How to Calculate Operating Expense Ratio?
The operating expense ratio allows you to understand the level of your expenses in relation to income.The more effectively the landlord minimizes their costs relative to a properties income, the lower this figure will be.
Use our operating expense ratio calculator to understand how efficient you are with this.
What is operating expense ratio?
In real estate, the operating expense ratio is an indicator of the cost of operating part of the property compared to the income generated by the property. It is determined by dividing the operating costs of the property by its gross operating income.
Operating expense ratio formula
In order to calculate the rental property operating expense ratio, you must first identify the operating costs.
For the operating expenses formula you need to include for example such costs as: maintenance and repairs, utilities, pest control costs, insurance fees, tenant screening fees, property management costs, etc. Be mindful that the operating expenses list does not include debt service costs and income taxes.
The operating expense ratio formula is the following:
OER = Operating Expenses / Effective Gross Income
What is a good operating expense ratio?
If you as an investor know how to calculate operating expense ratio and have been doing this over a number of years, it can help you to predict patterns in property operating expenses. If real estate costs grow at a faster rate each year than income, the operating expense ratio also increases each year. Thus, the investor may take a loss the longer he holds on to the property.
The rental property operating expenses ratio may be less than or equal to 15% under a semi-net lease, where the owner bears the cost of paying only certain items of expenses, such as insurance or real estate taxes.
For most apartments, the typical figure is 33-45%, except when the rent does not include payment for all utilities.
Owners should constantly monitor this indicator in order to capture all its changes.
A lower rental property operating expenses ratio usually means that the property is managed efficiently and is more profitable for investors, as well as less rental property income covers operating and maintenance costs. If the business is scalable, the owner can increase the rent for each unit without significantly increasing operating costs. In addition, the operating expense ratio can show where potential problems may arise, such as significantly increasing utility bills, allowing investors to solve problems faster and protect profits.
This analysis identifies problems that require additional attention and opens up opportunities to preserve current costs. The appraiser should try to estimate operating costs under typical competent management. Any non-standard cases, which differ from the generally accepted norms, can be attributed only to the abilities of the head and have nothing to do with the property itself.