![]() The capitalization rate or cap rate is used to indicate the rate of return for an investment. This means that operating expenses consume just under two-thirds of the revenue generated by this property. Therefore, the annual OER can be calculated as: The property is also expected to depreciate $18,000 this year. The investor pays a total of $2,000 a month in operating expenses. We can also estimate the vacancy rate at 5% which would make the effective income $3,420. The investor owns a triplex that brings in $3,600 in rent per month. What the owner pays in federal income taxes, for instance, would not affect the property’s ability to produce rental income.Īn Example of Operating Expense Ratio (OER) Note: These are not legitimate operating expenses because they are not directly related to the investment property’s core operations. ![]() Exclude expenses like these when calculating operating expenses: Other examples would include costs for administrative and accounting, telephone, supplies snow removal, janitorial service, pest control, rental advertising, and so on.Ģ. Note: These are legitimate operating expenses because they affect the day-to-day operation of the investment and contribute to the investor’s ability to rent the units. Include expenses like these when calculating operating expenses: Here’s a brief overview of the types of costs you want to include as an operating expense, as well as expenses that you want to exclude.ġ. In other words, they’re the costs that affect the day-to-day operation of the investment and are considered necessary to keep the revenue stream flowing. Operating expenses are ongoing costs to maintain and keep a rental property investment in service. Including vacancies in this way can help build a more accurate picture of the property’s financials. With this knowledge, you can determine strategies to combat these increasing costs such as investing in renovations to reduce maintenance costs, you can shop around for better deals to reduce things like property management fees, or increase rents to combat these rising costs.įor a multi-unit property or an apartment building, investors can figure in vacancies by calculating the potential rental income (rental income minus average vacancy rate and credit losses). This suggests that the overall profitability will decrease the longer you hold the property. For example, you might find that a property’s OER increases over time. Once you have these you need to calculate the gross annual income.Ĭalculating the OER for a property over a number of years can highlight important trends. However, for the purposes of this calculation you can estimate the depreciation amount so long as you know the value of the property and the value of the land it’s on. This will be personal to your property and it’s recommended you consult with a licensed real estate accountant or CPA to ensure you calculate this accurately. You may also need to calculate your property’s depreciation as this needs to be specifically excluded. You can read more about operating expenses here. The first step to calculating your operating expense ratio is to calculate your operating expenses. The formula for Operating Expense Ratio (OER) OER = (total operating expenses) / gross revenue Calculating Operating Expense Ratio Understanding Operating Expense Ratio (OER) A lower operating expense ratio (OER) is more desirable for investors because it means they have lower overheads relative to income.To calculate the operating expense ratio (OER), divide all operating expenses (excluding depreciation), and divide by operating income.The operating expense ratio (OER) for real estate investments is a comparison between operational expenses and gross income.A good OER is between 60% and 80% (although the lower it is, the better). ![]() On the other hand, a property with high operating expenses may deter an investor. The one with the lowest OER has the least operating expenses relative to income. For example, if you had to choose between three properties you could calculate the OER. This is a very useful calculation when comparing similar properties. To calculate it you divide the operating expenses (excluding depreciation) by its gross operating income. ![]() The operating expense ratio (OER) in real estate is a measurement of the operational costs of a particular property compared to the overall income that the property brings in.
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