Operating Statements, also called “profit & loss” or “P&L” statements, are one of the most important documents in investment real estate. This document provides a clear view into the financial health of a property and should be accurately maintained by all real estate investors.
Historical operating statements show how the property has performed in the past, and can can be used to identify areas of strength as well as areas of weakness where there’s room to improve a property’s cash flow. A “pro forma” operating statement shows how the property “should” perform in the future and can be viewed as a road map.
Let’s take a look at how an operating statement is structured.
First, at the top we have the income section. As you can see below, this section generally includes two types of income: gross rent and other.
Gross rent is the rental income received from tenants for the right to occupy space, while other income can include parking fees, moving in/out fees, late fees, laundry services, pet fees, etc. Sometimes “other” is actually broken out into these sub-categories and other times, they’re all grouped together, as it is above.
The investor’s goal is usually increase income as much as possible, but raising rents too fast can backfire if the property starts to lose tenants. By monitoring market factors such as market rental rates, occupancy levels, etc., a savvy investor will know when it’s time to raise rents or add fees to increase their total income.
Secondly, below income we have expenses. Below we can see typical expenses which include taxes, insurance, management fees, utilities (electric, gas, water, sewage, etc.), waste removal, maintenance/repairs, landscaping, reserves, etc.
These are typical expenses associated with managing a property, however, sometimes some (or all in the case of triple net lease properties) of these expenses are paid for directly by the tenant and will not show up on an operating statement. An investor should be aware of all expenses associated with a property, who pays for them (investor or tenant), and how these expenses can change over time. The investor should work to minimize expenses while ensuring the property is maintained and kept in good condition.
Investors often look at the expense ratio (expenses / total income) to gauge how high or low expenses are on a particular property. We have been asked what constitutes a “normal” expense ratio and while this ratio can vary by property type, location, lease structure, etc., we typically see a range of 25%–45%. In the example above, expenses of $19,950 / income of $52,000 give us an expense ratio of 38.37%.
Again, similar to income, managing expenses can be a balancing act with tenant satisfaction, but as expenses are decreased while holding income steady, NOI increases which means there’s potentially more cash flow and a higher property valuation. At a 5% cap rate, every incremental dollar of net operating income leads to a $20 increase in property value.