What Is A Good Operating Expense Ratio In Real Estate?

What Is A Good Operating Expense Ratio In Real Estate?

The operating expense ratio (OER) is a measurement of the cost to operate a piece of property in real estate, compared to the income brought in by the property. It is an essential metric for investors to assess the financial health and profitability of their real estate investments.

To understand what constitutes a good operating expense ratio, it is crucial to have a clear grasp of the formula and factors that impact this ratio in the real estate industry. By optimizing and reducing operating expenses, investors can maximize their returns and ensure efficient management of their properties.

Key Takeaways:

• A good operating expense ratio in real estate is typically between 60% and 80%, with lower ratios being more desirable for investors.
• The OER is calculated by dividing a property’s operating expenses (minus depreciation) by its gross operating income.
• Calculating OERs over time can help identify trends and potential issues that may need to be addressed.
• Operating expense ratios vary across different real estate sectors, and it’s important to compare ratios within specific markets and property types.
• The OER should be used alongside other metrics, such as the capitalization rate, for a comprehensive evaluation of property investments.

How to Calculate Operating Expense Ratio

To accurately calculate the operating expense ratio (OER) for a real estate property, you can use the following formula: OER = Total operating expenses – depreciation / Gross revenue. It’s important to note that operating expenses should only include fees and costs that are incurred in the normal course of business. Examples of operating expenses include property management fees, utilities, maintenance, insurance, repairs, and property taxes. However, expenses such as loan payments, capital improvements, and personal property should be excluded from the calculation.

Depreciation expenses can vary depending on the accounting method used. Therefore, it’s crucial to ensure consistency in accounting practices when calculating the OER over time. To obtain a more accurate picture of operating expenses, it’s recommended to account for vacancies and use effective rental income in the calculation. This approach can help paint a clearer picture of the property’s true operating expenses.

Comparing OERs over time can provide valuable insights into trends and potential issues that may need attention. However, it’s essential to consider that different types of properties have different expense structures. Therefore, when evaluating the OER, it’s important to compare ratios within specific markets and property types, taking into account factors like energy costs, rental income, vacancies, and maintenance expenses. This analysis can help investors make informed decisions and identify areas for improvement in their real estate investments.

How to Calculate Operating Expense Ratio – Summary:

1. Determine the total operating expenses incurred in the normal course of business.
2. Exclude expenses such as loan payments, capital improvements, and personal property.
3. Calculate the depreciation expenses based on the accounting method used.
4. Subtract the depreciation expenses from the total operating expenses.
5. Divide the result by the property’s gross revenue to obtain the operating expense ratio.

By following these steps, investors can effectively calculate the operating expense ratio, which is a crucial metric for evaluating the financial performance of a real estate property.

Factors Impacting Operating Expense Ratio in Different Real Estate Sectors

The operating expense ratio (OER) can vary significantly across different sectors of the real estate industry. It’s important for investors and property managers to have a clear understanding of the industry benchmarks for operating expenses in order to make informed decisions and optimize profitability.

When it comes to multifamily properties, a good operating expense ratio typically falls between 35% and 45%. This range takes into account expenses such as property management fees, maintenance, utilities, and insurance. Understanding and striving for a favorable OER in multifamily properties is crucial for maximizing returns and attracting quality tenants.

For office buildings, the operating expense ratio can range between 35% and 55%, depending on lease terms. Factors such as property size, location, and tenant services can influence the expenses incurred in operating office properties. It’s essential to carefully analyze lease agreements and negotiate favorable terms to keep operating expenses within a desirable range.

When it comes to retail properties, the operating expense ratio varies based on the type of lease. Triple-net leases commonly have a good OER between 20% and 30%, while modified gross leases may have a higher ratio due to additional expenses being passed on to tenants. Retail property owners need to carefully manage operating expenses while ensuring a vibrant and attractive shopping environment to drive foot traffic and maintain profitability.

Industrial properties tend to have lower operating expense ratios, typically ranging from 15% to 25%. The lower ratios are often attributed to the nature of industrial properties, which require less intensive property management and may have lower maintenance costs. Efficient space utilization and effective maintenance strategies are key factors in achieving a desirable OER in the industrial sector.

Hotels, or hospitality properties, have a higher operating expense ratio, typically ranging from 50% to 65%. This higher ratio is attributed to the significant costs associated with providing guest services, such as housekeeping, amenities, and 24/7 operations. Managing operating expenses while maintaining the quality of guest experiences is crucial for hotel owners to achieve profitability in this sector.

It’s important to remember that these operating expense ratios are industry benchmarks and can vary depending on specific market conditions and property types. Factors such as energy costs, rental income, vacancies, and maintenance expenses can all impact the operating expense ratio. Additionally, it’s essential to consider other metrics and factors when evaluating the overall value and profitability of a commercial real estate investment. By understanding these factors and applying effective management strategies, investors can optimize their operating expense ratios and drive long-term success in the real estate industry.