Operating Expense Ratio
Meaning and Definition
Operating expense ratio can be explained as a way of quantifying the cost of operating a piece of property compared to the income brought in by that property. As explained by Investopedia, the operating expense ratio (OER) is a helpful tool in carrying out the comparisons between the expenses of analogous properties. If a particular property piece features a high OER, an investor should take it as a warning signal and look into the matter for why is the OER high.
The investors using this ratio can further compare any type of expense including insurance, utilities, taxes and maintenance, to the gross income, and the sum of all expenses to the gross income.
The main items included in the operating expense include property management, property taxes, utilities, wages, insurance, fees, supplies, repairs and maintenance, advertising, accounting fees, attorney fees, pest control, trash removal, and similar more. However, the items not included in operating expenses are personal property, loan payments, and capital improvements.
Calculating the operating expense ratio
The operating expense ratio is, generally, calculated by dividing the operating expense of a property by its gross operating income.
The formula for OER is,
Operating Expense Ratio = Operating Expenses / Effective Gross Income
Importance of operating expense ratio
The importance of operating expense ratio lies in the fact of it being an indicator of the efficiency level of managing a property. A lower operating expense ratio indicates a greater profit for the investors. in simple words, the operating expense ratio reflects the percentage of a property’s income which is being utilized to pay operational and maintenance expenses. Moreover, the operating expense ratio also represents individual operating expenses items in the form of a percentage of the effective gross income and is also helpful in identifying potential problems.
Example for operating expense ratio
Let’s consider a piece of property which features a gross operating income of $50,000 and the total operating expenses are $6200. These operating expenses include insurance ($1,500), utilities ($700), and taxes ($4,000). The overall operating expense ratio, in this case, would be 12.4% ($6,200/$50,000). This operating expense ratio can be compared to other similar properties.