Common operating expenses include property management fees, utilities, maintenance, insurance, sales & marketing, general & administrative, property taxes, and reserves.
Some are projected based on a % of Effective Gross Income, some are based on $ per square foot or $ per square meter figures, and some are percentages of the property’s value.
Property Management Fees exist because owners rarely manage their properties directly; instead, they hire 3rd party management companies to deal with tenants, collect rent, resolve problems, and set up repairs and maintenance.
Simple Calculation: If the management fees are 3% of EGI and EGI is $1 million, then these fees are $30,000.
Other Operating Expenses might include insurance, maintenance and repairs, and utilities; if the property is big enough, this category might also include staff payroll, sales & marketing, janitorial, landscaping, and security services.
Simple Calculation: If the Operating Expenses are $10.00 per Rentable Square Foot per Year and there are 50,000 rentable square feet, then the annual Operating Expenses are $500,000.
Property Taxes are levied by nearly all local governments worldwide to fund school systems, police, and infrastructure.
In places like Australia and the U.K., there’s also a “Stamp Duty” on property sales, which may exist along with or in place of annual property taxes.
Simple Calculation: A property’s most recent assessed value was $20 million. The state and city charge property taxes for a total of 3% of the property’s value, so the taxes here are $600K.
Reserves exist to “smooth out” the property’s cash flows as large, irregular capital costs come up.
For example, if you allocate $200K per year to the Reserves over 5 years when there are no capital costs in Years 1-2, $600K of capital costs in Year 3, 0 in Year 4, and $400K in Year 5, you can use the Reserves to cover the Year 3 and Year 5 costs without dipping into the property’s cash flows.
If the Reserves are insufficient to fund these capital costs, then they will be funded with some of the property’s annual cash flow instead. Here’s an example:
NOTE: There is significant disagreement over where these Reserves should show up.
Some people argue that they should be below the NOI line and therefore not affect NOI, while others argue that Net Operating Income must reflect Reserve Additions to account for the true cost of running the property.
We tend to follow the latter approach, so we do that in all the models here; this approach is also more conservative and favored by lenders.
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