A rent line that lands on budget can be two large variances cancelling out, and the split takes two multiplications.
Split a rent variance in two: the occupancy variance is the change in occupied units times budget rent, and the rate variance is the change in rent times the units actually occupied. On an illustrative 400-unit property, a quarter that misses budget by only $5,880, or 0.28 per cent, is a $66,600 occupancy loss offset by a $60,720 rent gain. Both need explaining; the net figure explains nothing.
Worked in full in Real Estate Fund Management by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Budget against actual is the first report an asset manager reads each quarter and the one most often read at the net line. Rental income is a quantity times a price, so any variance on it is two variances. They usually have different causes, different owners and different consequences for value, which is why a fund manager wants them apart.
| Input | Budget | Actual |
|---|---|---|
| Units | 400 | 400 |
| Average occupancy | 95.0% | 92.0% |
| Occupied units | 380 | 368 |
| Average rent per unit per month | $1,850 | $1,905 |
| Rental income for the quarter | $2,109,000 | $2,103,120 |
The total variance is $2,103,120 less $2,109,000, a shortfall of $5,880. Against a threshold of $10,000 or 3 per cent of budget, it would not be flagged.
Occupancy variance = (actual occupied units − budget occupied units) × budget rent × months
Rate variance = (actual rent − budget rent) × actual occupied units × months
Occupancy variance + rate variance = total variance
In Excel, with budget in column B and actual in column C: =(C4-B4)*B5*3 for occupancy and =(C5-B5)*C4*3 for rate. The check cell =C6-B6-(D4+D5) must return zero.
The net line is under every threshold. The components are not: each is more than six times the $10,000 limit and the occupancy loss is above 3 per cent of budget on its own. The story behind them is common. Leasing pushed rents on renewals and new lets, and occupancy slipped while it did. Whether that trade was deliberate is the question the asset manager has to answer, and it only appears once the variance is split.
The two halves also carry different weight for value. Annualised, the occupancy shortfall is $266,400 of income; capitalised at an illustrative 5.50 per cent it is $4,843,636 of value. The rate gain annualises to $242,880, or $4,416,000 of value. If the rent gain sits in signed leases while the vacancy is temporary, the quarter was better than budget in value terms. If the vacancy is structural because the rent is now above the market, it was worse. Checking whether the lost units are real vacancy or non-paying occupancy is the job of the physical against economic occupancy test.
The split above prices occupancy at budget rent and rate at actual occupancy. Reverse it and the figures move:
| Convention | Occupancy | Rate | Joint term | Total |
|---|---|---|---|---|
| Occupancy at budget rent, rate at actual units | −66,600 | 60,720 | in rate | −5,880 |
| Rate at budget units, occupancy at actual rent | −68,580 | 62,700 | in occupancy | −5,880 |
| Pure effects, joint shown apart | −66,600 | 62,700 | −1,980 | −5,880 |
The joint term is −12 units times $55 times three months, −$1,980. It belongs to neither cause, so no convention is right. What matters is that the same one is used every quarter, so a trend in the rate variance is a trend in rents and not in method.
| Scenario | Occupancy | Rent | Occupancy var. | Rate var. | Total |
|---|---|---|---|---|---|
| Base case | 92.0% | 1,905 | −66,600 | 60,720 | −5,880 |
| Occupancy on budget, rent up | 95.0% | 1,905 | 0 | 62,700 | 62,700 |
| Rent on budget, occupancy down | 92.0% | 1,850 | −66,600 | 0 | −66,600 |
| Concession-led lease-up | 97.0% | 1,790 | 44,400 | −69,840 | −25,440 |
| Both down | 90.0% | 1,820 | −111,000 | −32,400 | −143,400 |
The concession-led quarter is the mirror of the base case: occupancy beats budget by two points and the net line shows a modest $25,440 miss, but the rent given away to buy that occupancy is $69,840 a quarter and will roll into the next valuation.
The common mistake is to apply the materiality threshold to the net line and stop. Offsetting variances are exactly the ones a threshold on the net figure hides, and they tend to come from a single decision, such as pushing rent at the expense of occupancy, that the investment committee would want to know about. Test the threshold on each component. The second mistake is to change the order of the split from one quarter to the next, which moves the $1,980 joint term between lines and creates a trend that is pure method.
Rent variance is quantity times price, so report it as both: here a $5,880 miss is a $66,600 occupancy problem and a $60,720 rent success, worth roughly $4.8m and $4.4m of value once annualised and capitalised. The free workbook for this case carries the full variance sheet, reconciled to the change in NOI, and the reforecast that keeps only the structural variance.
The volume, or occupancy, variance is the income lost or gained because a different number of units or square feet is let, priced at budget rent. The rate variance is the effect of a different rent on the space actually let. On the illustrative 400-unit quarter, 12 fewer occupied units at $1,850 a month cost $66,600 and $55 more rent on 368 units added $60,720.
Because a joint term, the change in units times the change in rent, has to land somewhere. Pricing occupancy at budget rent first gives $66,600 lost and $60,720 gained. Pricing rate at budget occupancy first gives $62,700 gained and $68,580 lost. Both sum to the $5,880 miss; the $1,980 difference is the joint term. Pick one convention and keep it every quarter.
A common rule is a fixed amount or a percentage of budget, whichever is hit first. With $10,000 or 3 per cent on a $2,109,000 rent line, the $5,880 net miss would pass unexplained, while both components exceed $10,000. Apply the threshold to the components, not only to the net line, or offsetting problems disappear.
This article is one calculation from Real Estate Fund Management. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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