out. The structure of operating expenses depends on the contract. 

Tenant Negotiations 

A business owner looking forward to renting your space carefully reads the operating expenses clause. A tenant might want to limit or exclude some of the terms. The tenant might ask you to specify that the management fee does not include any commission made by the property manager on new rentals. Major utility purchases should fall under capital improvements so that the tenant’s approval is required for these purchases. There can be several other negotiations a tenant can make.  

Expense Stop 

Expense stop is the annual threshold for the operating expenses a landlord has to pay in a gross lease.

Operating Expense Cap 

It is the landlord’s job to hire vendors and supplies for common area maintenance. So, the tenants can request a cap in annual expense charged from them. 

Operating expenses are as important as your rental income. So, use commercial property management software to track operating expenses.

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