Which Are Operating Expenses, Which Are Not?
Operating expenses are ongoing costs to maintain and keep a rental property investment in service. Typically they represent a huge financial chunk of what real estate investors must pay to own rental property and ultimately play a major role in the real estate investment decision.
It's crucial when creating a real estate analysis, therefore, that you understand which costs are classified as operating expenses, and which are not, because it's not uncommon for novices to be somewhat confused.
So for those of you who are new to real estate investing, here's a brief overview of the types of costs you want to include as an operating expense and those that you do not want to include.
DO INCLUDE expenses like these:
- Property taxes
- Property insurance
- Water and sewer
- Garbage collection
- Property management
- Maintenance and repairs
- Pool service
DO NOT INCLUDE:
- Debt service
- Investor income taxes
- Replacement reserves
- Capital improvements
1. INCLUDED: These are operating expenses because they are costs that affect the day-to-day operation of the investment and are considered necessary to keep the revenue stream flowing. Other examples would include costs for administrative and accounting, telephone, supplies, snow removal, janitorial service, pest control, advertising and so on.
2. NOT INCLUDED: These are not an operating expense because they are not directly related to the property's core operations. Missing a mortgage payment, for instance, will have not affect the property's ability to produce income.
Why It Matters
Operating expense is a key component in the calculation for the investor's cash flow, rates of return and profitability. Therefore when it's skewed with faulty data the ability to determine whether the investment is profitable is skewed.