Definition of "Operating expenses in Real Estate (OPEX)"
The operating expenses definition is the sum of costs or expenses a company deals to operate as a business. The term operating expenses is used in any business field and is commonly shortened to OPEX. Operating expenses include any kind of costs that the business operates in order to function like rent payments, equipment used in the field of work, inventory costs, expenses from marketing campaigns, employees’ payroll, insurance costs, and any funds that are distributed to research and development. In short, the operating expenses of a company are any expenses that the company uses to operate. The management’s job is to limit the operating expenses in such a way that the company profit would not suffer. The key is to prioritize the expenditures that will bring the highest returns on equity.
Do operating expenses matter?
The operating expenses are used by real estate investors to determine the profitability of real estate developments by calculating the operating expense ratio (OER). The OER that a real estate investor should aim for is between 60% to 80%. This is calculated by dividing the operating expenses of a real estate development by its net operating income.
Aside from ensuring a company’s or real estate development’s profitability, operating expenses are expenses that the internal revenue service (IRS) allows businesses to deduct. The IRS does make a distinction between operating expenses and capital expenditures. So the general rule of operating expenses states that expenses that don’t deal with producing or manufacturing goods and services go in the income statement and is deductible. Because of this, it is important for an investor to differentiate between operating expenses and capital expenditures.
What are Operating Expenses in Real Estate?
The most important expense in any real estate transaction for an investor is also the biggest. This is why we, unfortunately, have to point out that mortgages are not included in operating expenses. Debt payments or mortgages influence the cash flow of any real estate development, but when analyzing a possible investment’s books, don’t get stuck on the figure for operating expenses thinking that the value also includes a mortgage.
Some operating expenses of rental properties include: marketing and advertising, property taxes, insurance, utilities, trash collection, hired management, maintenance and repairs, landscaping and pool care, accounting and legal fees, snow removal, and pest control. All these expenses are deductible, as they are valid operating expenses. What the IRS does not consider an operating cost is any kind of major renovation.
Have a question or comment?
We're here to help.