Operating Expenses
Operating expenses are the costs required to run and maintain a property on an annual basis. This includes property management fees, maintenance and repairs, utilities, insurance, property taxes, and staffing costs. Notably excluded are debt service (mortgage payments), capital improvements (major renovations or replacements), and income taxes.
Assessors use operating expense data to determine a property's income-generating potential, which directly influences the assessed value. In income approach appraisals (common for commercial and multi-unit residential properties), lower operating expenses artificially inflate net operating income, pushing assessments higher. Understanding this connection is critical when challenging an assessment.
Operating Expenses in Assessment Disputes
Assessors often overestimate operating expenses by using industry averages rather than actual property-specific data. When you appear before a board of review hearing, you can challenge these assumptions with documentation of your real costs.
- Actual vs. Market Data: Provide three years of profit and loss statements, utility bills, and maintenance records. The IRS Schedule E form (for rental properties) or certified financial statements offer strong documentation. Assessors sometimes cite CAP (Operating Expense to Effective Gross Income) rates of 30-40% without verifying whether your property actually runs at those levels.
- Comparable Sales Method Cross-Check: When the assessor uses the income approach, verify their operating expense assumptions against comparable sales in your market. If comparable properties with similar rents show lower operating ratios, you have leverage. Request the assessor's worksheets showing how they calculated operating expenses for comp properties.
- Functional vs. Actual Obsolescence: Operating expenses can spike due to building age, deferred maintenance, or market conditions. Document these issues. An older building legitimately carrying higher heating costs than a newer comparable property should show lower net operating income and therefore a lower assessment.
- Exemptions and Relief Programs: Some jurisdictions allow deductions for specific operating costs. Agricultural properties, charitable properties, and religious institutions often qualify for expense-related exemptions. Verify what applies in your county or municipality.
Common Questions
Q: Can I use projected expenses, or must I use actual historical expenses?
A: Use actual historical expenses whenever possible. Most assessors rely on the prior year or three-year average. Projections are weaker evidence but can supplement actual data if they're reasonable and documented (for example, a new service contract starting mid-year).
Q: What happens if my property is newly constructed or recently purchased?
A: New properties are challenging because you lack operating history. The assessor will likely reference industry benchmarks or comparable properties. In your board of review hearing, request that the assessor disclose which comps they used and what operating expense ratios those comps actually reported.
Q: Should I include capital expenditures if they're listed on my accountant's statements?
A: No. Capital expenditures (roof replacement, new HVAC system, parking lot resurfacing) are excluded from operating expenses. Ensure your documentation clearly separates maintenance and repair from capital improvements. Many assessors incorrectly bundle these together.
Assessment Ratio Impact
Your state or county publishes assessment ratios that cap how much of market value can become the assessed value. If the assessor's income approach calculation produces an inflated net operating income due to overstated operating expenses, the resulting assessment may exceed the assessment ratio cap. This gives you a secondary argument in your appeal.