Annual EGI is $500,000 and all specified annual operating expenses total $215,000, excluding debt service. Using EGI as the denominator, what operating expense ratio results?
Correct Answer
A) 43.0%
215000÷500000×100 = 43. Common errors: inverting the ratio (EGI ÷ expenses) gives 232.6%; reporting the net income ratio instead of the expense ratio gives 57.0%; dividing expenses by NOI instead of by EGI gives 75.4%.
Why This Is the Correct Answer
Option A is correct because the operating expense ratio is $215,000 / $500,000 x 100 = 43.0%. The stem specifies EGI as the denominator, and debt service is excluded because it is not an operating expense.
Why the Other Options Are Wrong
Option B: 57.0%
Option B, 57.0%, comes from ($500,000 - $215,000) / $500,000 x 100 = 57.0%, which is the net income ratio rather than the expense ratio. The expense ratio is $215,000 / $500,000 x 100 = 43.0%.
Option C: 75.4%
Option C, 75.4%, comes from $215,000 / ($500,000 - $215,000) x 100 = 75.4%, which divides expenses by NOI instead of by EGI. Using the stated EGI denominator gives 43.0%.
Option D: 232.6%
Option D, 232.6%, comes from $500,000 / $215,000 x 100 = 232.6%, which inverts the ratio by dividing EGI by expenses. The correct ratio is $215,000 / $500,000 x 100 = 43.0%.
Expenses over EGI
The expense ratio is expenses on top, EGI on the bottom. The expense ratio plus the net income ratio equals 100%.
How to use: Use the 100% check to catch confusing the expense ratio with the net income ratio.
Exam Tip
An operating expense ratio above 100% means the fraction was likely inverted. Confirm which denominator the question specifies.
Common Mistakes to Avoid
- -Inverting the ratio
- -Including debt service in operating expenses
- -Using NOI or PGI as the denominator when EGI is specified
Concept Deep Dive
Analysis
This calculation tests the operating expense ratio, which compares operating expenses to effective gross income. With EGI as the stated denominator, the ratio is expenses divided by EGI. The distractors invert the ratio, compute the net income ratio, or use NOI as the denominator.
Background Knowledge
In income processing, potential gross income less vacancy and collection loss equals effective gross income, and EGI less operating expenses equals net operating income. The operating expense ratio expresses operating expenses as a percentage of EGI, and together with the net income ratio it adds to 100% of EGI. Debt service is a financing cost and is not an operating expense.
Real-World Application
An appraiser compares a subject office building's expense ratio with ratios from comparable buildings to test whether the owner's reported expenses are reasonable. Using EGI as the base for every property keeps the comparison consistent. Debt service is excluded because it relates to the owner's financing, not property operations.
More Income Approach Questions
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Previous Question
The subject property has annual PGI of $112,000, combined vacancy and collection loss of 5% and no other income. Property expenses are $18,000, and an annualized leasing-cost allowance, not included in that figure, is $7,000. The 10% capitalization rate was derived from income stated after the same allowance. What value is indicated?
Next Question
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?