Operating Expense Ratio
Real Estate Definitions for Real Estate Investing
Operating Expense Ratio
The Operating Expense Ratio (OER) is the ratio of the total operating expenses and the effective gross income of the property. Operating expenses are costs associated with the operation and maintenance of the property. Typical property expenses include such items as property taxes, insurance, pest control, utilities, repairs and maintenance, supplies, advertising, attorney fees, accounting fees, and lawn maintenance.
Operating expenses do not include loan payments, mortgage insurance payments, or capital improvements.
The effective gross income is the “gross scheduled” rental income plus “other” income less amounts provided for vacancy and credit losses. Other income can include items such as amounts received from laundry, vending machines, parking fees, and late fees. Think of effective gross income as the income from a property that you actually receive rather than what you should be receiving.
The operating expense ratio is calculated as follows:
Operating Expense Ratio =
Operating Expenses / Effective Gross Income
Example: An income producing property has gross scheduled rents of $100,000 plus $2,000 of other income for a total income of $102,000. The property’s vacancy rate is 5% or $5,000. The property’s operating expense is $45,000.
The effective gross income for the property is calculated as $100,000 + 2,000 – 5,000 or $97,000.
The operating expense ratio is calculated as follows:
$45,000 (Operating Expenses) divided by
$97,000 (Effective Gross Income)
= 46.39 %
The operating expense ratio shows us that 46.39% of the property’s income is being spent on rental operating expenses. The calculation in the Cash Flow Analyzer ® can be found in the Financial Measurements section of the Cash Flow Analysis report.
An operating expense ratio can also be calculated on a per expense basis. The individual calculations can be compared to similar income properties. Significant differences in comparing these ratios can alert you to problems areas. The individual expense calculations can be found in the Annual Property Operating Data (APOD) of the Cash Flow Analyzer software ®.
The operating expense ratio can also be an indicator of whether a property is being managed efficiently. The lower the operating expense ratios, the better the property is performing which obviously should result in more rental profit.
Our real estate investment software calculates an Operating Expense Ratio so that you are in a better position of understating how much to offer for a particular property and make the appropriate presentations to bankers, lenders and prospective real estate partners.