Investment property value is a function of net operating income, and controlling expenses is impactful to any investor’s returns. With a managed portfolio of about three million square feet (sf), Cushman & Wakefield | PICOR tracks operating costs by type of property and over time, identifying trends and opportunities.
Operating Expenses and Lease Structures
In our studies, total operating expenses (“opex”) incorporate all costs incurred to operate commercial buildings, including utilities, repairs and maintenance, roads and grounds, cleaning, administration, security, real property taxes, and insurance. While they are costs of ownership, expenses not typically included in opex are debt service, certain marketing costs, reserves for replacement and capital expenditures. While recovery of some of these items may be allowed by certain leases, we have excluded them from this study.
In a multi-tenant property, the tenant is typically responsible under certain lease types for their share of opex in proportion to their prorata share of the building. Expenses can be incorporated into their rent on a full-service or modified gross lease or can be passed through directly as a reimbursable expense as part of a net or triple net lease. In a single-tenant property the tenant or lessee is typically responsible for 100% of the opex.
The Impact of Labor on Operating Costs
With the passing of Proposition 206, minimum wage increases in Arizona began in 2017, increasing from $10.00 per hour to $11.00 per hour, stepping up to $12.00 per hour in 2020. Labor-intensive service providers have increased compensation to their staff in compliance with new requirements, passing through increased costs to their customers. Trades where this is most significant include janitorial/cleaning, landscaping, and general repairs and maintenance. While inflation since 2017 has averaged 1.8% per year, minimum wage increases have outpaced inflation and contribute to the rising costs detailed below.
We looked at opex trends over a five-year period for each market sector, including office, industrial, retail, and medical. Across all markets expenses remained flat in 2014 and 2015 and increased 10.2% from 2016 to 2018.
Because operating costs directly impact asset value, controlling them is key. A few ways you can reduce building operating expenses would include:
As we near the end of 2019, wage increases in labor-intensive services such as janitorial and landscaping will trend up. Construction costs have also been impacted due to both labor and materials increases. As we forecast into the new year, look for operating expenses to moderately increase in all sectors of the market In our annual budget process we poll utilities and service providers. For 2020 we expect an average utility cost increase of 7.0% and pass-throughs from trades such as janitorial, landscape, plumbing and sweeping. Because every $100 of expenses translates to $1,250 in building value (at an 8.0% cap rate), vigilant expense management is always of benefit to investors, and also controls tenant-shared costs. For a review of your property’s operating costs, contact us.
Tina M. Olson, RPA FMA is a Principal and Director of Property Management for Cushman & Wakefield | PICOR, having joined the firm in 1994. In addition to stewardship of C&W | PICOR's market leading management team overseeing over three million sf of commercial space, Tina is responsible for the management of TMC Healthcare's real estate holdings and non-acute facilities. She can be reached at email@example.com.
 Note that municipalities collect sales and use/rental tax on all operating costs. If a tenant or ground lessee pays property taxes directly to a county assessor, rental tax is still due and the landlord/lessor will be held responsible for payment.