Operating expensesOpex

Operating expenses are what it costs to keep an occupied building running year after year. The major categories are property taxes, property insurance, management fees, payroll for on-site staff, repairs and maintenance, utilities the owner pays, landscaping and cleaning, marketing and administration, and a contribution to replacement reserves for big-ticket items. They do not include the mortgage, income taxes, or depreciation.

In our illustrative 100-unit building we assume operating expenses of $6,000 per unit per year, or $600,000 in total. That is an assumption chosen for round arithmetic, not a market figure. Actual expenses vary widely with local tax rates, insurance markets, building age, climate, and how much service the building provides.

Operating expenses pass through to rent almost one for one. Because our formula divides by occupancy, every $1 of added annual expense requires about $1.05 of added gross rent to cover it, plus nothing for financing since the cost is paid as it arises. Assume property taxes or insurance rise by $500 per unit per year: rent needs to rise by about $44 per unit per month to stand still.

The largest and least controllable items are usually taxes and insurance, which is why Taxes and Insurance are topics on this site. The ratio of expenses to income, sometimes called the expense ratio, is a common shorthand in underwriting, and along with vacancy it is what turns gross rent into net operating income.