Operating Expense Ratio Explained
In apartment property investing, the operating expense ratio compares the cost of operating the asset to the income it produces.
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In apartment property investing, the operating expense ratio or OER is a metric representative of the cost to operate an apartment asset as compared to the income that the asset produces. Many apartment investors utilize the OER metric to compare the expenses of similar apartment properties, and to identify any potential expense issues that may make the asset less desireable as an investment.
Calculating an Operating Expense Ratio
The calculation of an asset's OER is relatively simple, so long as an investor understands the components involved. In order to properly calculate an apartment property's operating expense ratio, the property's total annual operating expenses (less depreciation) and total annual net income must be known. It is extremely important to get accurate measurements in both of these areas in order to get an accurate OER measurement.
The Operating Expense Ratio Formula
The formula for calculating OER is below:
Operating Expense Ratio = Total Operating Expenses ÷ Total Operating Income
In order to better highlight how the formula works, consider an apartment asset with an annual operating income of roughly $900,000. This figure includes rental income as well as any other sources, such as parking fees, pet fees, storage fees, etc. Let's assume the asset's annual expenses come out to $645,000.
OER = $645,000 ÷ $900,000 = 71.7%
In this scenario, the asset's OER would be 71.7%. In other words, the asset's expenses take up roughly 72% of the income produced by the property.
What Is a Good Operating Expense Ratio?
While every apartment property owner has different investment goals and may be able to tolerate higher expenses, there is an OER "sweet spot" that most investors aim for. In general, the lower the OER, the better — but an OER between 60% and 80% is broadly considered ideal.
Operating Expense Ratios and Cap Rates
A property's cap rate, or capitalization rate, is used in apartment finance to indicate an asset's expected rate of return. The cap rate metric is based on the net income of a property and is commonly used to estimate the investor's potential return on investment.
While both the cap rate and OER can be utilized to measure the profitability of an apartment property, a cap rate represents the relationship between the gross revenue of the asset in comparison to its market value, which OER does not take into account.
Related Questions
What is an operating expense ratio?
An operating expense ratio (OER) is a metric representative of the cost to operate an apartment asset as compared to the income that the asset produces. Many apartment investors utilize the OER metric to compare the expenses of similar apartment properties, and to identify any potential expense issues that may make the asset less desirable as an investment.
The formula for calculating OER is: Operating Expense Ratio = Total Operating Expenses ÷ Total Operating Income
In general, the lower the OER, the better — but an OER between 60% and 80% is broadly considered ideal.
How is an operating expense ratio calculated?
The calculation of an asset's OER is relatively simple, so long as an investor understands the components involved. In order to properly calculate an apartment property's operating expense ratio, the property's total annual operating expenses (less depreciation) and total annual net income must be known. It is extremely important to get accurate measurements in both of these areas in order to get an accurate OER measurement.
The formula for calculating OER is below:
Operating Expense Ratio = Total Operating Expenses ÷ Total Operating Income
In order to better highlight how the formula works, consider an apartment asset with an annual operating income of roughly $900,000. This figure includes rental income as well as any other sources, such as parking fees, pet fees, storage fees, etc. Let's assume the asset's annual expenses come out to $645,000.
OER = $645,000 ÷ $900,000 = 71.7%
In this scenario, the asset's OER would be 71.7%. In other words, the asset's expenses take up roughly 72% of the income produced by the property.
What factors affect an operating expense ratio?
The operating expense ratio (OER) is affected by two main factors: total operating expenses and total operating income. Total operating expenses include all costs associated with running the property, such as taxes, insurance, utilities, repairs, and maintenance. Total operating income includes all income generated from the property, such as rental income, parking fees, pet fees, storage fees, etc. In order to get an accurate OER measurement, it is important to get accurate measurements in both of these areas.
What is a good operating expense ratio?
While every apartment property owner has different investment goals and may be able to tolerate higher expenses, there is an OER "sweet spot" that most investors aim for. In general, the lower the OER, the better — but an OER between 60% and 80% is broadly considered ideal.
How can I improve my operating expense ratio?
Improving your operating expense ratio is all about reducing your operating expenses while maintaining or increasing your operating income. Here are some tips to help you do that:
- Negotiate better terms with vendors and suppliers.
- Reduce energy costs by investing in energy-efficient appliances and lighting.
- Reduce labor costs by automating certain processes.
- Increase rental income by offering incentives to tenants.
- Increase other income sources such as parking fees, pet fees, storage fees, etc.
For more information, check out this article.