What Is the Operating Expense Ratio (OER)?
An operating expense ratio (also referred to as OER) is an extremely common real estate analysis. OER measures where analysts measure the costs to operate a piece of property versus the income it generates.
Operating expenses are costs associated with running a business's core operations on a daily basis. Therefore, the lower a company's operating expense, the more profitable it generally is.
Operating Expense Ratio Formula
The operating expenses ratio formula is, simply, operating expenses divided by revenue:
OER = Operating Expenses / Revenues
Example: How to Calculate Operating Expense Ratio
Let's assume Company XYZ's operating expenses last year were $2,000,000 and its revenues were $10,000,000. Using the formula above, we can calculate that Company XYZ's OER was:
OER = $2,000,000 / $10,000,000 = 20%
If Company XYZ were a real estate company, it might calculate the OER on a potential property similarly.
Let's assume Company XYZ is considering renting a property to tenants for $100,000 a month. They would have to pay $35,000 a month in utilities, maintenance, insurance, and upkeep. In this case:
OER = $35,000 / $100,000 = 35% per month
Why Operating Expense Ratio Is Important
Over time, changes in the OER indicate whether the company can increase sales without increasing operating expenses proportionately (ie. if the business is scalable).
In real estate, companies can compare properties by using the ratio. The OER is also a measure of managerial flexibility and competency that makes companies easier to compare.
It’s important to note, however, that some industries have higher OERs than others. Comparing OERs is generally most meaningful among companies within the same industry, and the definition of 'high' or 'low' expenses should be made within this context.
