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The operating expense ratio also known as the OER is the ratio
between the total operating expenses and the effective gross income
for an income producing property.
Operating expenses are costs associated with the operation
and maintenance of income producing properties. They include
such items as property taxes, property management fees, insurance,
wages, utilities, repairs and maintenance, supplies,
advertising, attorney fees, accounting fees, trash removal, pest
control, etc. The following are not operating expenses; loan
payments, personal property and capital improvements.
The effective gross income for a property is the actual yearly
income from all sources. It is equal to the yearly gross rents
possible plus other income such as laundry receipts, vending
machines, parking fees, etc. less the yearly vacancy amount.
The operating expense ratio shows the percentage of a property's
income that is being used to pay maintenance and
operational expenses. Let's take a look at an example. An
income producing property has potential rents of $78,000 plus $2,000
of other income for a total of $80,000. The property has 4,000
of lost income due to vacancies. The yearly operating expense
are $30,400. The effective gross income for the property is
$80,000 - 4,000 or $76,000. The operating expense ratio
is calculated like this.
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Operating Expenses |
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Operating expense ratio =
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Effective Gross Income |
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30,400 |
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= ------------ =
.4 or 40% |
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76,000 |
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The operating expense ratio for the above property indicates
that 40% of the property's income is being spent on maintenance and
operational expenses. To establish a bench mark OER, you would calculate the
operating expense ratio of similar income properties. You would
then calculate the average OER
for the properties.
Why is the operating expense ratio important? The operating
expense ratio is an indicator of how efficiently a property is being
managed. The lower the operating expense ratio, the greater
the profit for the investor or investors. As the owner or
manager of an income producing property, you should be assessing
what steps you can take to reduce vacancies, reduce operating
expense items and increase income. Which operating expenses
are out of line and why? You can learn a lot about an income
property by examining the individual operating expense
items.
Many factors can impact the operating expense ratio for
income properties. Poor management will result in higher than
normal vacancies. The cause might be ineffective advertising, poor
maintenance, etc. Older income properties will have larger
maintenance and utility expenses than newer income properties since
newer income properties are usually insulated better and require
less maintenance. An income property with rents below market
value will have a higher operating expense ratio than one that is
managed effectively. Office buildings will generally have
higher OER's then apartment buildings because they require more
intensive management and maintenance.
As the owner of an income property or potential purchaser of
income property, you should examine the operating expense data
looking for potential problems. Compare the previous years
operating expense data to the current year. Compare the data
to properties you are considering purchasing.
What percentage of a property's effective gross income is being
spent on maintenance and repairs? What percentage is being
spent on advertising? What percentage is being spent on
utilities? Abnormally high utility expenses might indicate
that a property is poorly insulated. Even if you don't pay the
utilities, high utility bills might result in a higher than normal
turnover rate. Which operating expense items are out of line
and why? What actions can you take to correct the
problem? When you come up with a solution, monitor the
situation to determine if it has corrected the problem. Often
it is necessary to spend money to improve the operating
efficiency of a property. The operating expense ratio for
advertising would be calculated like this. |
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Yearly Advertising Expense |
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OER
Advertising = ---------------------------------------- |
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Effective Gross Income |
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The On Target real estate investment analysis software
calculates the operating expense ratio for individual expense items
such as advertising, insurance, maintenance, property taxes,
property management, repairs, supplies, utilities etc. You can
monitor up to12 different operating expense items via the Operating
Expense report. The operating expense report shows individual
operating expense items as a percentage of the effective gross
income and can help you identify potential problems. The On Target
software costs $97.95 and can be purchased by clicking on the
following link. Purchase
On Target To learn more about On Target,
click on the following link. On
Target Features The On Target real
estate software includes a 30 day money back guarantee and free
support.
(c) Copyright 2000 - 2008 Advantage Software
LLC |
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