What is the Operating Expense Ratio?

Operating Expense Ratio

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Operating Expense Ratio

The Operating Expense Ratio (OER) is a financial metric that helps investors, management, and analysts understand the cost of operating a property compared to the income that property brings in. It’s particularly used in real estate and measures the cost to operate a property as a percentage of the property’s income.

The formula to calculate the Operating Expense Ratio is:

Operating Expense Ratio = Operating Expenses / Gross Operating Income

Operating Expenses in this context would include costs like repairs, maintenance, property management fees, utilities, property insurance, property taxes, and so on.

Gross Operating Income is the total income generated by the property, including rental income but excluding any income taxes.

For example, if the operating expenses for a rental property were $50,000 in a year, and the property generated $100,000 in rent during that same period, the OER would be:

Operating Expense Ratio = $50,000 / $100,000 = 0.5 or 50%

This means that 50% of the property’s income is being used to cover operating expenses. The lower the OER, the more profitable the property is considered because a smaller portion of income is going toward expenses. Conversely, a high OER may indicate less profitability.

However, the acceptable range for an OER can vary depending on the type of property and its location, so it’s often used in comparison with similar properties or the averages within a certain market or area.

Example of the Operating Expense Ratio

Let’s consider a rental property:

  • Annual rental income from the property: $200,000
  • Operating expenses for the year, including maintenance, property management fees, insurance, and property taxes: $60,000

The Operating Expense Ratio (OER) is calculated by dividing the operating expenses by the gross operating income. Using the numbers above, we get:

Operating Expense Ratio = Operating Expenses / Gross Operating Income

Substituting in the actual numbers:

Operating Expense Ratio = $60,000 / $200,000 = 0.3 or 30%

So, the OER for this property is 30%. This means that 30% of the property’s income goes towards operating expenses. The remaining 70% could then go towards things like mortgage payments, profit, capital improvements, or other costs.

Remember, this is a simplified example. Real-world real estate investments may have additional complexities and factors to consider.

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