Annual operating expenses are $98,000, excluding debt service. Annual effective gross income is $280,000. Using EGI as the denominator, what operating expense ratio results?
Correct Answer
A) 35.0%
98000÷280000×100 = 35. Common errors: inverting the ratio (EGI ÷ expenses) gives 285.7%; reporting the net income ratio instead of the expense ratio gives 65.0%; dividing expenses by NOI instead of by EGI gives 53.8%.
Why This Is the Correct Answer
Option A is correct because the operating expense ratio is $98,000 ÷ $280,000 = 0.35, or 35.0%. Using EGI as the denominator, as the question specifies, gives the share of each EGI dollar consumed by operating expenses.
Why the Other Options Are Wrong
Option B: 53.8%
Option B, 53.8%, divides expenses by NOI instead of EGI: $98,000 ÷ ($280,000 − $98,000) = $98,000 ÷ $182,000 = 53.8%. The question specifies EGI as the denominator, giving 35.0%.
Option C: 65.0%
Option C, 65.0%, is the net income ratio: ($280,000 − $98,000) ÷ $280,000 = 65.0%. That is the complement of the expense ratio, which is 35.0%.
Option D: 285.7%
Option D, 285.7%, inverts the ratio: $280,000 ÷ $98,000 = 285.7%. Expenses belong in the numerator: $98,000 ÷ $280,000 = 35.0%.
Expenses over EGI
The expense ratio puts expenses on top and EGI on the bottom; the rest of EGI is the net income ratio.
How to use: Use it to set up the ratio and to check that expense ratio plus net income ratio equals 100%.
Exam Tip
An operating expense ratio above 100% would mean expenses exceed income, so an answer like 285.7% usually signals an inverted ratio.
Common Mistakes to Avoid
- -Inverting the ratio
- -Reporting the net income ratio instead
- -Dividing expenses by NOI instead of EGI
Concept Deep Dive
Analysis
This question tests the operating expense ratio, which is operating expenses divided by effective gross income. The distractors invert the ratio, report the net income ratio, or use the wrong denominator.
Background Knowledge
The operating expense ratio is the ratio of operating expenses to effective gross income, and the net income ratio is NOI divided by EGI. On the same base, the two ratios add up to 100%.
Real-World Application
An appraiser compares the subject apartment's operating expense ratio with ratios from comparable buildings. A subject ratio far outside the market range prompts a closer review of the owner's expense statement.
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