What Is the Operating Expense Ratio (OER)?

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What Is the Operating Expense Ratio (OER)?

Let me explain the operating expense ratio, or OER, directly to you as a real estate investor. It's a straightforward measure of how much it costs to run a property compared to the income it generates. You calculate it by dividing the property's operating expenses—minus depreciation—by its gross operating income. This ratio helps you compare similar properties and spot potential problems, like unusually high maintenance or utility costs that might make you think twice about buying. Aim for an OER between 60% and 80%; the lower, the better, as it means more of your income stays as profit.

Key Takeaways on OER

Here's what you need to know about OER in real estate: it's the cost of operating a property divided by the income it brings in, after subtracting depreciation. You want a lower OER because it shows expenses are kept in check relative to revenue, making the property more desirable for investment.

Formula and Calculation of the Operating Expense Ratio (OER)

The formula for OER is simple: OER equals total operating expenses divided by total revenue. To figure this out for your property, gather all your operating expenses—the everyday costs of running the place—and subtract depreciation. Depreciation varies based on your accounting method, so be consistent. This gives you a clear picture of operational efficiency.

What the Operating Expense Ratio (OER) Can Tell You

Tracking OER over years shows you trends in your property's expenses. If costs rise faster than income, your OER climbs, which could eat into profits the longer you hold it. For apartment buildings, use effective rental income—potential rent minus vacancies and losses—to get a realistic view. This includes management fees, utilities, maintenance, insurance, taxes, and more. A low OER means efficient management and higher profits; it can also highlight issues like spiking utility bills early on.

Example of How to Use the OER

Consider this example: suppose you own a multi-family apartment building pulling in $65,000 monthly rent, with $50,000 in monthly operating expenses including mortgage, taxes, and utilities, plus $85,000 in annual depreciation. Your annual OER would be [(50,000 × 12) - 85,000] divided by (65,000 × 12), which comes to 66%. That tells you operating costs eat up about two-thirds of your revenue.

OER vs. the Capitalization Rate

Don't confuse OER with the capitalization rate, or cap rate, which measures expected return based on net operating income divided by current market value. Cap rate looks at yield over a year, assuming a cash purchase, and uses gross revenue in its assessment. OER, on the other hand, sticks to operational efficiency without factoring in market value.

Limitations of Using the OER

OER has its downsides: it doesn't include a property's market value, so it won't tell you about purchase or sale value—pair it with cap rate for that. Also, depreciation methods can skew the number, so watch for that in your calculations.

Frequently Asked Questions

You might wonder what makes a good OER—it's between 60% and 80%, with lower being better. Operating expenses in real estate cover ongoing costs like repairs, insurance, taxes, and management. To calculate OER, subtract depreciation from operating expenses and divide by gross revenue.

The Bottom Line

In the end, OER lets you compare a property's income to its running costs, helping you decide if it's a solid investment and what returns to expect. Use it alongside other metrics to evaluate and compare properties effectively.

What Is the Operating Expense Ratio (OER)?

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