Whether you are purchasing a piece of property outright, investing in a building, or leasing a commercial space for your own business, it’s important to understand commercial real estate operating expenses, since they impact both tenants and net operating income (NOI) for the owner.
The smart property manager considers their expenditures when budgeting and knows how to minimize these business costs and negotiate favorable contracts, including monitoring how much is being spent and adjusting rates as necessary. For the inexperienced owner, not knowing how to calculate or structure these into a contract can be detrimental to their financial goals.
Often abbreviated to opex, these are the charges associated with maintaining and running a commercial property, such as an office building, retail space, or warehouse. They are part of the overhead and can be as important as the mortgage.
Depending on the building’s lease structure, these expenditures may be a component of the gross rent or be in addition to the base rent. In multi-resident buildings, each tenant is responsible for their share of management costs, which depends on the rentable square footage compared to the total rentable square footage of the building.
It should come as no surprise that the running costs of a building depend on the class of commercial property. An office or retail space will have different expenditures than a multi-family building. Many of the costs passed to renters are shared between lease holders and the owner in a commercial property. These include:
There are a few major charges not included in a property’s costs, although it’s important to note they may still be part of an owner’s responsibility. These include:
The formula used to determine NOI is meant to deduct the costs from gross operating income. Any landlord looking to maximize profits would benefit from minimizing expenditures or passing them along to residents. Another important formula to consider when evaluating properties is the operating expense ratio (OER). This is the costs to operate the property, not including depreciation, divided by gross operating income. A lower OER is better, as it usually indicates minimized expenditures and higher profit margins
The residents of a building generally split the financial burden of operating costs, paying based on the percentage determined by the rentable square footage on their lease. The owner, on the other hand, is responsible for the expenditures of any vacant space. This is why it’s usually to an owner’s benefit to keep as much of the building rented out as possible.
The way payments are structured depends on the kind of lease a tenant has, as well as any specifications they and owner agree to in the contract. Triple net leases cover base rent only, and any expenditures are assessed pro rata on top of the set rate. Full-service gross lease structures include the building costs in the rate, while a modified gross rent has different inclusions but typically includes some operating expenses in the base rate.
Anyone considering becoming a tenant will often read the operating expense clause in their lease carefully and come back with items they wish to exclude or limit. This could look like negotiating for a higher expense stop, wanting utilities measured or metered rather than automatically assessed, or asking for major expenditures to require their prior approval.
Tenants commonly ask for certain limitations and built-in safety parameters to ensure their charges don’t escalate beyond a reasonable amount. These include expense stops and operating expense caps.
In a gross lease, an expense stop is the maximum annual threshold for building management expenditures that owners are responsible to pay. Though gross leases include these, stops put a limit on what the owner must pay. A tenant in a gross lease may ask for a higher stop if they think the owner should be responsible for more of the management costs. This stop is also used as a numeric reference point on a lease for reasonable charges in the first year of that lease term. Meanwhile, a tenant in a net lease might ask for a lower stop in exchange for the ability to review the landlord’s list of expenditures.
The operating expense cap is a cap on annual expenditures charged to a tenant or a cap on expenditure increases. It is often requested for CAM fees, since owners have the responsibility to hire vendors and source supplies that are billed under CAM charges.
These are just as important as rent. Knowing the price of running a building may help accurately calculate its income potential. No matter the lease structure, operating expenses account for a significant portion of what tenants and owners worry about: the cost of running their business.
Typically, costs such as utilities, repairs, maintenance, exterior work, insurance, management, and property taxes all factor into the overall operating expenses.
Capital expenses, debt service, commercial property marketing costs, leasing commissions, tenant improvement allowances, and capital reserves are typically not included. This may vary from property to property.
In commercial real estate, the operating expense ratio is a measurement of the cost to operate a piece of property compared to the income that property brings to the investor. It can easily be calculated by dividing the property’s operating expenses (not including depreciation) by its gross operating income.
Investors may often confuse operating expenses with direct costs. Both are expenses incurred from operating your business or property, but the operating expenses are not directly tied to production. This only directly affects business owners, rather than investors who own a property, however.
If you’re looking to begin investing in commercial real estate, we can help you get started. Avistone is a rapidly growing commercial real estate investment firm focusing on the acquisition and management of multi-tenant flex/industrial properties and the acquisition and asset management of hotel properties nationwide.
Our firm offers accredited investors the opportunity to purchase equity shares with the potential to receive in-place cash flow from operations and capital appreciation upon sale. In order to provide the best possible outcomes for our investors, we acquire properties in markets with historically high occupancy rates, proven demand, and strong economic indicators.
We also focus on asset and property management to provide superior service to tenants and guests as a key to the success of our investment strategy. Since our founding in 2013, we have acquired 26 properties with more than 4 million square feet of space. Contact us to learn more about our current offerings.
© 2023 Avistone, LLC. All rights reserved.
Communications from Avistone, LLC or its affiliates (referred to together as "Avistone"), whether it is transmitted through its website or any other marketing platform used by Avistone (collectively termed "Avistone Communications") must not be interpreted or meant to be taken as recommendations or endorsements to purchase, sell, or hold any securities. Furthermore, Avistone Communications should not be considered as advice related to investment, taxation, finance, accounting, legal matters, regulations, or compliance.
The content provided herein and through Avistone Communications must be reviewed in conjunction with related private placement memorandums and other offering documents to comprehensively understand the risks associated with the securities to which it pertains. Participation in private placements necessitates substantial and sustained financial commitments, the capacity to withstand a complete loss of the investment, and minimal liquidity requirements. Avistone’s website and Avistone Communications imparts preliminary and generalized insights regarding the Investments, intended solely for initial reference purposes. It does not encapsulate or consolidate the entirety of applicable information. The information within is subject to qualification by and subject to more intricate details as presented in the relevant offering materials. Avistone is not registered as a broker-dealer. Avistone disclaims any assertion or warranty to any potential investor regarding the legality of an investment in any Avistone Investments.
Investments in securities or real property involve inherent risks and are exclusively available to accredited investors, as defined in the Securities Act of 1933, who comprehend and willingly assume the elevated risks associated with private investments. These risks encompass, but are not confined to, market fluctuations, credit vulnerabilities, interest rate exposure, and the prospect of partial or total loss of invested capital. Prior to investment, one should: (1) conduct an independent investigation and assessment; (2) meticulously evaluate the investment along with all concomitant fees, expenditures, uncertainties, and risks, including those stipulated in the offering materials; and (3) consult with individual investment, tax, financial, and legal consultants.
The content presented in Avistone Communications is neither intended as a recommendation nor a form of investment counsel, nor does it signify an entreaty to procure, vend, or retain a security or investment strategy, and it is not imparted in a fiduciary capacity. The information provided does not factor in the specific goals or circumstances of any given investor or propose any particular course of action. The information reflects Avistone’s interpretation of the prevailing market milieu. The viability of achieving the objectives of any Avistone fund or investment, or averting substantial losses, cannot be ensured. Investment determinations must be formulated on the basis of an investor’s individual goals and circumstances, and in collaboration with their financial professionals. Historical performance is not indicative of future outcomes. All research and supplementary information supplied through Avistone Communications is crafted exclusively for informational purposes, and Avistone assumes no accountability for any inaccuracies or omissions within the content of this website or any linked resources.
All approximated financial and investment benchmarks, inclusive of forecasted internal rate of returns (IRR), yields, multiples, and investment holding period returns, as displayed on Avistone Communications, stand as conjectural projects of performance exclusively, are hypothetical in nature, are not to be regard as actual investment outcomes, and do not present guarantees of future results. Such approximated benchmarks are invariably accompanied by intrinsic risks, encompassing but not restricted to market volatility, operational ambiguities, and limited liquidity, and do not signify or assure the real outcomes of any transaction; and no assertion is made that any transaction will, or is likely to, attain results or profits akin to those depicted. Moreover, additional financial metrics and calculations shown on Avistone Communications (including amounts of principal and interest repaid) have not undergone independent verification or audit and may diverge from the actual financial metrics and calculations realized for any investment. The investment data contained herein is sourced from entities Avistone believes to be reliable, yet no assertions or warranties are made as to the accuracy or comprehensiveness of said information, and no responsibility is accepted for the same.
Avistone’s historical track record showing past performance is no guarantee of future results. The performance of Avistone’s prior projects have not been audited by any third party. Not all investors received precisely the same returns due to differences in their respective commitment dates for individual property offerings. Full-Cycle Track Record average metrics are based on weighted averages that treat investment dollars equally and are calculated after summing the results of all Avistone full-cycle investments, weighted by the respective capitalization amount for each Full Cycle Investment.
Investments in private placements are speculative and involve a significant quantum of risk, and those investors whose financial situation cannot withstand a complete loss of their investment should abstain from investing. Moreover, investors may receive securities with limited liquidity and/or constraints on transferability, subject to specified holding duration prerequisites and/or concerns about liquidity. Investments in private placements inherently entail a high degree of illiquidity, and investors with an inability to retain an investment over the long term (at least 5-7 years) should refrain from investing. Real estate and alternative investments should only constitute a component of a broader investment portfolio.
Private placement investments are not equivalent to bank deposits (and consequently lack FDIC insurance coverage or safeguarding by any other federal government agency), are illiquid, are not endorsed by Avistone or any other entity, and may depreciate in value. Neither the Securities and Exchange Commission nor any federal or state securities commission or regulatory authority has recommended or endorsed any investment, or authenticated the accuracy or exhaustiveness of any information or materials furnished via Avistone Communications. Investors must be financially prepared to absorb the complete loss of their investment.
Materials or data emanating from third-party media external to this domain or Avistone Communications may address or refer to Avistone or correspond to information contained herein, however, Avistone does not extend endorsement or accountability for such content. Hyperlinks to external sites or reproduction of content from third-party sources do not denote an endorsement or approval by Avistone of the content thus linked or reproduced.