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.