July 6, 2023
OpEx in Real Estate: Everything you Need to Know
Welcome to our comprehensive guide on Operational Expenditure (OpEx) in the Real Estate industry. The world of real estate can often be a maze of figures, financial terminology, and complex strategies, but one of the fundamental components to understand is OpEx. Whether you're a seasoned real estate investor looking to optimize your portfolio, a property manager seeking to streamline costs, or a novice simply interested in understanding the industry's financial nuances, grasping the ins and outs of OpEx can prove to be a game-changer. In this blog post, we will demystify OpEx in real estate, provide practical examples, and offer insights into managing and leveraging these expenditures effectively.
Because OpEx is such a major component in creating a financial model for a real estate property I wanted to do a deep dive into the topic. I plan to cover the following:
With that as our guide, let’s dive in!
Operational Expenditure (OpEx) refers to the ongoing costs for running a product, business, or system. In the context of real estate, OpEx involves the expenses that owners or property managers incur while maintaining and operating a property.
OpEx and Operational Expenditures in real estate refer to the same thing. "OpEx" is simply a shortened term for "Operational Expenditures."
Operating expenses, often referred to as OpEx, are costs associated with running and maintaining a property on a day-to-day basis. In real estate, these can include a variety of costs. The following are common examples of operating expenses:
- Property Management Fees: These fees are often paid to a property management company for overseeing the property. This can include tasks such as collecting rent, dealing with tenant issues, and maintaining the property.
- Maintenance and Repairs: Regular maintenance and repair costs can include everything from routine maintenance like lawn care, to unexpected repairs like fixing a broken HVAC system.
- Utilities: In some cases, the landlord may be responsible for paying certain utilities, such as water, trash, or even electricity and gas, particularly in common areas of multi-unit buildings.
- Property Taxes: Property taxes are a significant operating expense for real estate and are based on the assessed value of the property.
- Insurance: Landlords typically carry property insurance to protect against various types of damage or liability.
- Janitorial Services and Landscaping: For commercial properties, landlords will often provide janitorial services and maintain the landscaping.
- Advertising and Leasing Expenses: These are the costs associated with finding new tenants when a property becomes vacant, such as advertising costs or fees paid to real estate agents.
- Administrative and Office Expenses: This category can include costs related to the general operation of the real estate business, such as office supplies, postage, and phone bills.
- Legal and Professional Fees: Legal and professional fees can include anything from the cost of using an attorney to evict a non-paying tenant, to accounting fees for preparing tax returns.
- Depreciation: While not a cash expense, depreciation is a significant component of operating expenses in real estate. This is the process by which the cost of an asset is spread out over its useful life.
These are all considered operating expenses because they are necessary for the daily operation and maintenance of the property. They are different from capital expenditures (CapEx), which are investments made to extend the life of the property or increase its value, such as major renovations or property improvements.
OpEx will appear on your property’s income statement. You can see operational expenses highlighted in our commercial real estate pro forma as an example below:
The amount spent on operating expenses (OpEx) in real estate varies widely depending on factors like the type of property, its location, age and condition, the rental market, and the level of service provided to tenants.
However, as a general rule of thumb, many real estate investors use the "50% rule" as a starting point. This rule suggests that, on average, about 50% of the rental income from a property will go toward operating expenses, excluding any mortgage payments. This is not an exact percentage and should be used as a rough estimate. Actual expenses can be significantly higher or lower depending on the specifics of the property and the market conditions.
For example, newer properties might have lower maintenance and repair costs, while properties in areas with high property taxes or insurance costs might have higher operating expenses. Also, commercial properties might have different ratios due to the tenants often being responsible for some of the operating expenses (a setup often referred to as a triple net lease).
It's important for investors to conduct a thorough analysis of potential operating expenses before purchasing a property. This analysis should include research into property taxes, insurance costs, average maintenance and repair costs, potential property management fees, and other relevant expenses.
The most accurate way to determine OpEx is to use actual historical expense data from the property in question or from similar properties in the same market. If that's not available, you might need to estimate costs based on your knowledge of the property and its location, the local real estate market, and your plans for managing the property. Always plan for unexpected costs and include a contingency amount in your budget.
Many real estate investors will assume that OpEx should be roughly 50% of revenue for a real estate property. This can vary dramatically depending on your unique circumstances.
OpEx expenses for a real estate property could be forecasted in a number of ways. Our Multifamily Pro Forma Spreadsheet allows you to forecast OpEx based on a:
- Per property basis
- Per unit basis
- Per square foot basis
- Percentage of revenue
- Fixed monthly $ amount
Different expenses will make sense to forecast based on different cost drivers. You can see an example of our OpEx forecast assumptions below:
Reducing operating expenses (OpEx) can increase the net operating income (NOI) and potentially the value of a real estate property. Here are several strategies that property owners or managers can consider:
- Preventive Maintenance: Regular preventive maintenance can help avoid more costly repairs in the future. For example, regularly servicing HVAC systems can extend their lifespan and reduce the need for expensive emergency repairs.
- Energy Efficiency: Investing in energy-efficient appliances, lighting, insulation, and HVAC systems can reduce utility costs over time.
- Renegotiate Contracts: Whether it's insurance, property management, or vendor contracts, periodically renegotiating these contracts can often lead to cost savings.
- Property Tax Appeals: If you believe your property is overvalued by the tax assessor, you can appeal the assessment to potentially reduce your property tax bill.
- DIY Property Management: If you have the time and skills, managing the property yourself can save on property management fees. However, this can also lead to increased time commitments and potential headaches.
- Technology Implementation: Use of property management software or other technologies can streamline operations, potentially reducing administrative costs.
- Strategic Vendor Selection: Select vendors carefully for services such as landscaping, repairs, and maintenance. Some vendors may offer lower rates or bulk discounts.
- Tenant Retention Programs: It's often cheaper to retain existing good tenants than to find new ones. Regular communication, prompt response to issues, and occasional upgrades can keep tenants happy and reduce turnover, and thus lower advertising, leasing, and vacancy costs.
- Water-Saving Upgrades: In properties where the owner is responsible for the water bill, installing low-flow fixtures or dual-flush toilets can lead to significant water savings.
Remember that while it's good to reduce OpEx where possible, it's essential to balance cost-cutting with maintaining the quality and safety of the property and keeping tenants satisfied. Cutting costs too much can lead to deferred maintenance, unhappy tenants, and ultimately lower property values. Each property and market is unique, so what works in one situation might not work in another.
I hope this has been helpful in understanding and mastering OpEx for your property. If you have any questions that I didn’t cover, please feel free to reach out!