Before choosing to invest in real estate, it’s important to have a clear understanding of the various costs and financial responsibilities expected of an owner-operator. Distinguishing among the various classifications of costs is equally important, and can spell the difference between a wise investment and an unfortunate leak in your finances. Operating expenditure is one of the more prominent kinds of expenses a business can accrue over time. Read on to familiarize yourself with their ins and outs, and how they factor into the health and profitability of an investment.
What is Operating Expenditure?
Broadly speaking, operating expenditure (a.k.a. Operating expenses, or OPEX) accounts for majority of a running business’ costs. Simply defined, OPEX refers to the sum of expenses incurred to keep a business running over a period of time, and are considered fully deductible from business income for the purposes of taxation. To illustrate, these are things like wages, minor repairs, transportation fees, office expenses, and property taxes.
OPEX vs CAPEX
Often confused with OPEX are capital expenses (CAPEX). Both are expenses incurred by businesses in the interest of generating future returns, but the difference in the ways they’re classified has implications for how large of a cut the tax man takes home.
Whereas operating expenses are incurred on a frequent basis and have to do with maintaining an operational status quo (e.g. Monthly interest payments, restocking inventory), capital expenses can be conceived of as a matter of acquiring for your business.
Capital expenses are generally more expensive, more durable, and useful over a longer period of time. While they may also be central to the way a business is run, they are usually purchased infrequently, and function as expansions of a business’ productive capacity rather than standard goods and services needed to stay open. If they typically aren’t “consumed” within the period of one year, odds are they’re capital expenses.
Key examples for the real estate industry would be the purchase of new office space (not to be confused with the rental thereof), furniture, and the construction of new properties or expansions of existing ones.
Distinguishing between these two classifications of expenses can get tricky, so the safest bet would be to leave it to a qualified accountant.
Operating Expenditure and Cash Flow
Cash flow is the general term for how much money your business is making or losing. In this regard, operating expenditure is a critical half of the formula: how much of all revenue will inevitably be lost to upkeep.
If we assume the goal of a business to be to maximize net income or profit, then minimizing OPEX is a crucial part of business planning and management. But an important mindset to keep when we talk about minimizing OPEX is that the best way to run a business isn’t to spend less, but to spend wisely.
You cannot run a business without incurring operating expenses, and in some cases, greater spending can lead to greater profits further down the line. One way or another, it takes money to make money; ascertaining how much money ought to be spent, and what it ought to be spent on is a matter of optimization.
Operating Expenditure and Rental Properties
If you’re planning to rent out a property for living or office space, your OPEX would likely consist of minor repairs, utilities, property tax, insurance, advertising, and similar, smaller expenses generally “usable” for no longer than a year.
For owners or developers of rental properties, the smartest approach to evaluating (and hopefully minimizing) your operating expense budget is to identify:
- What costs are non-negotiable, or are absolutely critical to keeping your property running (e.g. utilities, building maintenance, debt servicing, salary and benefits);
- What costs directly translate into revenue (e.g. restocking vending machines, detergent for a coin-operated laundry room); and
- What costs are optional, but contribute to your customer experience (e.g. costs of maintaining art installations or plants).
These costs are presented in decreasing order of importance. If you see the need to cut costs, start from the nice-to-haves and avoid reducing spending on your non-negotiables. Costs which translate into revenue ought to be evaluated in terms of how reliably they convert into income.
Deciding what optional costs to reduce is a matter of business savvy, though it should be evident in most cases when money is being put to waste. And if you run a tight enough ship, the solution isn’t likely to be found in reducing costs, but boosting spending in things like marketing and exposure.
OPEX, CAPEX, and Taxes in Real Estate
Expenses that fall under the classification of OPEX are fully deductible from taxes on business income.
In theory, this means landlords can enjoy a larger take-home share of gross income within a given tax year. But since they had to shell out in the first place, the net benefit to this is dependent on how easily those costs translate into profit.
CAPEX works in a very different way, with capital goods becoming deductible over the course of their expected durability (usually 5 to 10 years) through an accounting device called depreciation. Essentially, deductions for CAPEX can be broken down in terms of the supposed loss in the asset’s value over time –a machine bought for $20,000 with a “lifespan” of 10 years would depreciate at a rate of $2,000 per year ($20,000 / 10 years). This means that over the next few years, you can expect to deduct $2,000 each year thanks to depreciation, until you’ve either deducted its total cost (usually 90% of the amount you spent on the capital good), or retired the asset.
Conclusion
Apart from the initial CAPEX required to start a real estate business, there are certain costs associated with running one. The key to being successful in real estate–aside from finding tenants and renters–is managing your daily, monthly, and annual operating expenditures.
