Formula
OER = Operating Expenses ÷ Operating Revenues
Source: Commercial Mortgage Securities Association (now CRE Finance Council), Glossary of Terms: CMBS (updated March 2006) (opens in a new tab), “Expense Ratio”: operating expenses relative to operating revenues (read here as EGI; see the model's limits)
- Operating Expenses
- Recurring costs of operation, excluding debt service, capital expenditure and depreciation.
- Operating Revenues
- As this course reads it, effective gross income: revenue after loss to lease, vacancy and collection loss, and concessions, including other income.
How it works
OER is a diagnostic rather than a verdict. Its value lies in comparison: against the same property's own history, against genuinely similar properties, and against what the underwriter expected. A multifamily property reporting a 28% expense ratio in a market where comparable buildings run 42% is not efficiently managed; it is far more likely that expenses have been understated, deferred, or shifted below the line.
The ratio is structurally determined by lease type more than by management quality. Under a triple-net lease the tenant pays taxes, insurance and maintenance directly, so landlord-level expenses are minimal and OER sits in single digits. Under a full-service gross lease the landlord absorbs everything, and the same building shows an OER near 45%. Comparing a net-leased property's OER against a gross-leased one is comparing lease structures, not operations.
Because the denominator is EGI, the ratio is also sensitive to revenue. A property whose rents have fallen shows a rising expense ratio even with flat expenses, because the same costs are spread over less income. This makes OER a useful early indicator of pressure: a ratio drifting upward year over year usually signals either eroding rents or expenses growing faster than the market allows rents to follow.
The most productive way to use OER is to decompose it. A high ratio driven by insurance in a coastal market is a market condition; the same ratio driven by repairs is usually deferred maintenance catching up. The aggregate number identifies that something warrants attention; only the line items say what.
Worked example
The 40-unit building has EGI of $711,416. Operating expenses before normalization are $290,000: the owner self-manages and carries no reserve. Comparable properties in the submarket run at 42%.
| Step | Calculation | Result |
|---|---|---|
| Reported expense ratio | $290,000 ÷ $711,416 | 40.8% |
| Add market management fee at 4% of EGI | $711,416 × 4% | +$28,457 |
| Add replacement reserve at $300 per unit | 40 × $300 | +$12,000 |
| Normalized operating expenses | $290,000 + $28,457 + $12,000 | $330,457 |
| Normalized expense ratio | $330,457 ÷ $711,416 | 46.4% |
The reported 40.8% looked competitive against the 42% submarket benchmark. Normalized, the property runs at 46.4%, above the market rather than below it. The $40,457 of added expense reduces NOI by the same amount, which at a 6% cap rate is $674,000 of value. Neither the building nor its management changed; only the completeness of the expense schedule did.
Typical ranges
| Property type | Typical OER | Why |
|---|---|---|
| Multifamily | 35% – 50% | Landlord bears payroll, turnover, and often utilities. |
| Office, full-service gross | 40% – 50% | Landlord absorbs taxes, insurance, utilities and janitorial. |
| Retail, triple-net | 5% – 15% | Tenant pays operating costs directly. |
| Industrial, triple-net | 5% – 15% | Minimal landlord obligation beyond roof and structure. |
| Self-storage | 30% – 40% | Low maintenance but meaningful marketing and staffing. |
| Hospitality | 65% – 80% | An operating business rather than a lease. |
Common mistakes
- Comparing OER across different lease structures
- The ratio is determined mostly by who pays the expenses, not by how well the property is run.
- Treating a low ratio as good news
- An unusually low ratio more often indicates understated or deferred expenses than superior management.
- Computing the ratio on gross potential rent
- The denominator is effective gross income. Using GPR understates the ratio by the full vacancy factor.
Frequently asked questions
- What is a good operating expense ratio?
- It depends entirely on property type and lease structure. Multifamily typically runs 35% to 50%, triple-net retail and industrial 5% to 15%, and hospitality 65% to 80%. The only meaningful comparison is against similar properties with the same lease structure in the same market.
- Why is my expense ratio lower than comparable properties?
- Most often because the expense schedule is incomplete: commonly a missing management fee on a self-managed property, no replacement reserve, or deferred maintenance that has not yet been incurred. It occasionally reflects genuine efficiency, but that should be demonstrated line by line.
- Does the operating expense ratio include debt service?
- No. Debt service is excluded, as are capital expenditure, depreciation and income tax, because the ratio is meant to describe the property's operations independent of how it is financed or owned.