What Are Operating Expenses?

 
 
operating expense infographic.png
 

What Are Operating Expenses?

Operating expenses are expenses that are related to a company’s normal business operations. They are the day to day costs that allow the business to function. In real estate, these could include real estate taxes, management fees, property insurance, maintenance fees, repair fees, utilities, and other cash expenditures required to operate the property.

Operating expenses are an important part of the calculations used to derive Net Operating Income (NOI). NOI is used to analyze the profitability of income generating real estate investments.

 

Gross Rent Revenue – Vacancy/Credit & Collections Loss = Effective Gross Income

Effective Gross income – Operating Expenses = Net Operating Income

 

Operating Expense vs. Capital Expense

Unlike operating expenses, capital expenses are expenses incurred for benefiting the future. For example, a business could use this additional capital to fix/improve existing assets. In real estate, this could mean repairing the roof or HVAC systems.

operating vs capital expense.png

Here is an example of some operating and capital expenses listed in the industrial acquisitions model from Top Shelf Models.

 

Operating Expense in Real Estate Modeling

Here is an example using the industrial acquisitions model from Top Shelf Models:

industrial acquisition model.png
industrial acquisition model - operating exp.png

In the annual cashflows section above, total operating cashflows are derived by summing up costs incurred from insurance, management fees, security, and other operating expenses. By subtracting operating expense, non-operating expense, and capital expense from effective gross income, we derive unlevered operating cash flow.

 

Conclusion

Operating expenses are incurred through the day to day costs required to operate and maintain a property (AKA normal business functions). These expenses do not factor in any sort of improvements and additional purchases. Most commonly, these include taxes, insurance, and maintenance fees.

 

About the Author

Eric Bergin is the founder of TSM. He realized that there was a need for real estate financial models that were more than just generic templates. He wanted to create a personalized product for his customers that would ensure success for them and their company. Please reach out to him if you have any questions regarding discounted cashflows or if he can help you with your modeling needs.

 
Eric Bergin