Annual operating expenses are $165,000, excluding debt service. Annual effective gross income is $500,000. Using EGI as the denominator, what operating expense ratio results?
Correct Answer
A) 33.0%
165000÷500000×100 = 33. Common errors: inverting the ratio (EGI ÷ expenses) gives 303.0%; reporting the net income ratio instead of the expense ratio gives 67.0%; dividing expenses by NOI instead of by EGI gives 49.3%.
Why This Is the Correct Answer
Option A is correct because $165,000 ÷ $500,000 = 0.33, or 33.0%. EGI is the denominator, as specified. Debt service is excluded from the expense figure, consistent with an operating expense ratio.
Why the Other Options Are Wrong
Option B: 49.3%
Option B, 49.3%, divides expenses by NOI instead of EGI: $165,000 ÷ ($500,000 − $165,000) = $165,000 ÷ $335,000 = 49.3%. Using EGI gives $165,000 ÷ $500,000 = 33.0%.
Option C: 67.0%
Option C, 67.0%, is the net income ratio, ($500,000 − $165,000) ÷ $500,000, not the expense ratio. The expense ratio is $165,000 ÷ $500,000 = 33.0%.
Option D: 303.0%
Option D, 303.0%, inverts the ratio: $500,000 ÷ $165,000. The expense ratio puts expenses on top: $165,000 ÷ $500,000 = 33.0%.
Expenses over EGI
The expense ratio puts expenses on top and EGI on the bottom; one minus it is the net income ratio.
How to use: Use this to compute the expense ratio and to check the net income ratio distractor.
Exam Tip
An expense ratio above 100% means the figures were flipped. Check which base the question specifies.
Common Mistakes to Avoid
- -Inverting the ratio
- -Reporting the net income ratio instead of the expense ratio
- -Using NOI or potential gross income as the denominator when EGI is specified
Concept Deep Dive
Analysis
This question tests the operating expense ratio. Operating expenses are divided by effective gross income, as the question directs. The result is expressed as a percentage.
Background Knowledge
The operating expense ratio is operating expenses divided by effective gross income. The net income ratio is NOI divided by EGI, and on the same base the two ratios add to 100%.
Real-World Application
An appraiser compares the subject's expenses with market data by computing its operating expense ratio on EGI. A ratio well out of line with comparable properties prompts further investigation of the reported expenses.
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Previous Question
The subject property has annual effective gross income of $112,000 and a net income ratio of 62.5% of EGI. The overall capitalization rate is 8%. What value is indicated by direct capitalization, to the nearest dollar?
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A property produces annual NOI of $120,000, and the land is known to be worth $400,000. Market data indicate a 6% land capitalization rate and a 10% building capitalization rate. What building value does the building residual technique indicate?