How to Calculate Overhead for Real Estate Companies

If you’re new to the real estate business, this guide will give you the expertise you need to calculate overhead with as little fuss as possible. It will fill you in on direct vs. indirect costs, different types of expenses and categories, and why they are essential in the real estate world (or any business world).

Knowing how to calculate overhead for your real estate business is an essential ability. It might feel like an overwhelming task to track your expenses, but it will become second nature over time. 

But even if it doesn’t, you can always look into hiring a real estate accounting specialist to keep track of things for you, especially as your company grows. You cannot risk neglecting this area of your business. 

The bookkeeping side of a business might not be the fun part (unless that’s your job), but it is an essential component of profitable real estate companies. Solid record-keeping will keep you from losing money over time – you cannot calculate overhead without having an accurate account of how much money you’re spending to keep your business up and running.

If you’re new to the real estate business, this guide will give you the expertise you need to calculate overhead with as little fuss as possible. It will fill you in on direct vs. indirect costs, different types of expenses and categories, and why they are essential in the real estate world (or any business world). 

So let’s get started.

What Is Overhead?

Firstly, you have to understand what expenses to keep track of to know how to calculate overhead costs. Of course, you should keep a detailed record of all your business expenses, but to calculate overhead, you have to first separate indirect costs from direct costs.

Essentially, overhead is the ongoing costs associated with operating a business. Unlike the cost of goods sold (another important number), overhead is an indirect cost. It includes the necessary expense of running a business, such as rent, phones, and marketing. But these costs are not directly associated with the service or product you are selling.

It is good to keep in mind that overhead costs for a startup real estate company will be different from an established business. 

For example, becoming a licensed real estate salesperson or broker will take a considerable chunk of cash upfront for education, licensing, and association fees. 

Starting a brokerage firm will also require a sizable financial investment. A property management company will have to have significant funds to acquire investment property or rentals.

Whatever type of real estate business you’re in, the overhead costs will not be the same across the board. Your overhead costs as a real estate agent or brokerage firm will differ from a property management company. 

Types of Overhead 

  • Fixed overhead costs are operating expenses that don’t change month to month. They tend to stay the same and are easier to track.
    Example: rent or mortgage, salaried employees, property taxes and insurance, etc.
  • Variable overhead costs will change month to month, sometimes because of fluctuations in business activity or needs.
    Example: marketing, education and training, landscaping, rental maintenance, etc.
  • Semi-variable costs are operating expenses that fluctuate based on business activity but with a minimum base rate each month.
    Example: transportation, utilities, data plans for company cell phones, etc.

To know how to calculate overhead expenses, you must track all types of operating costs (fixed, variable, and semi-variable) to have an accurate representation of the total overhead. 

Although GAAP (generally accepted accounting principles) doesn’t require a breakdown between types of overhead costs, it is helpful to distinguish them because it makes you a better businessman/woman.

Ultimately, every real estate business will have different overhead costs, but below is a list of the most common expenses you’ll run into.

Marketing and Advertising

This variable expense is critical and may even account for most of your overhead. You cannot be successful unless people know about your business, and a good marketing plan will get the word out there. 

People often use the terms “marketing” and “advertising” interchangeably, but they do have some differences. Marketing is the umbrella that advertising falls under. A company generally has a budget for its marketing needs, some of which might be advertising costs.

But even if you hire a professional marketing agency to promote your business, you will still have to advertise your services to some degree. With so many people online and on their mobile devices, a social media presence, website, and blog are legitimate ways to get the customer’s attention and earn their trust. 

These things require time and money. Although you can hire out, making a name for yourself in the professional real estate world will mean lots of facetime with potential clients, digital and otherwise. Networking is key to success.

Check out these top trends for Real Estate Marketing in 2021, and you’ll know what I mean.

Office Expenses

A business needs a place to operate, even if you sell or manage other people’s homes for a living. 

If you own your place of business, you will have to pay a monthly mortgage. The same applies if you rent. These are ordinary fixed expenses that will stay the same throughout the year. They’re easy to budget for because they’re obvious.

In addition to a mortgage or rent, you will have to pay any other costs associated with your place of business. Utilities, labor, transportation, wifi, insurance, and office supplies are some of the expenses you can expect to incur from a brick and mortar (or even your home office).

You will need computers and software to run a business. Tech and gadgetry are now legit business expenses that you have to have to operate a business efficiently. You have to keep up with the times.

Real Estate Education and Licensing Fees

There are also specific costs associated with becoming a real estate salesperson, which also all count as overhead.

You will have to take real estate classes and pass an exam. The exam is not identical across Canadian provinces, so keep that in mind while studying. Fees vary, but you can expect to pay around $7,000 to become a licensed real estate agent in Ontario. This cost includes education, exam fees, and miscellaneous costs. 

Real Estate brokers take additional classes and must also pass an exam. These fees add up to approximately $2,000, depending on where you go. These costs count as overhead, so keep track of these upfront expenses and any licensing maintenance fees you accrue.

In addition to exam fees and education, some miscellaneous costs include membership fees to real estate associations. You will also have opportunities to continue your training as real estate guidance or practices evolve.

Brokerage Fees and Commissions

Real estate salespersons who work for a brokerage firm will likely have to pay a commission on a house sale. The percentage they earn from the sale of a home is split four ways between the buyer’s real estate salesperson and brokerage firm and the seller’s real estate salesperson and brokerage firm. 

Any fee or commission paid to other real estate salespersons or brokers counts as overhead. These will be variable costs, fluctuating with real estate market changes and home prices.

Property Management Expenses

If you are a lessor or property manager, all costs associated with rental property maintenance are included in overhead. These, of course, consist of the rental property’s mortgage, maintenance, cleaning fees, property taxes, and anything that goes towards business upkeep. 

However, these expenses do not include construction or materials and labor when building the property itself.

Why Is Knowing How to Calculate Overhead in Your Business Important?

Although overhead counts the indirect costs of running a business, it directly impacts your revenue. If you don’t know how much you’re spending on overhead, you will not know how profitable your real estate company is. 

You also will not have an accurate idea of how to price your services. You could price them too low and end up with a thin net profit.

This is why it is essential to know how to calculate overhead expenses for yourself.

Overhead lets you know how your business is functioning and where your money is going. Knowing the health of your real estate business at a glance will show you areas where you might need to trim. Shooting for low overhead expenses is the goal, but not so low that you cannot keep the lights on.

How to Calculate Overhead for your Real Estate Business

Calculating overhead is not as difficult as it sounds, so don’t be intimidated. A simple 3-step formula exists that will teach you how to calculate overhead in your real estate business. 

1. Keep an Accurate and Categorized Record of all Your Expenses.

Track all expenses. Remember, overhead is the indirect expense of operating a business. Direct costs to produce a product or service are not on this list (but are still important). 

If you have accounting software or outsource to an accounting firm, it is much easier to keep track of what you’re spending. If not, you’ll have to do the work manually. 

Categories might include those from above: office supplies, mortgage, fees, advertising, etc.

Or you can keep track of both direct and indirect costs together and sort through them. Take the total sum of both expenses and subtract your direct costs, which will produce your total overhead. 

Using this method will require you to tally up the direct costs, which might be a little easier if you’re new to bookkeeping. When you arrive at the amount of overhead, you’ll still want to analyze it so you can trim whatever’s needed and have the right idea of where most of your money’s going. This process helps you catch any mistakes.

2. Add Them up to Discover Your Aggregate Overhead Costs

The aggregate cost is your minimum operating cost rate. Add up only the overhead expenses you need to run your business – just the bare necessities – to produce your aggregate cost. 

You might have paid for something that doesn’t ultimately profit your company or included personal expenses by mistake, which is exactly why analyzing your overhead is crucial.

3. Calculate to Find Your Standard Overhead Rate

The simplest way to find your standard overhead rate is this formula:

(Total Monthly Aggregate Cost / Total Expected Monthly Revenue)

Multiply your answer by 100, and this will produce your overhead percentage rate for the month. 

For example, if your aggregate costs for the month were $500 and you expected to receive $5,000 in total monthly revenue, your formula would look like this:

(500/5,000)

The answer to this (.1) is multiplied by 100, giving you a total monthly overhead of 10%.

Easy, right?

I Know How to Calculate Overhead – Now What?

Again, knowing how much you’re spending on overhead is an indicator of your company’s health and financial fitness. It is also a substantial number that should be listed and detailed in your company’s income statements. You will need it for your financial records, but it also helps you budget for the month and/or the year. 

The standard overhead percentage is what you will need to allocate for your indirect expenses. A profitable real estate business needs a monthly and yearly budget to keep spending in check and track expenses. 

Accounting and Overhead

If you don’t have an in-house accountant or the skills and time to keep up with your numbers, an accounting firm that has experience with real estate laws and taxes will help you. They will keep an accurate account of your expenses, categorizing direct and indirect costs correctly.

If you are investing in real estate and using the cost-plus-based pricing scheme, this involves allocation for both direct and indirect expenses at the same time, although indirect costs are not as easy to pin down. This study reveals that real estate investment firms need a better understanding of overhead to maximize profitability. 

We hope that this guide will give you more insight into overhead and help you understand why this number is so significant. 

An accounting firm that specializes in real estate will be an asset to your business. They will use the best methods for determining what your overhead costs are month to month and year to year, so you don’t have to. This will clear your plate and give you confidence that your finances are being handled correctly. 

You should expect variance. Overhead does not typically stay the same due to outside factors or business activities and growth. An accounting firm can help you allocate a correct amount of cash flow towards overhead, reducing costs overall and increasing profitability. 

A larger company should always have an accounting specialist calculate the company’s expenses so that no mistakes are made. Whether you have the resources to hire an in-house accountant full-time or outsource, this is an investment you cannot afford to do without. They will accurately assess overhead costs and make adjustments whenever necessary. 

What Overhead Does Not Include

Overhead does not include any expense that goes towards the actual product or service. Those are called direct costs. You will still need to know how much you’re spending overall, but overhead and direct operating costs have different functions. 

Direct costs can indicate some of the same things as overhead. For example, the number of costs associated with directly producing a product or service will also factor into pricing models. But you must sort direct and indirect costs to know how to allocate the correct amount into each category. 

Direct operating costs are also an essential factor in calculating the cost of goods sold (COGS). Unless a real estate company is involved in building projects, they do not produce a product. Rather, they offer a service. 

For a real estate company, examples of direct costs include the cost of construction for an investment property. Labor, materials, and contractor fees would also be a direct cost. These costs are not included in overhead expenses. 

Why Do You Need to Separate Direct and Indirect Costs? 

You might wonder why you need to separate direct and indirect costs at all. 

Overall, it is necessary to separate these costs for several reasons. 

First of all, it is always helpful to break down your business expenses as much as possible. You have to understand your financial situation as a business owner, even if it is just a rundown from a professional who does the books.

Secondly, separating direct and indirect costs will give you the best understanding of where you need to allocate your money. For budgetary purposes, it is a necessary step.

To get your standard overhead percentage, you also have to know your total overhead (subtracting direct costs or vice versa). Again, it is a budgetary need.

The same goes with your direct costs. The total direct costs are used to calculate your cost of goods sold, which is an important factor in determining company health and pricing (among other things).

Separating these expenses lets you know, as precisely as possible, where your money is going, where you need to cut or increase spending, and where to invest it in the future.

Summary

Even if you eventually decide to hire an accounting firm to punch the numbers, knowing how to calculate overhead is vital for your real estate company. It can feel like a daunting task at first, but the calculations are easy enough. The hardest part is figuring out how to track and categorize the costs associated with running your business.

Overhead is the indirect cost of operating a business. Any expense that goes into a service or product is the direct cost – this is not included in overhead. Overall, direct costs are easier to track because they are more apparent. 

But overhead is just as significant a number. You need to include it in your financial records because it is a good indicator of your real estate company’s profitability and health. Without knowing how much overhead costs are, you run the risk of bleeding money and turning a razor-thin profit (or none at all). 

There are fixed, variable, and semi-variable indirect costs associated with a business. Real estate accounting specialists know how to correctly categorize and track expenses that might go unnoticed for a while or become miscalculated as a direct cost. 

Common overhead categories that real estate companies have include the following: marketing costs, office expenses, real estate education, licensing fees, brokerage fees and commissions, and property management expenses. 

To calculate your overhead, you must track all of your expenses. The bare minimum dollar amount you need to keep your business running is called the aggregate cost. If you divide your aggregate cost by your total expected revenue and multiply by 100, you will arrive at your overhead percentage rate. This rate will help you allocate the right amount of resources towards your indirect costs each month. 

Budgeting the right amount for each expense category is essential if you want to be a successful company. Without tracking the numbers, you will not have an accurate assessment of how much money you’re spending. You could end up spending far too much on overhead, which affects your company’s net profit. Or, you might accidentally misrepresent how much of a profit your company makes, which can sink a company fast. Leaving room for error in your financial records is a huge problem and leads to faulty decision-making. 

Consider pricing. If you don’t have a correct understanding of what goes into producing a product, your prices might be too low. If you don’t account for all overhead expenses, especially the variables, you will have a skewed picture of your actual financial situation.

This is where an accounting firm that specializes in Canadian real estate – like Hart Accounting Services – can help. We know how to help you, and we can make sure your company maximizes its profits with accurate bookkeeping, tax planning, and expense tracking. 

With Hart Accounting Services, you don’t have to worry about what’s not included in overhead. You don’t have to worry about miscalculating your expenses or losing track of anything. We will give you peace of mind if accounting is not your forte, freeing you up to focus on other things.

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