5 Ways to Lower Operating Expenses For Your Investment Properties

You’ve got your eye on an investment rental in Denver that looks like a once-in-a-decade opportunity — but how do you know for sure?

There are plenty of metrics an elite investor can use to evaluate a potential investment, but one of the simplest, and most insightful, is to look at how the operating expenses compare to the property’s income. 

Operating expenses include anything that takes money out of your pocket, such as property taxes, utility bills, insurance and other costs. If those operating expenses go up, your profits go down. These are the types of out-of-pocket costs that smart investors do their best to minimize, whether that means investing in energy-efficient upgrades upfront or selling without an agent to save on commission. 

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Let’s touch on some of the most common operating expenses, and how to use them to evaluate a potential investment. 

Property management 

This is one of the most common, and most substantial, operating costs that investors have to deal with. Property management fees usually fall in the range of 4% to 10% of gross income, and professional management companies can handle everything tasks like collections and tenant screening, as well as overseeing the minutiae of day-to-day operations. 

This is often one of the first expenses that cost-conscious investors identify for reduction. But managing your investment property yourself will come either at the cost of your time — time that might be better spent on the rest of your investment plan — or at the cost of reduced services for your tenants. 

Ideally, an investor should try to bring management fees down toward the lower end of the spectrum — but not forgo professional management entirely, even if that means using a property management software solution.

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Insurance

Owners will have to carry property and liability insurance, as well as other types of insurance, depending on their exposure to additional risks. 

Insurance premiums can sometimes increase significantly, as they have in the past few years due to the impacts of climate change. Investors can comparison shop among different insurance providers to get lower premiums in the same way that a home seller can shop among agents to find the ones who charge the lowest commission. Investors looking to reduce their insurance costs can also change their coverage to reduce costs, though they’ll likely have to accept less coverage in exchange for lower bills.

Routine maintenance

Maintenance is another expense that investors sometimes view as reducible. Routine maintenance of property features like major systems (e.g., plumbing, HVAC, electrical, etc.) might seem like it can be put off for a while with no consequences, but it will eventually take a toll. 

Skipping maintenance will eventually lead to larger breakdowns and expensive repairs that could’ve been avoided. And properties that aren’t in great condition won’t be very appealing to prospective tenants, resulting in the classic case of a property that gets initial interest — but loses that interest further in the process. 

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Utility costs

Expenses like electricity, gas, water and trash removal can be significant for larger properties, and can rapidly increase according to movements in the market, much like the price of gas or the value of REITs.

Investors have to pay their utility bills, even when rates go up, but there are some measures they can take to reduce or offload costs. Installing energy-efficient upgrades can bring costs down a lot, and utilities can sometimes be included in the rent agreement, so they’re the responsibility of the tenant.

Marketing costs

If you have a big apartment complex or multifamily property, you’ll have a steady stream of vacancies to fill. That requires marketing and advertising across multiple platforms to bring in qualified tenants.

The best pathway to reducing marketing costs isn’t always to figure out ways to pay less for marketing, but to reduce your vacancy rate — which goes back to other quality-of-life items on this list.

Calculating your operating expense ratio

Once you total up all your operating expenses, do the same with your gross operating income. Then, divide your operating expenses by your gross income to produce your operating expense ratio (OER).  

For example, if you have a property that generates $200,000 in gross income, and has operating expenses of $50,000, you have an OER of 25%. 

Ideally, this OER is as low as possible, as it represents the percentage of your income that you have to allocate to your operating costs. An investment that requires, say, 90% of your income just to operate is probably going to be a lot less profitable than one that only requires 20%.

That said, your OER shouldn’t be extremely low. As we touched on above, there’s a level of operating expenses that are necessary just to maintain an attractive property, and dipping below that level is going to prove counterproductive in the long run. The best OER isn’t the lowest one — it’s the one that gets you the most bang for your buck by allowing you to maximize your investment’s potential most efficiently.

Luke Babich is the Co-Founder of Clever Real Estate, a real estate education platform committed to helping home buyers, sellers, and investors make smarter financial decisions. Luke is a licensed real estate agent in the State of Missouri and his research and insights have been featured on BiggerPockets, Inman, the L.A. Times, and more.