Operating Expenses

Over the past couple of weeks I have been writing about operating expenses in relation to the Net Operating Income (NOI) of an income producing property. The general premise is the higher your properties' NOI, the higher the property value. It is the job of the property owner/property manager to research and plan ways to maximize rental income and lower expenses. As a hypothetical scenario, let's take a look at property A and property B:

bigstock-Landlord-Communication-43247131-558029-editedProperty A:

4 unit apartment building 

Taxes: $8,000

Property B: 

4 unit apartment building 

Taxes: $10,000

As you can see, although both properties have 4 units, unit B's operating expenses are much higher than property A's. Anyone who looks at these numbers is going say something like, 'I can't believe both buildings have 4 units yet one building is paying $2,000 more in taxes than the other...its blasphemy!" What if I told you that Building A was all one bedroom units and building B was all 3 bedroom units and that was the only difference; what would you think then? Hopefully it makes sense now that building B has higher property taxes. Property B is most likely generating more income. But how do we know if the tax bill is reasonable, and what metrics can we evaluate in order to answer this question? 

Let's assume that property A has an annual rental income (before any expenses) of $75,000 and that property B has an annual rental income of $95,000. If we take the $8,000 in taxes and divide that into $75,000 and multiply by 100 we get, ($8000/$75,000)x100 = 10.6%. In other words, building A's property taxes account for 10.6% of the income generated by the property in a given year. Let's do the same for property B. ($10000/$95,000) x 100 =10.52%. Now it is clear that both properties are paying a fair price for their property taxes, regardless of the fact they are both 4 unit buildings. Again, it all comes down to the income. In this case both properties are paying a little over 10.5% of their income in property taxes. 

The calculator below is a spin off of an earlier calculator I shared, the Vacancy Calculator. This one allows you to input your income and a vacancy rate (just like the vacancy calculator), but then takes things a little further by letting you record all of your expenses in a given year. Simply input your total annual expenses and the calculator allows you to see what percentage of your income is going towards a certain expense. The calculator then provides you with a total at the bottom. 

As a general rule, your expenses should account for 30-50% of your properties' income. The 30% bracket is mostly comprised of buildings with under 4 units and 50% being buildings over 4 units. Click below to download a free operating expense calculator now.