Commercial real estate brokers use the operating expense ratio to calculate net income. The operating expense ratio (OER) compares the operating costs of a commercial property with the gross income from the property. This can help property investors to spot a good deal on commercial real estate or stay away from properties with high maintenance costs and low income.
Let’s look in more detail at what exactly the operating expense ratio is and how you can use it to make sound real estate investments.
Using the operating expense ratio
The gross income from a commercial property in no way reflects the profit that you can make on your investment.
There many expenses connected with running a property that the OER takes into consideration. For example, there are property maintenance fees, utilities, insurance, taxes, and emergency repairs. Because these are the expenses directly connected with the day-to-day running of the property, factors like loan repayments and capital improvements are not used.
It’s also important to calculate vacancies and any extra fees that are connected to running the property.
Usually, a low operating expense ratio means that the property is operating efficiently and profitably. This means that it’s possible to increase rent without significantly increasing OER. Investors also use OER to identify trends in utility costs and plan for increases in the future.
How to calculate the OER
Calculating the operating expense ratio is very simple.
- Add up the total operating expenses for the property.
- Divide the figure by the revenue from the property.
- The figure is the OER
For example, let’s say an investor owns an office block that brings in $40,000 in rent and the operating expenses are $16,000. That means the OER is 40% ($16,000 / $40,000 = 40%).
Why OER is Important
Keeping track of the operating expense ratio helps an investor to ensure a good return on investment. For example, if there is a trend for utilities and maintenance to increase every year but rent remains stagnant, it means that the property will eventually become a financial liability.
OER can also help investors to see if the investment property is being managed properly and efficiently.