Operating expenses are the recurring costs of running a rental property and keeping it in rentable condition. They include property taxes, insurance, property management, repairs and maintenance, owner-paid utilities, HOA dues and lawn care. They do not include the mortgage payment, depreciation or income taxes.
Operating expense ratio = operating expenses ÷ effective gross income
A duplex collects $24,000 a year after vacancy. Its yearly costs are:
- Property taxes: $3,600
- Insurance: $1,800
- Management at 8% of collected rent: $1,920
- Repairs and maintenance: $1,680
- Lawn care: $600
Operating expenses total $9,600, so the ratio is $9,600 ÷ $24,000 = 40%. What is left, $14,400, is the net operating income. The mortgage gets paid out of that.
The most common mistake is trusting a seller's expense list. Listings often leave out management because the owner does the work personally, show an old tax bill even though taxes in some areas are reassessed after a sale, or skip repairs entirely. Rebuild the list yourself with real quotes. Big replacements like a roof are capital expenditures. The strict definition keeps them out of operating expenses, but many investors, and DealLitmus's analyzer, budget a monthly reserve for them alongside. All figures are pre-tax.