How to Build an Operating Budget (+ Calculation Guide)
Written by Julia Ribeiro and Marisa Marulli (REMCO Communications)
Reviewed by Lisa Gerard (REMCO Founder and Principal)
December 14, 2021
Operational budgeting is a crucial activity commercial real estate property managers must perform on at least an annual basis to determine revenue potential, operational costs, recurring expenses, market trends and more.
When considering finances leading into a new year, an owner and his or her property manager should understand that the property should not only satisfy current tenants but also stay up to date with market standards to attract future occupancy.
In this article, we will outline operational budgeting related to commercial real estate property management and provide a calculation guide.
What is an Operational Budget?
Woman analyzing financial budget in the office
An operational budget predicts the amount of revenue a property will generate and determines an optimal amount of finances necessary to preserve the value of the asset. The costs associated with maintaining the value of the property are called operating expenses; these costs are non-negotiable costs that must be incurred to continue business operations.
For example, property taxes are a necessary cost associated with the ownership of an asset. Interest charges, on the other hand, would not be considered an operational cost because although a particular property owner may need to secure financing, the asset could be owned without it.
Commercial real estate operating activities may include property taxes, insurance, building maintenance and repairs, management salaries, utilities and more.
Why is an Operational Budget Necessary?
An operational budget allows property managers to track income and expenses, and consequently evaluate the viability of the asset. Property managers will typically prepare an annual operating budget and present it to the property owner before a new year begins.
Who Pays Property Operating Expenses?
Man signing a contract
The responsibility of paying for operating expenses will vary depending on the contract between tenants and landlords, known as the “lease.” In the case of a “net lease,” for example, tenants are responsible for expenses such as property taxes, insurance and maintenance costs. However, in a “full-service gross lease,” the landlord incurs the operating expenses previously mentioned.
The best type of lease contract will vary for investors depending on their strategy, as each option presents unique advantages and disadvantages.
Net Operating Income Calculation Guide
To arrive at an operating budget, one needs to understand a primary accounting equation for net operating income (NOI).
As operational expenses are part of the NOI formula, understanding this equation is crucial to yielding the most value from it: a grasp on not only a property’s expenses, but also its revenue and net income potential.
Net Operating Income = Gross Revenue - Total Operating Expenses
A good place to begin with this formula is gross revenue. This figure should be the sum of all rental income and any other sources of income achieved from the property.
Total operating expenses, as discussed earlier, will be the sum of items such as salaries, maintenance, insurances, taxes, marketing and any others.
Once these two numbers are figured, a property owner or manager can then subtract total operating expenses from gross revenue to achieve an evaluation of the asset’s profitability.
