Definition
The Operating Expense Ratio (OER) is a financial metric in real estate that shows the proportion of a property’s operating expenses to its potential gross income. The formula is expressed as follows:
\[ \text{OER} = \frac{\text{Operating Expenses}}{\text{Potential Gross Income}} \]
This ratio helps investors and managers assess how well a property is being managed in terms of the costs required to operate it.
Examples
-
Apartment Complex:
- Potential Gross Income: $500,000
- Operating Expenses: $200,000
- OER: \( \frac{$200,000}{$500,000} = 0.40 \) or 40% Apartments generally have operating expense ratios between 30% and 50%, reflecting the average cost-efficiency of managing such properties.
-
Office Building:
- Potential Gross Income: $1,000,000
- Operating Expenses: $500,000
- OER: \( \frac{$500,000}{$1,000,000} = 0.50 \) or 50% Office buildings often have higher operating expense ratios (40%-60%) due to more intensive management and maintenance services, such as cleaning and security.
FAQs about Operating Expense Ratio
What expenses are included in the operating expenses?
Operating expenses typically include maintenance costs, property management fees, utilities, insurance, property taxes, and other day-to-day operational costs.
What is considered potential gross income?
Potential Gross Income (PGI) is the total revenue a property can generate if fully leased, under ideal conditions without accounting for vacancies and credit losses.
Why is the OER important for investors?
The OER is important because it provides insight into the profitability and efficiency of a property, allowing investors to compare the operating performance of different properties.
How can a property manager improve the OER?
Property managers can improve the OER by reducing operating expenses through cost-cutting measures and improving property management efficiency without compromising the quality of services.
What is a ‘good’ Operating Expense Ratio?
A ‘good’ OER can vary depending on the type of property. For residential properties, 30%-50% is typically acceptable, while commercial properties might have higher ratios, reflecting more intensive management needs.
Related Terms
- Net Operating Income (NOI): The income generated from a property after subtracting all operating expenses, but before deducting taxes and financing charges.
- Gross Income: Total income generated from a property, including rent and other revenue before any expenses are deducted.
- Capitalization Rate (Cap Rate): The rate of return on a real estate investment property based on the expected income the property will generate.
- Gross Rent Multiplier (GRM): A method used to appraise investment properties by taking the asking price and dividing it by the gross rental income.
Online Resources
- Investopedia: Operating Expense Ratio
- Property Metrics: Understanding Operating Expense Ratio
- Real Estate License Training: OER Explained
References
- “Investing in Income Properties: The Big Six Formula for Achieving Wealth in Real Estate” by Kenneth T. Blomsterberg.
- “Real Estate Finance & Investments” by William Brueggeman and Jeffrey Fisher.
Suggested Books for Further Studies
- “The Millionaire Real Estate Investor” by Gary Keller
- “Real Estate Finance and Investments” by Peter Linneman
- “The ABCs of Real Estate Investing” by Ken McElroy
