Variable Costs
Operating expenses that vary based upon of the property’s level of operation. For example, property management fees vary directly based on the property’s revenue and therefore will likely be higher the greater the occupancy of the building. This is in contrast to Fixed Costs, such as property insurance, which do not generally vary with the property’s level of operation or occupancy.
Putting ‘Variable Costs’ in Context
Scenario: Crestview Capital, a notable real estate investment firm, recently expanded its portfolio by acquiring Oakwood Plaza, a grocery-anchored retail center located in a bustling suburban area near a major metropolitan city. Oakwood Plaza encompasses 100,000 SF with 30,000 SF of inline retail space and a 70,000 SF grocery store.
Context and Application of Variable Costs: Upon acquisition, Crestview Capital embarked on a strategic value-add initiative aimed at boosting the occupancy and enhancing the tenant mix. The occupancy at the time of acquisition was 75% (5,000 SF of occupied inline space and 25,000 SF of vacant inline space), with the goal of increasing this to 95% within two years by attracting high-quality tenants and renovating the property.
In managing Oakwood Plaza, Crestview faced various operating expenses classified as fixed and variable costs. Among the variable costs, property management fees and repairs and maintenance expenses were directly influenced by the property’s performance.
As occupancy rates improved due to strategic leasing efforts, variable costs associated with property management began to increase. This was because the property management company, hired by Crestview, charged a fee proportional to generated revenue, which is a common practice in the industry to align the interests of property managers with those of the property owners.
For instance, if property management fees were set at 3% of gross revenues, the annual cost would escalate as the occupancy and rental rates increased. Initially, with the property earning $1,500,000 in annual revenues at 75% occupancy, the management fees amounted to $45,000. With successful leasing strategies pushing occupancy to 95%, and assuming a proportional increase in revenues to $1,900,000, the management fees would rise to $57,000.
- Initial Revenue at 75% Occupancy: $1,500,000
- Property Management Fees (3%): $45,000
- Projected Revenue at 95% Occupancy: $1,900,000
- Property Management Fees (3%): $57,000
This example underscores how variable costs such as property management fees fluctuate based on the level of property operation, demonstrating a direct correlation with the revenue and occupancy levels.
This scenario is hypothetical and is meant to illustrate how variable costs behave in a real estate investment context.
Frequently Asked Questions about Variable Costs in Commercial Real Estate
What are variable costs in real estate operations?
Variable costs are operating expenses that change based on the level of a property’s operation, such as occupancy. An example is property management fees, which typically increase as property revenue increases.
How do variable costs differ from fixed costs?
Fixed costs (e.g., property insurance) remain constant regardless of occupancy, while variable costs (e.g., management fees or maintenance) fluctuate based on the property’s income or usage levels.
How did variable costs affect Crestview Capital’s investment?
As occupancy at Oakwood Plaza increased from 75% to 95%, property management fees rose from $45,000 to $57,000 annually due to the 3% fee being tied to gross revenues.
What caused the increase in property management fees at Oakwood Plaza?
The fee was based on 3% of gross revenue, which grew from $1.5 million to $1.9 million as occupancy increased—thus raising management costs proportionally.
Why are variable costs important to monitor during lease-up?
As occupancy rises, variable costs like management fees and maintenance typically increase. Monitoring these helps accurately project net operating income (NOI) and ensures profitability expectations are realistic.
What are other examples of variable costs in real estate?
Other examples include repairs and maintenance, utilities for tenant spaces, and janitorial services that scale with building usage or occupancy.
Where can I find related concepts like fixed costs?
See the Glossary: Fixed Costs entry linked in the Related Content section of the post.
How can I get a downloadable glossary of terms?
Click the link in the post that says “Click here to get this CRE Glossary in an eBook (PDF) format.”
Click here to get this CRE Glossary in an eBook (PDF) format.