If you benchmark one operating number for a commercial building, make it total operating expense per square foot. Not because the total tells you much on its own, but because five lines inside it do almost all of the moving, and when the total rises the only useful question is which of the five moved.
This is the third article in a series on how to read your own building. The first covered why NOI is not your cash flow; the second, asking rent against effective rent.
The five lines
Property tax. Insurance. Utilities. Repairs and maintenance. The management fee.
They are not the whole operating statement. Janitorial, landscaping, security, administrative costs and the rest are real, and they belong in the total. But they tend to move slowly and predictably. The five above are where a building's cost per square foot changes from one year to the next, and they change for five different reasons.
Two of them are set largely outside the building. Property tax comes from the county's assessed value and the millage the taxing authorities adopt. Insurance comes from a market that, in Florida, has not been kind. You do not control either number, but you have more influence on both than most owners use: the assessment can be petitioned in a short window each year, and an underwriter prices what you can document about the roof, the wind mitigation and the insured value.
Two of them are set by how the building is run. Utilities are common-area lighting, HVAC schedules, irrigation and water leaks nobody found. Repairs and maintenance is either the steady cost of looking after a building or the lumpy cost of not having done so. Both are management outputs, whether the manager is you or someone you pay.
The fifth is what you pay to have someone run it. The management fee is usually a percentage of collections, and it is the one line on the statement that you can renegotiate on a phone call. It is also the line owners cut first and regret most, because the manager is the person who decides what happens to the other four.
The method
Take last year's operating statement. Find the rentable square footage of the building, the number on your lease abstracts, not the gross building area. Divide each of the five lines by it. Divide the total operating expense by it too. Write the six numbers on one sheet with the year at the top.
That is the whole method. It takes fifteen minutes and almost nobody does it, because the statement already shows the totals and the totals feel like enough.
They are not, for two reasons. Per-square-foot numbers let you compare your building to itself across years, regardless of what rolled in or out. And they let you compare it to another building you own, or one you are thinking of buying, without the size of the buildings confusing the comparison.
A worked example
The figures are illustrative, not a property we manage.
A 25,000-square-foot multi-tenant office building. Year one, per rentable square foot:
- Property tax: $2.10
- Insurance: $1.40
- Utilities: $1.25
- Repairs and maintenance: $1.10
- Management fee: $0.55
- Everything else: $1.60
- Total operating expense: $8.00
Year two, same building:
- Property tax: $2.30
- Insurance: $1.95
- Utilities: $1.20
- Repairs and maintenance: $1.60
- Management fee: $0.57
- Everything else: $1.63
- Total operating expense: $9.25
The total moved $1.25 a foot, about 16 percent, which on 25,000 square feet is a little over $31,000 of NOI gone in a year with no change in rent. An owner looking at the total sees "costs are up" and starts a conversation about cutting.
The five lines say something more useful. Insurance moved $0.55 and repairs moved $0.50; between them they are most of the increase. Tax moved $0.20. Utilities went down. The management fee moved two cents because collections rose a little.
Those are three different problems. The insurance line is a conversation about deductibles, the roof file, a wind-mitigation inspection and whether the insured value on the policy is a real replacement cost. The repairs line is either deferred work finally being done, in which case it should fall back next year and you should know what was done, or a vendor problem, in which case it will not. The tax line is the assessment, and the only time to argue with it is the window after the notice arrives in August.
None of those is solved by cutting the others, and the one line an owner can reduce by fiat, the management fee, was not the problem.
What the lines cannot tell you
A rising repairs line and a falling capital reserve often describe the same building. Owners who stop funding replacements find the roof, the rooftop units and the parking lot reappearing as repairs, a little at a time, at a higher cost than a planned replacement. If repairs are up two years running, read the capital plan before you read the vendor invoices.
The per-square-foot sheet also says nothing about who ultimately pays. On a triple-net lease the tenants reimburse most of these lines, and the temptation is to stop caring. Two reasons not to. Operating cost is part of the tenant's total occupancy cost, and a building whose expenses run high leases slower and renews harder than one whose expenses run tight. And every line you pass through is a line a sophisticated tenant can audit at reconciliation, which is a subject for a later article.
What to do with this
Build the sheet for last year. Add this year when the books close. Two years is a trend; three is a benchmark that is about your building, not a market average.
When the total moves, name the line. Then name the reason for the line, because the fix for a tax increase, an insurance increase and a repairs increase have nothing in common except the sheet they sit on.
About this series
Gain Property Group manages more than 600,000 square feet of office, retail, industrial and multifamily property across Hillsborough, Pinellas, Pasco, Polk, Manatee and Sarasota counties. We also own commercial buildings ourselves, in other markets, so we read these numbers the way an owner does. Once a quarter we publish what we are actually seeing across that portfolio in the Tampa Bay CRE Letter, including what insurance, tax and the other operating lines are doing across the six counties. It is free, and it is one email a quarter.
If you own commercial property in Tampa Bay and want your five lines put next to comparable buildings we run, request a free management assessment. In writing, no obligation, whether or not you change managers.
This article is general information about commercial property operations. It is not investment, legal or tax advice.