[fa icon="calendar"] 06.28.2016 / by Rory Williams
When investing in commercial real estate, it is essential that you understand your property expenses. These expenses typically make up around 50 percent of the gross income for a property. This means that if you are collecting $9,000 in rent, you can expect to put between $4,000 and $5,000 of that towards operating expenses. Generally speaking, the smaller the property, the more expensive it will be to operate.
When using an expense ratio as your guide for making deals, it is important to make sure that your numbers are as accurate as possible. Typical expenses will fall into one of the following categories:
This is usually the most difficult expense to calculate and is quite often underestimated. A general rule is 2 percent of the property value. This means that a property valued at $300,000 would cost approximately $6,000 per year, or $500 per month to maintain. Of course, this number can be impacted by things such as the condition, age, size, and type of the property. Also, keep in mind that major repairs will come up on occasion, so be sure to not underestimate these expenses.
You can contact your county assessor to get an exact estimate of your current property taxes. It is important to make sure that this estimate tells you how much you will be paying once you close escrow as your cost could be different than what the seller is currently paying.
If you want to hire a third-party property manager to handle the daytoday responsibilities, this will be another expense. Call around to different management companies to get a cost estimate. In most cases, this will be between 6 and 15 percent of your monthly income plus a releasing fee.
Additional costs such as gardening, pest control, security, cleaning, etc. need to be taken into account, as well. If you plan on leasing the property, these expenses can be shared with your tenants, depending on the lease agreement you have. You’ll need to discuss this in detail with your tenants, however, to come to a fair agreement beforehand.
How to Calculate Your Net Income
Now that you have an idea of how much it will cost to keep your commercial property running and your tenants happy, it is time to determine how much revenue you are able to generate. To determine how profitable your investment will be, follow these steps:
- Add up the total of all potential rents you will receive from your tenants, assuming your property is 100% occupied. This is called the gross potential rent (GPR).
- Next, add the GPR to any expense reimbursements, such as reimbursement for cleaning or landscaping services that your tenant agreed to pay for. This is called the gross potential income (GPI).
- Now, add up all your total vacancies and other losses and subtract this amount from your GPI. This is called the gross operating income.
- Calculate your effective rental income (the amount of rent you actually expect to collect, considering any vacancies) and add this amount to any other income you expect to receive (for example, advertising space, parking, vending, etc.)
- Now subtract this number from your gross operating income. This is referred to as your net operating income (NOI).
- Finally, subtract mortgage interest, income taxes, and depreciation to get your final net income.
Now that you have an idea of how to estimate your property expenses and calculate your net income, reach out to other commercial real estate investors and property managers for some added perspective. And don’t underestimate your expenses. They will quickly add up to more than you think.