In finance, the break-even ratio compares your property’s gross income to its total expenses. It tells you the rental occupancy rate you need to have in order to break even on your investment, and it lets lenders and other investors assess the ability of the property to cover expenses, service debt, and offer a profit. This ratio lets you know how much of your gross income you can afford to lose while still breaking even.
To calculate the break-even ratio, take the property’s debt service and operating expenses total and deduct reserves, then divide that number by the gross operating income (total expenses: debt service + operating expenses – reserves) / gross operating income = break-even ratio
Let’s put this formula into action. For example, say your property has an annual debt service of $20,000 and annual operating expenses of $15,000, so its annual expenses are $35,000, and your gross income on the property is $45,000 according to your income statements. When we plug these numbers into the formula:
total expenses / gross income = break-even ratio
$35,000 / $45,000 = 77.8%
So, to cover your expenses and break even, this means you’ll need about 78% rental occupancy on the property.
Both lenders and investors will find the break-even ratio helpful since it tells them the occupancy level needed to cover the bills to maintain a property. For instance, if your break-even ratio is 93%, an investor or lender may not feel too confident putting money out for the deal because of the very high occupancy rate required to keep the property going. Particularly during economic slowdowns or recessions, it’s quite common for occupancy levels to get below 90%.
But, if you’re looking at a break-even ratio of 74%, they would probably feel much more comfortable with the deal since they’ll know in the worst possible scenario of 26% vacancy, property expenses will still be covered In general, lenders like to see a break-even ratio of about 85% or less.
