Annual EGI is $120,000 and all specified annual operating expenses total $45,600, excluding debt service. Using EGI as the denominator, what operating expense ratio results?
Correct Answer
A) 38.0%
45600÷120000×100 = 38. Common errors: inverting the ratio (EGI ÷ expenses) gives 263.2%; reporting the net income ratio instead of the expense ratio gives 62.0%; dividing expenses by NOI instead of by EGI gives 61.3%.
Why This Is the Correct Answer
Option A is correct because the operating expense ratio is expenses divided by EGI: $45,600 ÷ $120,000 = 0.38, or 38.0%. Debt service is excluded, as the stem specifies.
Why the Other Options Are Wrong
Option B: 61.3%
Option B, 61.3%, divides expenses by NOI rather than EGI: $45,600 ÷ ($120,000 − $45,600) = $45,600 ÷ $74,400. The stated denominator is EGI, so the ratio is $45,600 ÷ $120,000 = 38.0%.
Option C: 62.0%
Option C, 62.0%, is the net income ratio: ($120,000 − $45,600) ÷ $120,000. That is the complement of the expense ratio, which is $45,600 ÷ $120,000 = 38.0%.
Option D: 263.2%
Option D, 263.2%, inverts the ratio: $120,000 ÷ $45,600. Expenses go in the numerator, giving $45,600 ÷ $120,000 = 38.0%.
Expenses over EGI
The ratio's name tells you the numerator: an operating expense ratio puts operating expenses on top. The expense ratio and the net income ratio on EGI add up to 100%.
How to use: Use this to check your answer: if expense ratio plus net income ratio does not equal 100%, recheck the denominator.
Exam Tip
Look for a ratio above 100% as a sign the fraction was inverted in this kind of problem. Confirm which denominator the question specifies.
Common Mistakes to Avoid
- -Dividing EGI by expenses
- -Reporting the net income ratio as the expense ratio
- -Using NOI as the denominator
Concept Deep Dive
Analysis
This question tests the definition of the operating expense ratio when EGI is the denominator. You divide total operating expenses by effective gross income. Distractors come from inverting the ratio, reporting its complement, or using the wrong denominator.
Background Knowledge
The operating expense ratio compares operating expenses to income, commonly EGI. The net income ratio is NOI divided by EGI, so the two ratios add to 100% when both use EGI. These ratios help test whether a subject's expenses are in line with comparable properties.
Real-World Application
An appraiser reviewing an apartment operating statement computes a 38% expense ratio and compares it with ratios from similar complexes. A ratio well outside the comparable range prompts her to investigate the expense items.
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