By Yoan Valiente, Founder & CEO · Updated · Part of the CRE investment glossary
How the operating expense ratio works
The operating expense ratio puts expenses on a common scale. Two buildings with different sizes and rents can be compared by how much of each dollar of collected income they spend on taxes, insurance, repairs, payroll, utilities, management and administration.
It is the mirror of the NOI margin: whatever share of effective gross income is not spent on operating expenses is net operating income. A rising ratio with flat rents means expenses are growing faster than income.
The formula
For one year:
Operating expense ratio = operating expenses ÷ effective gross income NOI = EGI − operating expenses
- Operating expenses: property taxes, insurance, repairs and maintenance, payroll, utilities, management fee, administration and marketing.
- Not included here: debt service, capital expenditures, replacement reserves, depreciation and income taxes.
- Definitions vary. Some reports divide by gross potential rent, include or exclude reserves and the management fee, or use a different base. This page divides by effective gross income and counts the management fee; the example does the same. State the definition when you quote the ratio.
Worked example
A fictional property has effective gross income of $1,200,000. Its operating expenses are listed below and total $580,000, with the management fee set at 4% of EGI as an example.
The operating expense ratio is $580,000 ÷ $1,200,000 = 48.3%, so NOI is $620,000. To check it, enter the same income and expenses in the NOI calculator. The figures are illustrative, not market figures.
| Line | Arithmetic | Amount |
|---|---|---|
| Effective gross income | $1,200,000 | |
| Property taxes | $150,000 | |
| Insurance | $60,000 | |
| Repairs and maintenance | $90,000 | |
| Payroll | $120,000 | |
| Utilities | $80,000 | |
| Management fee | 4% of $1,200,000 | $48,000 |
| Administration and marketing | $32,000 | |
| Operating expenses | $150,000 + $60,000 + $90,000 + $120,000 + $80,000 + $48,000 + $32,000 | $580,000 |
| Operating expense ratio | $580,000 ÷ $1,200,000 | 48.3% |
| Net operating income | $1,200,000 − $580,000 | $620,000 |
Reading the ratio
There is no single good ratio. Expense levels depend on property type, age, how utilities are billed, tax jurisdiction and service level, so compare a property with its own history and with similar properties from the same source, defined the same way. A ratio quoted without its definition is not comparable.
In underwriting, check each line against the T-12 and the market before accepting an OER from an offering memorandum. Property taxes and insurance can reset on a sale, and a ratio built from the seller’s history can understate the buyer’s costs.
Common mistakes
The usual errors are about the line items:
- Including debt service or capital expenditures in operating expenses.
- Leaving out the management fee because the owner manages the property.
- Dividing by gross potential rent in one report and effective gross income in another.
- Using the seller’s property taxes and insurance when they will reset after the sale.
General information, not legal, tax or investment advice. Your operating agreement, offering documents, counsel and CPA govern your deal.