Operating Expense Ratio (OER)
Definition
The operating expense ratio (OER) measures how much it costs to operate a real estate property relative to the income it generates. It helps investors evaluate operational efficiency and compare similar properties.
Formula
Commonly used formula:
OER = (Operating Expenses − Depreciation) / Gross Operating Income
Note: Some practitioners omit depreciation (a non-cash item) and use:
OER = Operating Expenses / Effective Gross Income
Be consistent with the definition you use when comparing properties.
How to calculate (step-by-step)
- Determine gross operating income (use effective rental income = potential rental income − vacancy and credit losses).
- Sum recurring operating expenses (property management, utilities, maintenance, insurance, property taxes, landscaping, trash removal, legal fees, etc.).
- Subtract depreciation if you are excluding it.
- Divide expenses (or expenses minus depreciation) by gross operating income and express as a percentage.
Example:
- Monthly rent income: $65,000 → annual = $65,000 × 12 = $780,000
- Monthly operating expenses: $50,000 → annual = $50,000 × 12 = $600,000
- Annual depreciation: $85,000
OER = (600,000 − 85,000) / 780,000 = 515,000 / 780,000 ≈ 66%
This means operating expenses consume about two-thirds of the property’s revenue.
What OER tells you
- A lower OER indicates more efficient operations and better potential profitability.
- Tracking OER over time reveals trends—rising OERs suggest expenses are growing faster than income.
- Using effective gross income (accounting for vacancies) gives a realistic picture of management effectiveness.
What’s included and excluded
Included:
- Property management fees
- Utilities
- Maintenance and repairs
- Landscaping, trash removal
- Insurance (property and landlord)
- Property taxes
- Routine legal or administrative fees
Excluded:
- Debt service (mortgage payments)
- Capital improvements and major renovations
- Personal property or one-time extraordinary expenses
- (Often) Depreciation, because it’s a non-cash accounting item
OER vs. Capitalization Rate (Cap Rate)
- OER measures operating efficiency (expenses relative to income).
- Cap rate measures expected rate of return based on net operating income and property value:
Cap rate = Net Operating Income / Current Market Value - Use OER to assess operational performance and cap rate to estimate return and compare value. Both metrics together give a fuller investment picture.
Limitations
- OER does not reflect property value or purchase price—only operational efficiency.
- Depreciation methods vary; excluding or manipulating depreciation can change the OER.
- Comparing OERs is meaningful only among similar property types and markets.
Benchmarks and guidance
- Typical “good” OERs often fall between 60% and 80%; lower is preferable.
- Always compare properties within the same segment (multifamily vs. retail) and the same market.
- Combine OER with other metrics (cap rate, cash-on-cash return, vacancy trends) before making investment decisions.
Practical tips
- Use effective gross income (not potential income) to include realistic vacancy rates.
- Monitor expense categories individually to identify cost drivers (e.g., utilities, maintenance).
- Verify accounting conventions (especially depreciation) when comparing OERs across properties.
Bottom line
The operating expense ratio is a straightforward metric for evaluating how much of a property’s income is consumed by ongoing operations. It’s a useful tool for spotting efficiency issues and comparing similar properties, but it should be used alongside valuation and return metrics to make fully informed investment decisions.