Operating Expense Analysis for Commercial Real Estate

What Are Operating Expenses in Commercial Real Estate?

Operating expenses represent the recurring costs required to maintain, manage, and operate a commercial property. For investors and lenders evaluating a deal, operating expense analysis is the critical link between gross revenue and net operating income (NOI). Every dollar of unnecessary expense directly reduces property value and borrowing power.

Operating expenses typically fall into six core categories: property taxes, insurance, utilities, repairs and maintenance, property management fees, and administrative costs. Together, these expenses consume 35% to 65% of a property's effective gross income, depending on property type and lease structure. Understanding how to analyze, benchmark, and optimize these costs is essential for accurate NOI calculations and sound investment decisions.

A thorough operating expense analysis does more than tally costs. It reveals operational inefficiencies, highlights areas where value can be created, and provides the foundation for realistic pro forma projections. Whether you are underwriting an acquisition or preparing for a refinance, expense analysis determines your bottom line.

What Are the Major Operating Expense Categories?

Commercial property expenses break down into six primary categories. Each category has distinct drivers, typical ranges, and management considerations.

Property Taxes account for the single largest operating expense in most markets, typically representing 15% to 40% of total operating costs. Tax assessments are based on property value, and reassessments after acquisition can significantly alter expense projections. Smart investors analyze the current tax basis, pending appeals, and reassessment risk before closing.

Insurance covers property damage, liability, loss of rents, and environmental risks. Premiums vary by location, construction type, and claims history. Coastal and flood zone properties face substantially higher insurance costs that can reshape deal economics.

Utilities include electricity, gas, water, sewer, and trash removal. In gross lease structures, the landlord absorbs these costs entirely. In triple net (NNN) leases, tenants pay directly. Utility expenses are heavily influenced by building age, HVAC efficiency, and climate zone.

Repairs and Maintenance cover day-to-day upkeep including HVAC servicing, plumbing, electrical work, janitorial services, landscaping, and general building repairs. This category is distinct from capital expenditures (CapEx), which are one-time improvements with multi-year useful lives.

Property Management Fees typically range from 3% to 8% of effective gross income, depending on property type and size. Self-managed properties still incur management costs through owner time and overhead, which sophisticated underwriters account for regardless.

Administrative and General Costs include legal fees, accounting, marketing, leasing commissions, and office supplies. These expenses are often overlooked in preliminary analysis but can total 2% to 5% of gross income annually.

How Do Expense Ratios Vary by Property Type?

Expense ratios, expressed as operating expenses divided by effective gross income (EGI), vary dramatically across property types. These ratios serve as the first benchmark for evaluating whether a property's expenses are reasonable.

Office buildings carry the highest expense ratios, typically ranging from 45% to 55% of EGI for full-service gross leases. The combination of common area maintenance, elevator service, HVAC for large floor plates, and janitorial costs drives these ratios higher than other property types.

Retail properties show wide variance based on lease structure. Single-tenant NNN retail may show expense ratios as low as 5% to 10% since tenants handle most costs. Multi-tenant retail centers with gross leases typically run 30% to 45%.

Industrial and warehouse properties are the most efficient, with expense ratios of 20% to 35%. Simple construction, minimal common areas, and tenant-responsible utilities keep costs low.

Multifamily properties generally fall in the 35% to 50% range, with older properties trending higher due to deferred maintenance and less efficient systems. Garden-style apartments run leaner than mid-rise or high-rise buildings.

These benchmarks matter for underwriting. If a property shows an expense ratio 10+ percentage points below its peer group, that signals either exceptional management or, more commonly, deferred maintenance that will eventually require capital investment. Conversely, ratios far above benchmarks suggest opportunities for value-add improvements that can boost NOI.

What Is the Difference Between Controllable and Uncontrollable Expenses?

Separating expenses into controllable and uncontrollable categories is fundamental to identifying value creation opportunities. This distinction determines where management decisions can directly impact the bottom line.

Uncontrollable expenses are costs that property owners cannot meaningfully influence through operational decisions. Property taxes are set by local assessors (though appeals are possible). Insurance premiums are determined by market conditions, location, and claims history. Utility rates are set by providers. These expenses generally increase with inflation or market forces, and budgets should reflect realistic escalation assumptions.

Controllable expenses respond directly to management decisions and operational efficiency. These include repairs and maintenance spending, management fees, janitorial and landscaping contracts, marketing costs, and administrative overhead. Controllable expenses typically represent 30% to 45% of total operating costs and offer the primary avenue for expense optimization.

The controllable expense distinction matters most in value-add strategies. An investor acquiring a poorly managed property can often reduce controllable expenses by 10% to 20% through competitive bidding of service contracts, implementing preventive maintenance programs, upgrading to energy-efficient systems, and renegotiating vendor agreements. These savings flow directly to NOI, amplifying property value through the capitalization rate.

For example, reducing controllable expenses by $50,000 annually on a property valued at a 6% cap rate increases property value by approximately $833,000. This leverage effect makes expense analysis one of the most impactful tools in commercial real estate investing.

How Do Expense Stops and CAM Reconciliation Work?

Expense stops and Common Area Maintenance (CAM) reconciliation are lease mechanisms that allocate operating expense risk between landlords and tenants. Understanding these structures is critical for accurate expense forecasting.

Expense stops establish a base year or fixed dollar amount of expenses that the landlord covers. Tenants reimburse the landlord for any expenses exceeding the stop. For example, if the expense stop is $12.00 per square foot and actual expenses are $14.50, tenants pay the $2.50 overage proportional to their leased area.

Base year stops use the actual operating expenses from the first year of a lease as the benchmark. This approach is common in office leases and automatically adjusts for the property's specific cost structure. However, base year stops can create complications if the first year has abnormally low or high expenses.

Fixed stops set a specific dollar amount per square foot. These provide more predictability but require careful negotiation to ensure the stop reflects realistic expense levels.

CAM reconciliation is the annual process of comparing estimated CAM charges collected from tenants throughout the year against actual expenses incurred. The reconciliation produces either a billing (if actual exceeded estimates) or a credit (if estimates exceeded actual). Key considerations include:

Landlords must clearly define which expenses are included in CAM and which are excluded. Capital expenditures, ground lease payments, and ownership entity costs are typically excluded. Management fees included in CAM are often capped at 3% to 5% of collected rents.

A detailed rent roll analysis should identify each tenant's expense stop, reimbursement method, and any caps on annual escalation. Properties with favorable expense recovery structures, where tenants reimburse a high percentage of operating costs, carry less expense risk for investors and typically support stronger loan terms.

How Do You Benchmark Operating Expenses Using Industry Data?

Expense benchmarking compares a property's costs against industry standards and comparable properties. Two primary data sources dominate commercial real estate benchmarking: BOMA (Building Owners and Managers Association) and IREM (Institute of Real Estate Management).

BOMA's Experience Exchange Report provides detailed operating expense data for office buildings segmented by region, building class, and size. The data covers over 5,000 office buildings nationally and includes granular category breakdowns. BOMA data is considered the gold standard for office property benchmarking.

IREM's Income/Expense Analysis covers a broader range of property types including apartments, office buildings, shopping centers, and industrial properties. IREM data segments by geographic region, property age, and building size, allowing for highly specific comparisons.

When benchmarking expenses, follow these steps for meaningful comparisons. First, ensure you are comparing similar property types, ages, and geographic markets. A Class A office tower in Manhattan has fundamentally different expense profiles than a Class B suburban office park in Dallas. Second, normalize expenses on a per-square-foot basis to account for size differences. Third, evaluate individual expense line items rather than just the total, since aggregate numbers can mask significant variances in specific categories.

Red flags in benchmarking analysis include property tax assessments significantly below market value (reassessment risk), insurance costs well below comparable properties (potential coverage gaps), and maintenance spending below 1% of replacement cost annually (deferred maintenance risk). Each of these situations suggests that current expenses understate the true cost of operation and that future expenses will likely increase.

Lenders pay close attention to expense benchmarking during underwriting. If a borrower's pro forma shows expense assumptions below industry norms, the lender will typically adjust expenses upward, reducing the underwritten NOI and lowering the available loan amount. To strengthen your loan application, use benchmarked expenses and provide documentation supporting any assumptions that deviate from market norms. Run your numbers through our DSCR calculator to verify your debt service coverage with realistic expense projections.

What Are the Best Strategies for Reducing Operating Expenses?

Expense reduction strategies fall into three categories: procurement optimization, operational efficiency, and capital improvements. The most effective approaches combine all three.

Procurement optimization involves competitive bidding of service contracts every two to three years. Many property owners default to renewing existing vendor contracts without testing the market. Soliciting three to five bids for janitorial, landscaping, security, and elevator maintenance contracts frequently yields 10% to 25% savings. Bundling services across multiple properties provides additional negotiating leverage.

Operational efficiency focuses on process improvements that reduce waste. Implementing preventive maintenance schedules extends equipment life and reduces emergency repair costs. Energy audits identify opportunities to reduce utility consumption through lighting upgrades, HVAC optimization, and building automation systems. Many utility companies offer free or subsidized energy audits and rebates for efficiency upgrades.

Capital improvements with strong payback periods deliver the most significant long-term savings. LED lighting retrofits typically pay back in 18 to 36 months. HVAC upgrades can reduce energy costs by 20% to 40%. Water-efficient fixtures reduce water and sewer expenses by 15% to 30%.

The key is prioritizing improvements based on payback period and impact. Start with low-cost, high-impact changes like renegotiating contracts and fixing deferred maintenance. Then pursue capital improvements with sub-three-year payback periods. Finally, evaluate larger capital projects that deliver savings over five to ten years.

Contact our team to discuss how expense optimization can improve your property's NOI and unlock better financing terms for your commercial loan.

How Does Expense Analysis Impact Commercial Loan Underwriting?

Lenders scrutinize operating expenses during underwriting because expenses directly determine NOI, which drives loan sizing. Understanding how lenders analyze expenses helps borrowers prepare stronger applications and avoid costly surprises.

During underwriting, lenders compare the borrower's reported expenses against three benchmarks: historical property performance (typically three years of operating statements), comparable properties in the market, and industry data from sources like BOMA and IREM. The lender will use the higher of reported or benchmarked expenses for conservative underwriting.

Common lender adjustments include adding a management fee (typically 3% to 5% of EGI) even if the property is self-managed, increasing reserves for replacement above reported levels, normalizing property taxes to reflect post-acquisition reassessment, and adjusting insurance to current market rates if the existing policy appears below market.

These adjustments frequently reduce the lender's underwritten NOI by 5% to 15% compared to the borrower's submitted figures. The gap translates directly into lower loan proceeds. To minimize this gap, borrowers should present realistic expense projections supported by third-party data, historical trends, and vendor quotes.

Use our commercial mortgage calculator to model different expense scenarios and see how they impact your borrowing capacity. Preparing detailed expense documentation upfront demonstrates sophistication and can accelerate the loan approval process.

What Are the Most Common Questions About Operating Expense Analysis?

What is a good operating expense ratio for commercial real estate?

A "good" expense ratio depends on property type and lease structure. Office buildings typically run 45% to 55%, retail centers 30% to 45%, industrial properties 20% to 35%, and multifamily 35% to 50%. NNN lease properties can have expense ratios below 10% since tenants cover most costs. Compare against BOMA or IREM benchmarks for your specific property type and market.

What is the difference between operating expenses and capital expenditures?

Operating expenses are recurring costs necessary to run the property on a day-to-day basis, such as utilities, maintenance, and management fees. Capital expenditures (CapEx) are one-time investments in improvements with useful lives exceeding one year, such as roof replacements, HVAC system upgrades, or parking lot resurfacing. Operating expenses reduce NOI directly, while CapEx is typically handled below the NOI line.

How do you calculate the operating expense ratio?

Divide total operating expenses by effective gross income (EGI), then multiply by 100 to get the percentage. For example, if a property generates $500,000 in EGI and has $200,000 in operating expenses, the expense ratio is 40%. This ratio helps compare efficiency across properties of different sizes and income levels.

What expenses are included in CAM charges?

CAM charges typically include property maintenance, landscaping, snow removal, common area utilities, janitorial services, security, parking lot maintenance, and property management fees. Excluded items usually include capital improvements, debt service, depreciation, income taxes, and leasing commissions. The specific inclusions and exclusions are defined in each tenant's lease.

How often should operating expenses be benchmarked?

Benchmark operating expenses annually during the budgeting process. Compare year-over-year trends for your property and evaluate individual line items against current BOMA or IREM data. Major benchmarking reviews should occur before acquisitions, refinancing, and when evaluating management company performance.

What are expense escalation clauses?

Expense escalation clauses in leases allow landlords to pass through increases in operating expenses to tenants. Common structures include fixed annual increases (e.g., 3% per year), CPI-based escalations tied to inflation indices, and base year expense stops where tenants pay increases above the base year level. These clauses protect landlord income from rising costs.

How do property taxes get reassessed after acquisition?

In most jurisdictions, a property sale triggers a tax reassessment based on the purchase price. If the property was previously assessed well below market value, the new assessment can increase property taxes by 20% to 50% or more. Sophisticated buyers factor reassessment risk into their acquisition underwriting and may budget 1 to 2 years of elevated taxes before filing an appeal.

Can reducing operating expenses increase property value?

Yes, and the impact is amplified by the capitalization rate. Every $1 reduction in operating expenses adds $1 to NOI. At a 6% cap rate, $1 of additional NOI translates to approximately $16.67 of property value. Reducing operating expenses by $100,000 at a 6% cap rate increases property value by roughly $1.67 million, making expense optimization one of the most effective value creation strategies.

Need help with operating expense analysis for your next deal? Reach out to our lending team for personalized guidance on expense optimization and commercial financing.

Where Can You Find Reliable Operating Expense Data?

1. Building Owners and Managers Association (BOMA). "Experience Exchange Report." Annual publication providing operating expense benchmarks for office buildings across North America. boma.org

2. Institute of Real Estate Management (IREM). "Income/Expense Analysis Reports." Annual benchmarking data covering apartments, office, retail, and industrial properties. irem.org

3. National Association of Realtors (NAR). "Commercial Real Estate Market Insights Report, 2024." Includes operating expense trends and cap rate data by property type and region. nar.realtor

4. U.S. Energy Information Administration (EIA). "Commercial Buildings Energy Consumption Survey (CBECS)." Federal data on energy use and costs in commercial buildings. eia.gov

Ready to optimize your property's operating expenses and strengthen your financing position? Contact Clearhouse Lending today to discuss how our commercial loan programs support properties with strong expense management. Use our DSCR calculator to see how improved NOI impacts your borrowing power.