Calculating Expenses on Commercial Properties

Accurately projecting expenses on commercial real estate deals can make or break a deal. It is necessary to understand both the current expenses of a commercial property, and the pro forma expenses of a commercial property.

During your analysis of a property, simply using the seller’s expenses could be insufficient. Every individual and entity’s costs are different, and in some cases, a seller may be managing a property completely differently than how you plan to manage it. For example, the owner may be paying 10% for property management, but you know your property management expense will decrease because, not only is market property management 8%, but you have a relationship with a property manager where you are charged 7%. Conversely, the owner may be living onsite, and paying zero for property management, all the while not logging any maintenance costs because s/he is addressing maintenance items.

Here are some common expenses to account for when compiling your pro forma expenses:

1. 1. Property management

1. 2. Insurance

1. 3. Taxes

An investor should always underwrite for a potentially new tax liability. Understand that taxes are based on the assessed value of a property. If the property is assessed at $100,000 before you purchase it, and you purchase it for $1,000,000, expect that the assessment will increase. Therefore, the property taxes will increase. When the property taxes increase is city, county, and state dependent. Sometimes taxes “chase the sale” and can increase at closing, whereas other areas may not reassess properties for several years.

1. 4. Utilities

If a property was only 50% occupied for an entire calendar year, the utility costs on the owner’s P&L may be significantly lower than what they would be during an entire calendar year of 90%+ occupancy. Be sure to account for increased utility costs in this scenario.

1. 5. Maintenance and Capital Expenditures

1. 6. Administration/payroll/contract labor

Be sure to consider how you will operate the property. While the seller may have done some contract labor himself/herself, or had access to folks in their network that did same for a reduced price, you may not have this luxury.

1. 7. Advertising

If the business plan calls for increasing occupancy, you will likely have some increase in advertising costs to help accomplish that.

1. 8. Fees and miscellaneous

Credit card fees, pest control, security, and everything else you may not think about!

Understanding how to properly analyze the expenses on commercial properties is paramount. Accurate projections will help ensure that you do not overpay for a property. Conversely, understanding commercial valuations will also ensure that you do not pass on solid commercial deals. How else do you analyze expenses for commercial real estate properties?