A measure of profitability, Operating Expense Ratio (OER) tells you how well you are controlling expenses relative to income. Take all operating expenses and divide them by operating income to get your Operating Expense Ratio. A lower OER is preferable as it means the landlord or property manager is minimizing expenses relative to income. Use our Operating Expense Ratio Calculator to see how well you are doing.
Operating Expense Ratio Calculator:
What is Operating Expense Ratio?
The Operating Expense Ratio measures the cost to operate a property versus the income it generates. By dividing your operating expenses by your property’s operating income you will determine your OER.
Operating Expense Ratio Formula
The operating expense ratio formula is:
OER = Operating Expenses / Effective Gross Income
Operating expenses can include:
- Pest control costs;
- Insurance fees;
- Utilities;
- Maintenance and repair costs;
- Lost income due to vacancy;
- Property management costs;
- Tenant screening fees;
- Property taxes.
Effective gross income includes rental income as well as other revenue such as laundry fees, utility charge-backs, and parking, less the expected vacancy factor.
How is Operating Expense Ratio in Real Estate Used?
OER compares what it costs to operate a property with the income that it generates to help you ensure you are running your rental – IE your business – efficiently. When property expenses are being well managed OER will either stay the same or decrease over time, which will allow you to welcome more income.
A lower operating expense ratio means that you’ve minimized expenses relative to revenue. If your OER has been rising over time, it could indicate many issues. For example, maybe annual rent increases haven’t matched expense increases. Similarly, calculating OER while isolating specific expenses can help you narrow down the reason for its rise and help you get it back under control.
What Information Will I Need to Calculate Operating Expense Ratio?
- Operating Expenses
- Monthly Rental and Other Income
- Expected Vacancy Factor
You will need to calculate the Operating Expenses of your property. The operating expense ratio focuses on the day-to-day cash costs of running a property. Items like depreciation (non-cash), debt payments, and capital improvements are not included in the calculation because they are not costs in direct operations of the property. Please see our rental property calculators overview for examples of operating expenses.
Next, calculate the Effective Gross Income, which is the total of all rent and other income earned, less lost rent due to vacancies (vacancy factor). Similarly, loss of income from vacancies needs to be factored into your gross revenue.
How to Calculate Operating Expense Ratio?
To find out the OER, you need to divide the Operating Expenses of a property by the Effective Gross Income. To put it another way, it demonstrates how much of the rental income will be used on Operating Expenses. Use our simple Operating Expense Ratio calculator above, or follow the formula below:
Operating Expenses / Effective Gross Income = OER
However, the Operating Expense Ratio calculator does not include debt in its calculations, which can make the findings a little misleading. OER is a measurement of operational efficiency, not of profitability. You may also want to use additional calculators, such as CoC and ROI, which include mortgage costs when you’re analyzing the performance of rental investments.
What is a Good Operating Expense Ratio: An Example
It is considered ideal to have an operating expense ratio in the 35-45% range for multi-family apartment buildings, though the lower it is, the better. A lower OER typically means the property is being operated efficiently and is more profitable. In other words, operational and maintenance costs offset less of the income received.
For example, suppose Jane has been operating her 3-unit apartment building the past several years. She receives monthly rent plus parking fees of $3,100 per month. Typically, she experiences a 3% vacancy rate on average. Therefore, her effective gross income is $36,084 ($3100 x 12 x 0.97).
Jane’s annual operating expenses, including property taxes, insurance, utilities, repairs, and property management fees, totals $13,700.
She inputs these figures into her operating expense ratio calculator and finds her Operating Expense Ratio is 38%. Because she has done this calculation regularly each of the past 5 years, she knows that her OER has steadily gone from 43% 5 years ago to 38% today. Jane has done an excellent job keeping her expenses manageable while experiencing slight improvements in market rents recently. Keep up the good work, Jane!
Operating Expense Ratio Calculator: Takeaway
The Operating Expense Ratio calculator provides a useful metric for rental property investors to understand how well their property is operating. Digging into the components that make up the operating expense ratio calculation can indicate where there is potential room for improvement. We believe that utilizing the key benefits of the top reporting and accounting tools helps landlords to maintain accurate records. In turn, this allows for more useful rental property calculations and a better understanding of portfolio performance.
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