Operating expense percentage is a financial ratio used primarily by real estate companies to evaluate property profitability. The basic calculation for the operating expense percentage ratio is operating expenses divided by effective gross income.
You must first calculate business operating expenses for the period. Operating expenses include all costs incurred in day-to-day operations. All selling and administrative expenses -- such as rent, insurance, executive salaries, marketing, office supplies and equipment depreciation -- are part of operating expenses. Expenses incurred for purposes other than business operations, such as interest expense on financing or fees for investing, are not included in operating expense.
Calculate effective gross income for the period. Effective gross income is a specific term used for rental property income. Effective gross income is the potential rental income of business properties minus an estimated vacancy factor. For example, say that your business rents 10 properties at a rate of $30,000 a year. On aggregate, the properties tend to be vacant 5 percent of the time. Effective gross income is $285,000 -- $300,000 minus a vacancy factor of $15,000.
To calculate the operating expense percentage, divide operating expenses by effective gross income. For example, say your real estate business has operating expenses of $200,000 and effective gross income of $285,000. The operating expense ratio is $200,000 divided by $285,000, or 70 percent.
In general, a lower operating expense percentage is better than a high one. The lower the percentage, the more relative income the properties are bringing in. However, a high ratio in and of itself isn't a cause for alarm. Some types of properties may simply be more profitable than others. For example, a real estate company with buildings in very lucrative areas will tend to have a lower percentage than a company with property in a less desirable area. That's because the company can charge higher rent even though operating expenses would be relatively similar in both companies. For this reason, it's best to compare the percentage against companies that rent similar types of real estate.