Certified Pennsylvania Evaluator Practice Exam

What method can be used to calculate the expense ratio?

1. Allowed expenses divided by net income

2. Allowed expenses divided by effective gross income

3. Total income divided by management expenses

4. Gross expenses divided by net income

The correct answer is: Allowed expenses divided by effective gross income

To calculate the expense ratio, the correct approach is to divide the allowed expenses by the effective gross income. This method effectively assesses the proportion of a property's operating expenses compared to the income it generates, which is a critical component in understanding the financial health of an investment property. Effective gross income is calculated by taking the total income a property generates and subtracting any vacancies or losses. By using this figure, the expense ratio provides insights into how much of the income is required to cover the operating costs. This ratio is an essential metric for property investors and managers, as it helps them evaluate the efficiency of a property's management and inform operational decisions. In contrast, the other methods involve inaccurate comparisons or numerators. For instance, using total income divided by management expenses would yield the reverse of what the expense ratio intends to convey. Similarly, allowed expenses divided by net income doesn’t reflect the accurate relationship between expenses and income from property operations. Gross expenses divided by net income also misrepresents the necessary relationship as it does not account for the effective gross income, which is pivotal in calculating the expense ratio correctly. Thus, using allowed expenses divided by effective gross income is the proper method for determining the expense ratio.