As an investor, controlling expenses for a property is paramount in order to protect cash flow. As a building owner, your job is to maximize profits while minimizing expenses, thereby increasing your bottom line.
In office buildings this is particularly tricky, since there are costs to running a building which aren’t present in multifamilies. The operating costs of running the building are essentially the costs incurred in order to keep the building running, per square foot.
Operating costs equal rent
Examples of these include repairs and maintenance, utilities, real estate taxes, contracted services (landscaping, window washing, etc), administrative costs, and insurance.
These costs are on top of the mortgage, marketing and advertising, leasing commissions, and other expenses that can’t be easily passed on to tenants. Plus, as owner you are still required to pay for every square foot of unleased space while keeping costs down in case of vacancies.
To put it simply, whatever it costs to run the property are termed operating expenses, and the various types of leases – net, triple net, full gross, modified gross, double net, full service grosss – are all an effort by the owner to recoup as many expenses as possible through the tenant’s rent.
Likewise, the various twists and turns that affect the tenant’s rent, like stops, base years, cumulative caps, and CPI increases, to name a few, are meant as a hedge against inflation and to ensure that the original numbers quoted don’t go too far above (or below) reasonable levels.
Green buildings decrease costs and attract tenants
Green buildings are an excellent strategy to both lower operating expenses and increase the ability of owners to attract, retain, and satisfy tenants. In fact, surveys by LEED report that 60% of companies believe LEED positively affects their ROI, 70% said they are actively using LEED guidelines to save money, 80% believe LEED is a key way to communicate sustainability to shareholders.
Items included as operating expenses
In a single tenant property all operating expenses are paid by the tenant. In a multi-tenant building – which covers the majority of office buildings, the operating expenses are shared proportionately by all tenants either as part of or in addition to the base rent.
Here is a list of typical operating expenses:
- Property taxes
- Property insurance
- Maintenance and Repairs (includes contracted services like janitorial, landscaping, etc.)
- Administrative expenses
Note that not all expenses are considered operating expenses, even if they seem necessary to the functioning of the building. Tenant improvements, for example, are excluded, as are leasing commissions, capital improvements, and the mortgage.
Insurance expenses are included, but they are sometimes difficult to control. There may be certain upgraded or precautions you can take to lower your insurance rates, but often something as fickle as a bad winter can cause a significant rise in insurance rates.
As an owner and investor, the best suggestion is to make sure you have a plan to actively monitor expenses, and that you seek to lower them as often as possible. Nowadays this can be easily done with automated tech systems, for example some shut off the lights at a certain hour, others automatically raise and lower the heating or cooling system based on the number of people in the building, and so on.
You also need to make sure you understand every detail of the leases you are involved in. This means everything from the wording, to how the calculations are done. Having an experienced team behind you is critical for this, as each member of the team will have a different (but important) angle on the issue in question.
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