7.8.3 General

A. Operating expenses are periodic expenses needed to maintain the project and to continue the production of effective gross income, and represent the totality of all expense items as recognized under Generally Accepted Accounting Principles (GAAP), except to the extent modified by HUD Program Obligations. Operating expenses must include the annual amounts deposited to the Reserve for Replacement. Operating expenses shall not include interest charges, or charges or allowances for depreciation of real or personal property, or amortization of financing expense, or payments to any officer or director of the corporation, unless such payments are for services which are necessary to the operation of the project. For appraisal purposes, an operating statement that conforms to the above definition of operating expenses may differ from statements prepared for accounting purposes. Current or historic statements must be prepared on a cash basis. It is important to verify the accounting basis for the operating statement since project operating expenses for appraisal purposes must be reported on a cash basis. Typical categories of expenses are as follows:

1. Fixed Expenses. Fixed expenses are those that generally do not vary with occupancy and have to be paid regardless of whether the project is occupied or vacant, and generally do not fluctuate greatly from year to year. Real estate taxes and insurance costs are typically included as fixed expenses.

2. Variable Expenses. Variable expenses are operating expenses that vary with the level of occupancy or the intensity of project operation. Operating expenses for large properties frequently list many types of expense variables, but typical broad categories include the following:

   • Management charges

• Utilities – electricity, gas, water, sewer charges

• Heating, ventilation, and air conditioning (HVAC)

• General payroll and security

• Cleaning expenses

  • Maintenance and repairs

• Decorating

• Grounds maintenance

• Exterminating

• Trash removal

  • Miscellaneous (supplies, etc.).

3. Reserve for Replacements. This reserve category provides for the periodic replacement of the building components that wear out more rapidly than the building shell itself and must be replaced periodically during the building’s economic life. These components may include but are not limited

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to roof covering, carpeting, plumbing fixtures, appliances, and HVAC. The estimate of the reserve for replacements should be based on reserves that are typically collected for comparable properties in the subject’s market area, without regard to FHA programmatic requirements used for determining the required replacement reserves when calculating debt service coverage. The appraiser must document the research conducted to make this determination. The MAP Lender’s underwriting narrative must address any variance between the market reserve cost used on the appraisal and the FHA-required deposits included in the underwriting.

4. Total Operating Expenses. Total operating expenses for residential properties are the sum of the fixed expenses and variable expenses updated to the appraisal date, plus the reserve for replacements.

5. Commercial Facilities. Where commercial facilities are included in the subject project, a separate analysis must be made to determine the effect that the commercial operation will have on the project expense estimate.