It is acknowledged that a commercial real estate business is responsible for making you a billionaire, but what about the expenses when you are associated with any commercial property? These expenses are mainly called operating expenses. In this article, we will talk about the average operating expenses of commercial real estate.
What are the Operating Expenses of Commercial Real Estate?
Commercial property operating expenses refer to the costs linked with the maintenance and operation of a commercial property, such as retail space, office place, and warehouse space. It solely depends on the lease structure of the building; hence it might be a part of the gross rent or an extension to the base rent. Similarly, in triple net leases, the operating expenses are mostly paid by tenants as base rent addition.
In the case of the buildings with multiple tenants, the operating expenses are the responsibility of the tenant, which is the due share amount for his part, which in turn depends on the comparison between the occupied square footage of the space tenant and the square footage of the total rentable space/building.
While leasing commercial real estate, it is important to consider what is included in the decided rental rate and what amount you are paying. Most commercial leases will be triple net leases where you pay your pro-rata share of operating expenses and the base rental rate.
Breakdown of Commission Costs
Even though each state and territory has its own regulation, in most cases a broker’s fee for representing a client in buying or selling single-family home runs between 6% and 6.5%. The same range applies to some forms of cooperative housing.
On an apartment building with 10 units or fewer, agents typically charge between 4% and 5% of the sale price; if there are more than 10 units that fee drops to 3%. In general, larger apartment buildings incur lower commissions:
Common Operating Commercial Real estate Expenses: Bar Chart
Whether you have an office building or a retailer, you need to bear the burden of CAM, which is the Common Area Maintenance Expenses.
They are given as:
- The electricity expenses related to billing and repairing electric appliances, including the wiring.
- The Janitorial Expenses to manage and maintain the property up to its market value.
- Expenses related to water supply or sewerage to add value to your property.
- The company mainly decides the insurance fee, and the landlord has little or no control over it, which passes to the tenants. If you are working as a team with several employees, you need to cover the compensation insurance of workers and the liability insurance.
- The landlord normally pays real Estate Taxes, but the lease structure of NNN makes the tenant liable for paying taxes.
What is not counted as Operating Expenses?
Property management is not an easy job, nor is it free of cost. It includes operating expenses and other levies that are not typically regarded as operating expenses.
- Amount spent on the marketing of the property,
- The debt service,
- Capital reserves for the mega repair projects for the future,
- Improvement allowances of tenants or the leasing commissions.
Are the operating expenses negotiable?
It depends on the type of expense, typically Common Area Maintenance expenses (CAM), as the property managers or the landlords decide how and what to manage? Tenant protection can be ensured by proper capitalization rate (cap) negotiation.
Similarly, when it comes to the property tax, which is fixed by the state and the insurance amount is considered to be non-negotiable.
What is the operation pattern of the Capitalization rate or cap?
Cap expenses operate in three ways.
It is also known as Year-to-Year Cap. There is a cap on the percentage that the landlord can increase the CAM year-over-year.
Example: An agreement between a landlord and a tenant can be explained with a simple example if a contract caps the amount of 4 percent.
Still, if it increases by 3%, then the tenant will pay only that 3%, but in the next years, if it increases to 6%, then the tenant will pay only the agreed amount, that was 4%. Since the year-to-year cap is predictable, thus tenants prefer it.
Cumulative Compounding Cap
It is also set on a percent basis. However, in this type, the landlord carries authority to increase CAM every year, but upon a condition that is the landlord is liable to recoup the previous year’s unused increases.
Example: If the cap is set as 4%, upon a 3% increase, the tenant can pay only 3%, but next year if it is increased to 5% in next year, the tenant is responsible for paying 5%, as the landlord collects 4% from the current year and the leftover 1% from the previous year. Therefore, it is mostly preferred by the landlords.
Useful Tips for Tenants
Be careful if you intend to operate in a completely or partially occupied building. In such cases, the landlords mostly charged for the vacant spaces. While signing a contract, ensure the clarity of every clause so that you don’t find yourself in trouble with any ambiguous injunctions in the future.
Commercial tenants should be more concerned about the following hazardous issues.
If the operating costs paid by the tenants are used to pay the salary of the property manager, and any increase, let’s say 20% from the landlord, would be deemed as double dripping.
They are mostly mentioned in the contract, which clarifies who is responsible for paying for natural gas, gas, and water, whether the landlord or a separate meter would be installed for every tenant to make him responsible for paying the bill. Depending on the scenario, the lease agreement should be vocal to save you from extra charges in the form of operating expenses.
Tenant Audit Rights:
Don’t forget to refer to the tenant audit rights in your lease agreement. It provides you backup to save your money, which is lost in the form of spare charging. It will enable you to examine the record-keeping book of the landlord, or you can demand any document related to the expanses.
Frequently Asked Questions
What are common operating expenses for commercial property?
General operating expenses for a commercial property such as a company include utilities, rent, insurance, payroll, travel, property taxes, maintenance and repairs, office supplies, employee incentives, depreciation and marketing expenses.
What is the operating expense ratio?
It is mostly expressed as a percentage, the net amount of operating expense minus depreciation and omitting interest, and then divided by the gross income to give the operating expense ratio. The point to be noted is that a normal operating expense ratio range is between 60% to 80%, and the better it is, the lower.
What are the primary operating costs, especially as a real estate investor?
Some operating costs might be mandatory, and some are optional. The additional operating expenses for the investors need to figure into the OER are given as property management fees, attorney fees, landscaping, basic property insurance, and landlord insurance.
Is rent encompasses operating expense?
Normally, rent does not come under the operating expense of the commercial real estate. In leasing, agreement rent is mentioned in a distinct clause while other expenses like the insurance, tax (mandatory), utilities, and administrative charges (non-mandatory) are mentioned separately.