Operating expense ratio: when rising costs deserve a closer look

Operating expense ratio (OER) measures how much rental income is used by operating costs. A rising ratio deserves a closer look, but it does not tell you whether expenses rose, income fell, or both happened.

Use it as a pointer to the underlying numbers. A single percentage cannot tell you whether a rental is a good investment.

The simple version

If a property takes in CAD 100 and spends CAD 33 on operating costs, about CAD 67 remains before financing and capital spending. The operating expense ratio is roughly 33%.

That does not mean CAD 67 is available to withdraw. The mortgage and a future roof still have opinions.

Define the numerator and denominator first

In this article, OER = operating expenses ÷ effective gross income × 100%.

Operating expenses are the recurring costs in our owner tracking convention: property tax, insurance, owner-paid utilities, management, ordinary repairs, and other operating items. They exclude debt payments, capital spending, income tax, depreciation, and reserve transfers.

Effective gross income is rental income after vacancy and credit loss, plus other property income. It is not the maximum rent you could collect with every unit occupied and every tenant paying.

$$\mathrm{OER}=\frac{E}{I}\times100\%$$

Here, $E$ is annual operating expenses and $I$ is annual effective gross income, in the same currency.

Other reports may use different income or expense definitions. For example, the OCC's commercial real estate lending handbook includes an imputed replacement reserve in its NOI framework. Our owner convention keeps reserves separate. Compare reports only after reconciling their inputs.

A worked example

Use our hypothetical annual CAD rental example, before income tax.

$$\mathrm{OER}=\frac{12{,}000}{36{,}000}\times100\% \approx33.3\%$$

Operating costs use about one-third of effective income. The remaining CAD 24,000 is NOI under the same definitions.

Using scheduled rent instead would produce about 31.7%. That smaller percentage did not make the property cheaper to run; it used income the property did not fully receive.

If effective income is zero, the ratio is undefined. Focus on the actual costs and the reason income stopped.

A higher ratio can come from two different problems

In the second case, look at occupancy, collections, concessions, and other income. Costs did not increase, so hunting for CAD 6,000 of mysterious new invoices would miss the problem.

In the third case, compare expense categories with the budget and previous period. Did insurance rise? Is a repair unusual? Was a capital project incorrectly booked as an operating repair?

Both cases squeeze NOI. With the base example's CAD 18,000 annual debt service, the income-drop case leaves zero before capital spending. The cost-rise case leaves CAD 3,000 before capital spending. OER has to be read alongside the dollars that remain.

Is there a healthy operating expense ratio?

There is no universal percentage that makes these examples good or bad investments.

Compare a property with its own justified budget and history first. For other properties, check that the buildings and accounting are comparable. A landlord who pays heat and water will have different expenses from one whose tenants pay those bills. Building condition, property taxes, service level, and management arrangements also matter.

A lower ratio can conceal deferred maintenance or unpaid owner labour. Self-management may reduce recorded cash expenses, but your time still has a cost when you compare alternatives. Keep an actual-cash view and, where useful, a separately labelled view that estimates hired management.

An expense ratio also says nothing about the purchase price or the amount of debt. Two properties with identical OER can have very different owner cash flow and investment returns.

Turn a change into a useful question

Do not cut necessary maintenance simply to improve the ratio. A spreadsheet is much cheaper to impress than a building inspector.

How often should you track it?

Review monthly expense categories and collections. Use a quarterly trailing-twelve-month OER to reduce noise from annual insurance bills, property tax timing, or a single repair. Compare the same seasons and accounting basis.

For a new purchase, prepare a forecast with credible vacancy and normalized expenses, then keep it distinct from actual results. After a major change, update the forecast rather than waiting for a year of history.

The useful habit is straightforward: when OER moves, split the change into income and expense drivers, then check its effect on NOI and available cash. You do not need a new universal benchmark to do that.

Continue reading

• Operating expenses: choose consistent cost categories.
• NOI: turn income and expenses into an operating result.
• Rental cash flow: see what remains for the owner.
• Related guide: If you track only a few rental metrics, start here.

Sources

• Office of the Comptroller of the Currency, Commercial Real Estate Lending handbook, Version 2.0, March 2022, with March 20, 2025 update; NOI glossary on printed page 140. Cited for differing expense/reserve conventions, not a universal OER benchmark. Accessed October 1, 2026.