A controllable expense is one that provides proactive property management an opportunity to generate meaningful financial impact.
In this definition, many will then consider "every expense" as a controllable expense. That is too far-reaching. While you can bid insurance and challenge real estate taxes, these expenses remain firmly fixed based on factors out of the control of property ownership or property management. Does that leave everything else? No. We still have to narrow the scope to items that can have a material impact on NOI.
Operating expenses definition: the costs of running and maintaining the building, including insurance premiums, legal fees, utilities, property taxes, repair costs, and janitorial fees. -Investopedia
In the rental property business, operating expenses represent any expenditure necessary to maintain the flow of revenue (income, or rents). Said another way, it's the money you must spend to make money. For example, you can't produce quality cookies without using real butter. Many have tried, and they have all failed. A cookie without butter is a fake cookie, and everybody knows it. Similarly, cutting expenses to the bone indiscriminately will never be a winning strategy.
Try operating a rental property without common-area lighting or doors that open and close and lock. Go ahead - don't pay real estate taxes. These are all necessary components of operating a successful rental property. Sure, you can get away with deferring maintenance for a season, but it always catches up. How? Not so much as in presentation or functionality - it takes time for that to occur. The real hurt is in reputation and going-forward revenue. Once you are known as a landlord that skimps on the basics, word will spread, and it is hard as hell to reverse it.
A family with a successful restaurant in a small seaside town was ready to retire and sold the business to a cost-conscious new owner. The first thing the new owner did was to cut portion size and raise prices. The business was a goner within months.
We want our efforts to control controllable expenses to have a meaningful financial impact—disregard prejudiced assumptions such as eliminating property management. Removing property management is a pipe dream as there is no such thing as an asset that manages itself - and self-insurance (for deep-pocketed owners only).
Note the wording, controlling controllable expenses. Too often, there is a focus on eliminating costs detrimental to real estate operations under the guise of preventing expenses. When reviewing "broken" properties, I'm willing to try anything to assist in a turnaround. What I mean by this is have a willingness to seek solutions outside of the norm.
When people pro-forma, or estimate the projected financials of a real estate deal, the operating expenses are typically 35 to 80 percent of the gross operating income (GOI), depending on the type of rental property. Zillow
You are not helping a struggling asset by eliminating landscaping, as this will only harm leasing efforts when, at some point, property presentation is affected. However, consider reducing mowing (grass cutting) from four times each month to a ten-day schedule and replacing high maintenance plantings with drought-resistant varietals. Sure, you can cut grass just once a month, but the negatives outweigh the brief dip in the expenditure. How many leases lost in the interim?
See this article on Tips for Controlling your Insurance Cost from the National Real Estate Insurance Group.
While it is great to get a "quick hit" in cost savings, the real savings come from affecting recurring costs in controllable operating expenses in real estate. Here are some examples:
Let's go a little deeper into defining controllable expenses by segregating expenditures as fixed and variable.
Fixed expenses are those necessary to operations; utilities, public safety, real estate taxes, insurance (again), and property management. The definition is self-explanatory; the removal or non-payment of a fixed expense is detrimental to the business's ongoing operations.
Variable expense savings come in two categories: one-time cuts and ongoing savings. The unique cuts get the headlines, but reductions to current costs are the real stars. I wish I could attribute this statement:
"Variable expenses are where your profit margins go to die."
It's telling that too often, real estate operators (owners and property managers) will affix a great value to having slashed a fixed expense to the bone and never review spending on cleaning supplies, office supplies, and travel. There are many moving pieces here. Just like a tune-up on a car, you can't just replace half the spark plugs or half the motor oil when doing an oil change.
Think micro and macro. Think short-term and long-term.
How do you decide which items to focus on in terms of controlling expenses? Start with your most significant dollar outflows and look at cutting these as a percentage of X. Consider contracting fixed-rate pricing on such items as lawn care, painting and, a fixed-rate service call for repairs for consistent needs like HVAC and plumbing. On all of these items, based on the dollar volume your asset generates - you should never be paying retail price points for service on the property.
Select a meaningful dollar amount in terms of savings, an annual target, an amount that makes the time required to obtain the savings a worthy cost/benefit endeavor. Savings of $10,000 from a $50,000 line item far outweighs $1,000 from $5,000.
Example: A fixed-priced contract to paint all units at a set price regardless of size (1, 2, 3 bedrooms) with built-in year-over-year savings over the prior year for this expenditure. Remember also that some "single cuts" have multiple-year effects in terms of cost savings. Insulation, for example, is a one-time expense providing multiple years of savings.
Variable expenses include maintenance and make-ready as these costs "vary" depending on need (and age of the asset, and quality of construction and ownership and management methodology).
Controllable operating expenses in real estate are necessary for running the rental property business, and they will never be zero dollars. Consider reducing costs predominantly in areas that avoid any negative impact on public safety or revenue generation. All other regions for controlling controllable expenses should be open for discussion. Negotiate a discount with local service providers based on being a consistent customer. Make them your "exclusive" service provider in exchange for preferential rates.
