Suneet Singal on operating expenses in a property budget

Suneet Singal has a published background in real estate and corporate finance, so a property budget is something a reader should be able to take apart. Filings on this site record a chief executive officer departure from FC Global Realty Incorporated effective 2 January 2018 and an acting chief executive officer appointment at First Capital Investment Corporation effective 12 September 2017. An officer title does not identify a utility bill or a tax bill. Operating expenses are the recurring costs of running the property, and they are subtracted from effective income to reach net operating income. Debt service, major capital projects, and income taxes usually sit somewhere else. This entry walks a labeled hypothetical budget, says what the backup should show, and explains the mix-ups that make a building look cheaper to run than it is.

Which bills belong in the budget

An operating-expense budget is a list of costs that keep the property in service for the year you are looking at. The usual lines are real estate taxes, insurance, utilities the owner pays, repairs and maintenance, contract services such as landscaping, trash, security, and elevator, payroll if the property has staff, a management fee, and administrative costs such as office and accounting at the property level. Not every property has every line. A single-tenant building on a net lease may show a thin list because the tenant pays many of the bills. The thin list is only honest if the lease really moves those bills.

People sometimes call taxes and insurance non-controllable, meaning the manager cannot set the tax rate or the insurance market, and call repairs more controllable. The labels are informal. A manager can still appeal a tax assessment, shop a policy, or defer a repair in a way that costs more later. Use the labels as a hint about which lines a management change is unlikely to cut. Do not use them as a promise that the "non-controllable" lines will stay flat. They are often the lines that jump.

The budget is an input to net operating income. If you understate expenses, you overstate income, and any cap rate applied to that income overstates value or overstates the yield. The error does not have to be dramatic to matter. A hypothetical $20,000 of missed expense, capitalized at a hypothetical 6 percent, is about $333,000 of value. That is the same identity as elsewhere in this reference: income and price are tied by the rate. Expense errors become price errors when someone capitalizes them.

A labeled hypothetical budget

Take a hypothetical building of 20,000 square feet. The annual budget you are testing is: real estate taxes $80,000, insurance $20,000, utilities the landlord pays $30,000, repairs and maintenance $25,000, contract services $20,000, general and administrative $8,000. Effective gross income is a hypothetical $400,000, and the management fee is 3 percent of that income, which is $12,000. Add the lines: 80, 20, 30, 25, 20, 8, and 12 thousand is $195,000. Per square foot, $195,000 divided by 20,000 is $9.75. Every one of those figures is a labeled hypothetical so you can see the shape of a budget. None of them is a quote for a real building.

A reserve for replacement can be added underneath. A hypothetical $0.50 per square foot is $10,000. If the net operating income you were quoted already deducted the reserve, the expense total that matches that income is $205,000, not $195,000. If the quoted income did not deduct the reserve, cash still has to fund replacements somehow. Write "NOI before reserve" or "NOI after reserve" on the page. The $10,000 difference is the entire argument in this sketch. It is large enough to see and small enough to hide in a rounded headline.

Now test a reimbursement. Suppose tenants repay $40,000 of the taxes under their leases. The honest presentation shows $80,000 of tax expense and $40,000 of recovery income. NOI includes both. If you show the recovery and omit the tax, you overstate NOI by $80,000. If you show the tax and omit the recovery, you understate NOI by $40,000. If you show neither, because you think of the tenant's share as "not the landlord's problem," you have omitted the landlord's remaining $40,000 share and you have also made the budget impossible to tie to the tax bill. Show the bill, then show who pays it.

Trailing statements and one-time lines

A budget without a trailing twelve months is a wish. Lay the budget next to the last twelve months, line by line, and explain every large difference. A repairs line that was $60,000 in the trailing period and $25,000 in the budget needs a sentence. Maybe the trailing period included a one-time patch that will not repeat. Maybe the patch was a sign that a larger capital job is coming and the budget's $25,000 is the ordinary residual only. The sentence decides whether you believe the budget. The lower number does not decide by itself.

One-time items should be marked in the trailing period before you annualize them. A hypothetical $15,000 legal bill, or a hypothetical $15,000 insurance refund, will distort the year if you treat it as a run rate. Remove it from the run rate and keep it in a note so the total still ties to the statement. Do the same with a month in which a tenant reimbursed two years of taxes in one check. The cash was real. It is a bad template for next year. The property tax entry is where a reassessment can make next year different even when last year was ordinary.

Payroll and contracts need a check against the actual agreements. A budget that cuts payroll in half has assumed a staffing change. A budget that holds a landscaping contract flat has assumed the vendor will renew at the same price. Neither assumption is outrageous. Both should be visible. If the property is owner-managed and the trailing statements show no management fee, decide whether the forward budget will impute one. An imputed fee is a modeling choice for comparison. An omitted fee is a claim that nobody will be paid to manage the building. Those are different sentences. Write the one you mean.

Capital projects are not operating lines

A repair keeps the property in its current use. A capital project replaces a major component or changes the property. The line between them is judgment, and tax rules can draw it in a different place from an underwriting model. IRS Publication 946 explains depreciation of capital costs for tax purposes. It does not tell you whether to put a roof in this year's operating budget. For underwriting, the practical question is whether the cost is a recurring annual expense or a chunk of cash you should show in the year you expect to spend it.

If you leave a known roof replacement out of operating expenses, you have not made it free. Put it in the capital plan in a stated year, and decide whether the exit price in that year should reflect a buyer who inherits the job. If you expense the entire roof in one year, NOI for that year collapses and a cap rate applied to that single year will look punishing. Either treatment can be explained. An unexplained omission cannot. The holding-period model should show the dollar in some year, or explain why a reserve already represents it.

Small recurring capital items, such as appliances in an apartment community or a hypothetical unit-turn cost, are easy to lose because each invoice looks minor. A trailing statement that buries them in repairs is more informative than a budget that drops them because they were "capitalized last year." Ask for the list of items capitalized in the trailing period. If the list is a steady stream of ordinary replacements, a reserve belongs in the underwriting whether or not last year's accounting called them assets.

What the budget page should contain

The page should name the building, the year, the area or the unit count used for per-unit figures, and whether amounts are monthly or annual. It should show trailing figures beside the budget. It should state the management fee as a percent and a base: percent of effective income, of collections, or of some other line. It should say which expenses are recovered from tenants and point to the lease clause or the recovery column on the rent roll. It should footnote non-recurring items. That is enough for a reader to recompute NOI. A single "expenses" number is not enough.

Per square foot and per unit are checks, not explanations. The hypothetical $9.75 per square foot means nothing until you know what was included. A building that looks cheap per foot because taxes are under-assessed, or because the tenant pays utilities, is not comparable to a building that looks expensive because the owner pays both. Compare lines, not only totals. If a published survey offers expense benchmarks, read the survey's year, property type, and what it includes. Do not paste a benchmark over a bill you already have. The bill is better evidence than the benchmark.

Insurance and taxes deserve their own backup even when they are lines in the budget. The policy declarations show the premium and the limits. The tax bill shows the assessed value and the rate. The tax entry explains why the seller's bill can be the wrong buyer's bill. A budget that copies last year's premium and last year's tax without those documents is a photocopy, not an underwriting. Attach the documents, or say they were requested and have not arrived.

Usual mix-ups

The first mix-up is putting the loan payment in operating expenses. Debt service is a financing cost. It does not get subtracted to reach NOI. If the budget you were handed has a line called "mortgage" above the total that is about to be capitalized, move the line. Then recompute. A building can look wildly expensive to operate when the "expense" is mostly principal and interest. It can also look fine on NOI and still be unable to pay the loan. Those are two different tests. Keep both, and do not blend them.

The second mix-up is the recovery that is counted once on the wrong side, already described, or counted twice. A variant is the gross-up. Some leases let the landlord bill expenses as if the building were full, so vacant space does not stick the landlord with the entire fixed cost. If your model has a vacancy allowance and also a full recovery gross-up, read the clause before you take both. You can overstate recovery income by assuming a gross-up the lease does not give, or understate it by ignoring one the lease does give. The lease, not the software's default toggle, is the source.

The third mix-up is a fee computed on the wrong base. Three percent of effective income is not 3 percent of net operating income, and it is not 3 percent of the purchase price. In the hypothetical, 3 percent of $400,000 is $12,000. Three percent of the $195,000 expense total would be a different and odd construction. Three percent of a $10,000,000 price would be $300,000, which is a different kind of fee entirely and should not be slipped into operating expenses without a sentence. Read the management agreement. If there is no agreement because the owner self-manages, say whether you are imputing a fee and the base you used.

What the budget cannot prove

An expense budget cannot prove that next year's bills will match it. Insurers reprice, assessors reassess, vendors raise contract rates, and a hard winter changes utilities. The budget is a structured estimate tied to a trailing period and to documents. It is not a cap. An operating-expense ratio, expenses divided by effective income, describes one year. In the hypothetical, $195,000 divided by $400,000 is about 49 percent. That ratio does not stop the tax bill from rising. It is a summary of the year you built. Use it to compare, and then go back to the lines.

The budget cannot prove that costs were prudent. A low repairs number can be good management or deferred maintenance. A high payroll number can be appropriate staffing or a related-party wage. The documents and the property condition report are how you tell. A ratio by itself cannot tell. If you are comparing two properties, match what is inside the ratio first. A net-leased building with a low ratio and a gross-leased building with a high ratio may be operating exactly as their leases intend.

The budget cannot prove a personal cost structure. These hypothetical lines are not the expenses of a property owned by Suneet Singal, and the page does not say he manages a building. The career record holds the dated roles. Use the budget method on statements you have. If a line has no trailing number and no document, leave it marked as an assumption. An assumption can be necessary. It should not be formatted to look like a bill.

What this entry does not claim

Suneet Singal’s published professional background is in real estate and corporate finance. Company filings linked from this site record a chief executive officer departure from FC Global Realty Incorporated effective 2 January 2018 and an acting chief executive officer appointment at First Capital Investment Corporation effective 12 September 2017. The Suneet Singal Scholarship, Grant and Giving websites describe him as the founder of those programs. This entry explains a general subject. It is not a private track record, a current job title, an investment result, or a quote.

This page is a reference, not investment advice. The income that remains after these bills is net operating income, and the tax line inside the budget is treated on its own in property taxes in underwriting.