BLOG #3 of 4 – ADDING VALUE TO YOUR INVESTMENT

This blog relates to the third step in adding value to your investment or “Reducing Operating Expenses”. The four (4) ways you can create value for your real estate investment are:
1. Raising Occupancy
2. Raising Rental Rates
3. Reduce Operating Expenses
4. Make Building Improvements

SAVING MONEY - As in any business, excessive operating expenses can make or break the profitability of the business. What are some ways to reduce operating expenses and maximize the profitability of the investment? For commercial properties across the board (retail/office/apartments/industrial/etc), cost savings may be obtained in several categories, including:
• real estate taxes
• insurance
• maintenance/supplies
• utilities
• contracted services

When looking specifically at apartments, there are additional areas where an investor can save money, including:
• On-site payroll
• Marketing
• Legal/Administrative
• Repairs and Reserves


STAYING COMPETITIVE
How can you spot ‘high’ operating expenses? One of the better ways is to obtain data from industry averages, which you can obtain by asking brokers/agents/property managers who are in the business and have access to the data. Industry averages are important because you need to be competitive with your operating expenses, especially triple net leases where the tenants pay 100% of the expenses (typically in retail leases and partially in office/industrial leases). If you are not competitive, the building owner ends up ‘absorbing’ some of the expense, which is self defeating and reduces the net cash flow (and therefore the property value). For retail/office/industrial properties, I’ve found the best cost cutting measure is to get competitive bids for contracted services. For apartments, the categories that present the best opportunity to save money are on-site payroll, utilities, and maintenance/supplies.

ESTIMATING REAL ESTATE TAXES/INSURANCE/ COMMON AREA CHARGES ETC.
As far as numbers go in the Phoenix Metro Area, real estate taxes are estimated at $1.50-3.00 per square foot of building area, depending on the age and condition of the property. Property insurance is typically estimated at roughly .25 cents per square foot of building area. Common area charges (which are typically utilities, lot sweeping, landscaping, lighting, building maintenance, etc.) for commercial properties (retail/office/industrial) can range from $.75 per square foot, up to $2.50 per square foot, depending on the number of services provided. For apartments, the operating expenses run between 35-45% of effective gross income (EGI). These numbers would exclude capital improvements, which would be another 5-10% of EGI. When you see below normal operating expenses, take a good, thorough look when verifying the numbers to ensure the numbers are real/accurate. One last note about apartment operating expenses; in reference to utilities, older properties can be ‘master metered’, meaning there is only 1 electric meter on the property and the owner/landlord pays for this expense (i.e. utilities are included for the tenant). This expense is a key component in the analysis, as there is an opportunity to save money by converting the utilities (electric) to individually metered accounts, depending on the cost/benefit savings analysis. In our next discussion we’ll cover the last way to create value in your investment #4 “Making Building Improvements”.