In this article, we’ll show you several ways a close examination of operating expense ratios can alert you to possible problems existing with the rental property you are considering to purchase.

First, however, let me briefly explain what operating expenses are and how operating expense ratios are computed.

Operating expenses are costs an owner incurs to keep a property in service such as property tax, insurance, repairs and maintenance, utilities and so on. Operating expense ratio is the ratio of individual operating expenses to the gross operating income, or Operating Expense / Gross Operating Income, essentially showing you how big a bite each operating expense partially takes from the gross operating income.

For our illustration, we’ll say you’re examining an annual property operating data (or APOD) handed you for a subject rental property and have already compiled enough data on similar rental properties to have developed reasonable ratio expectations that can serve to signal the presence of possible problem areas if different or non-existent from those in your property of interest.

Here’s how to react when you uncover differences between the subject rental property and similar properties in the following operating expense ratios:

1) Property Taxes - This might be a clue that the subject property’s data or the county tax assessor’s data is faulty. Request the tax statements, and maybe meet with the tax assessor to become reasonably assured that nothing hidden or misconstrued might be lurking in the background.

2) Insurance - A higher-than-norm insurance cost ratio should prompt you to have someone from your insurance company do a field inspection and advise you whether there are violations or other issues with the property that might affect insurability.

3) Electricity – This could be the result of separate metering or more or less lighting of common areas. In the former case, if the subject property were not separately metered, would a new owner be compelled by local codes or ordinances to install them? If electricity is non-existent in the subject property’s operating expenses, you would want to know why.

4) Heating – If the ratio for this operating expense is higher than you would expect, it could indicate a faulty heating system. Is it possible for you to affordably correct the deficiencies and cut costs? In any case, always verify heating and other utility costs by contacting the utility providers directly, and always conduct a careful inspection of the property.

5) Repairs and Maintenance - Several explanations are possible and you should make it your business to find out why. A higher-than-norm ratio could spell “money pit” or indicate perhaps some recent remodeling or updating. Likewise, a lower-than-norm ratio might mean the owner neglected caring for the property, perhaps shaved costs by doing the work himself, or maybe the property simply didn’t require much maintenance this year. Whatever the reason, as you approach repairs and maintenance costs, remember to ask yourself, “Yes, but what will I pay when I own this property?”

You get the idea. Examine each of the operating expense ratios looking for notable disparity between rental properties you consider purchasing and what is reasonably expected and when discovered ask plenty of questions before you consider the property further.

Finally, reconstruct the APOD using income and expense projections you feel confident in and see whether the subject rental property makes sense as an investment based upon the numbers you deem reasonable.

Here’s to your real estate investing success.