Commercial Real Estate Investing – Expenses Part II
We will be finishing up the topic of TIMMUR expenses in this posting. Last time we discussed the first 3 of the 6 major expense categories that make up the Operating Expenses. This week I’ll teach you about the last 3; Maintenance, Utilities and Repair adding up to our acronym “TIMMUR”.
We left in the spreadsheet right below this sentence as a refresher. Now, let’s look at the last 3 expenses.
Scheduled Gross Income
=Effective Gross Income (EGI)
-Operating Expenses (TIMMUR)
Net Operating Income (NOI)
Maintenance/Repair: Rather than getting into a long discussion over what the difference is between Maintenance and Repairs, I’ll spend this time talking about the difference between R&M and Capital Expenditures, sometimes referred to as ‘Cap Ex’. Considering the IRS looks at R&M as pretty much the same, don’t worry about it. If you have a nagging desire to learn more, call the IRS or just ask your CPA. My CPA just spreads out the expenses over both the R&M categories unless the price of one item/repair is above $1000. If it is, it may be considered a Cap Ex expense and the item/repair may need to be depreciated over a number of years.
Here are some things you’ll find under the R&M category; cleaning the carpet, mowing the lawn, replacing a broken window, light bulbs, unclogging toilets, fixing a hot water heater or an AC unit, painting a unit, clean up of a unit, fixing a hole in the roof, replacing a faucet or toilet; pretty much anything that you would typically repair or maintain during the life of the property on a routine day in and day out basis.
Capital Expenditures are where things can get a little tricky. What if you repair a hole in a roof and the cost is over $1000? Talk to your CPA. Mine will typically consider that a repair even if it’s slightly over $1000. However, if you replace an entire roof or all the roofs in the complex, that becomes a Cap Ex expense and the cost will need to be depreciated over time. Other items that would be considered Cap Ex would include replacing a boiler system, painting or residing the entire complex, redoing the landscaping, completing a major rehab project in which the individual pieces might all be less than $1000, but when added up costs tens or hundreds of thousands of dollars. The nice part is that Cap Ex doesn’t affect the NOI of the property. Thusly, the value of your property doesn’t drop due to some large expense like replacing the entire roof or rehabbing multiple units or the entire complex.
Maintenance and Repairs combined will average between 5%-15% of EGI depending on the age of the complex and how long it’s been since the last substantial rehab performed. Another factor that will affect where a complex will fall within this range is weather. Typically, properties that are in colder winter climates will drift towards the higher range. The warmer the climate, the lower it will generally gravitate.
Utilities will include, at minimum, the gas, electric, water and/or sewer costs for the property that are being billed directly to the owner/landlord. Of course, some or all of these charges maybe for the expenses incurred on the common areas of the property like the hallways, leasing office, laundry room and landscaping, some maybe charges incurred by the tenants themselves. Complexes that pay some or all of the Tenants’ utilities are considered ‘All Bills Paid’ which means the owner pays for the utilities that the tenants use. The downside to this situation, which you’ve probably already figured out, is that you have little to no control over the energy consumption of your tenants. It’s not uncommon to see a tenant’s window open in the dead of winter with the heater running full blast. Most owners will try and do what they can to pass this expense onto the tenants. Sometimes that’s not easy. You may or may not be able to charge a portion of the utilities back to the tenants. It really depends on what the market will bear and what’s ‘customary’ in that market. Fortunately, most new owners are doing what they can to charge the tenants. If you do collect something from the tenants for their portion of the utilities, that ‘Income’ would be added to your ‘Other Income’ category above.
Repairs/Reserves: See Maintenance above
Let’s recap. In the last posted we learned about Effective Gross Income (SGI – Vacancy + Other Income = EGI). The last 2 lessons I taught you about the 6 major expense categories that make up our Operating Expenses or TIMMUR; Taxes, Insurance, Maintenance, Management, Utilities and Repair. You subtract the Operating Expenses from the Effective Gross Income (EGI) to arrive at your Net Operating Income (NOI).