Operating Expense Ratios: Benchmarks by Property Age and Class

The operating expense ratio says how many cents of each collected dollar go to running the building. It is the fastest credibility check on any listing, because buildings of a given age and class cannot run far outside a certain band, and a seller's sheet that claims otherwise is missing lines.

The example in this post is an eight-unit building from 1965. The seller's sheet implies a 32% expense ratio. Rebuilt from the actual bills, it is 54%, and the NOI is $27,228 lower than advertised.

One caution up front. Every range in this post is a rule of thumb. None of them is survey data, and the post explains how to replace them with numbers from your own market.

What the operating expense ratio is and how to compute it

Operating Expense Ratio = Operating Expenses / Effective Gross Income

Operating expenses are the same lines that go into NOI: taxes, insurance, management, repairs and maintenance, owner-paid utilities, turnover costs, grounds, pest control and administrative costs. Mortgage payments, capital expenditures and depreciation stay out. Effective gross income (EGI) is gross potential rent plus other income, minus vacancy and credit loss.

Watch the denominator. Some brokers and some published sources divide by gross potential rent instead of EGI. That produces a lower ratio from the same expenses. This blog uses EGI, so that the ratio and the NOI margin add to 100%: a 54% expense ratio means NOI is 46% of collected income. When you compare against any outside figure, find out which denominator it uses.

The right way to compute the ratio is from documents, one line at a time. Here is the example eight-unit building, with units renting at $1,050.

The ratio is $52,528 divided by $96,600, or 54.4%. NOI is $44,072. Compute the per-unit figure too: $52,528 across eight units is $6,566 per unit per year. Expenses per unit stay comparable across buildings with different rents, which the ratio does not.

Why age and class move the ratio more than location

The numerator and the denominator respond to different things. Most operating costs are physical. A water heater, a plumber's hour and a gallon of paint cost about the same in a $950 apartment as in a $2,100 apartment. Rent is what changes with class. So the same dollar of expense is a much bigger share of a low rent than of a high one.

Age pushes from the other side. Older buildings have original plumbing, older roofs and more repair calls. Many are master-metered, which leaves water, heat or both on the owner's bill. Where lower-rent units turn over more often, each extra turn adds cost too.

An example comparison of two units, one in each kind of building:

The A-class unit costs $1,767 more to operate in dollars and 25 points less as a share of income. That is the denominator at work.

Location still matters, and it shows up mainly in two lines: property taxes and insurance. Within a single metro, where buildings share a tax system and an insurance market, age and class explain most of the spread between one building's ratio and another's. Across state lines, check those two lines first.

One more effect of age sits outside the ratio entirely. Capital expenditures are excluded from operating expenses, and old buildings need far more of them. A 1965 building with a 54% expense ratio can still absorb another large slice of income in roofs, boilers and sewer lines. The comparison of capex reserves for 1950s and 1990s rentals covers that second layer.

Benchmark ranges: newer A-class through older C-class

These are rules of thumb for screening. They assume professional management is included, reserves and capex are excluded, and the denominator is EGI.

This post does not quote a survey for these ranges, and you should not treat them as one. For published figures, look up the National Apartment Association's income and expense survey and the income and expense reports from the Institute of Real Estate Management. Check what each currently publishes, which denominator it uses and the edition date before you rely on a figure. Agency and bank lenders also publish or will tell you the minimum expense assumptions they underwrite to. The best benchmark of all is local and free: ask brokers and property managers for trailing 12-month statements on comparable buildings, and compute the ratios yourself.

Three adjustments move a building within or outside its band:

• Owner-paid utilities. In the example building, water, common electric and trash total $10,100, which is 10.5% of EGI. The same building with those costs billed back to tenants would sit about ten points lower.
• Self-management. A statement with no management line is understated by whatever a manager would charge. Add it before comparing.
• Scale. Small buildings cannot spread fixed costs such as snow contracts, accounting and minimum trash service across many units. Expect a four-unit building to run above a forty-unit building of the same age.

The 50 percent rule is the bluntest version of this table. It assumes half of income goes to operating costs for every property. The table shows when that guess is too harsh and when it is too kind, and the full test of it is in the 50 percent rule for rental expenses.

The lines that blow out the ratio: taxes, insurance, turnover

Most expense lines drift. Three of them jump.

Property taxes. In many jurisdictions a sale triggers reassessment at or near the purchase price. The seller's bill reflects an assessment that may be decades old. In the example, the seller pays $12,600. If the building sells for $700,000 in a jurisdiction with an example effective rate of 2.2% of value, the new bill is $15,400. That $2,800 increase is 2.9 points of EGI, and it takes the ratio from 54.4% to 57.3% before you have changed anything else. Call the assessor's office and ask how a sale is treated.

Insurance. Premiums reprice at renewal, and older buildings with aging roofs, wiring or plumbing are the ones carriers surcharge or decline. The seller's premium tells you what the seller negotiated years ago on a policy you cannot assume. As an example of scale, a 40% increase on the $6,400 premium adds $2,560, or 2.7 points of EGI. Get a written quote during due diligence, before your contingency expires.

Turnover. Each turn has a direct cost apart from the lost rent. Say make-ready runs $1,500 and the leasing fee is half a month's rent, $525, for $2,025 per turn. In the eight-unit example, four turns a year cost $8,100, which is 8.4% of EGI. Two turns cost $4,050, or 4.2%. Same building, different tenant base. Note that rent lost while the unit sits empty belongs in vacancy, inside EGI. Counting it again as an expense double counts it.

Reading a seller's expense ratio for missing lines

Here is the same eight-unit building as the example seller presents it.

Two things are going on. First, the denominator: the seller divides by potential rent of $100,800 as if every unit paid all year. Second, the missing lines. Management, turnover, grounds, administrative costs and pest control are absent, and repairs are $5,200 light. Those omissions total $20,628. The seller's NOI adds the full $100,800 of rent and $2,400 of laundry, subtracts $31,900 and reports $71,300. The rebuilt NOI is $44,072. The gap is $27,228, made up of $6,600 of income that was never collected and $20,628 of expenses that were never listed.

The ratio flagged all of this before any rebuilding. A 32% ratio belongs to a new A-class building with submetered utilities, and this is a 1965 C-class building with owner-paid water. When a ratio lands a full band or more below the building's profile, go down the standard list and find what is missing:

1. Management at a market fee
2. Repairs at a level the invoices support
3. Turnover and leasing costs
4. Every utility the owner pays, for a full 12 months
5. Grounds, snow, pest control and trash
6. Accounting, legal, licenses and inspections
7. Taxes at the post-sale assessment
8. Insurance at a current quote

Compare your deal against the range

Practical next steps for any deal on your desk:

1. Build the ratio from documents, as in the first table. Use collected income as the denominator.
2. Compute expenses per unit per year alongside the ratio. When rents are unusually high or low for the building type, the per-unit figure is the more honest comparison.
3. Place the ratio against the rule-of-thumb band for the building's age and class. If it falls outside, explain the difference line by line. A legitimate reason exists sometimes, such as tenant-paid heat in an old building. More often a line is missing.
4. Reset taxes and insurance to what you will pay as the new owner.
5. Replace the rules of thumb with real comparables as fast as you can. Every trailing 12-month statement you collect from a broker or manager is a data point from your own market.

That last step compounds. Underwrite each deal in the multifamily calculator and save it, including the ones you pass on. After a dozen saved deals in one market, your own portfolio of underwriting becomes the benchmark, and you can hold any new listing's expense ratio against buildings you have already taken apart line by line.