Optimization of residential property management

Purpose – The paper aims to provide an analysis of the principle‐agent relationship between owner (principal) and manager (agent) of investment properties by: developing an optimization model for the net profit scenario that any third party manager of properties in multiple locations faces; and describing the principal's (or owner's) problem and likewise developing an income optimization model. The model allows illustrating the misalignment of incentives and compensation arrangements common to the business of managing small investment properties. Design/methodology/approach – The paper provides an in depth review of literature on the agency problem, both in general as well as in real estate research and compares the qualitative findings with analytical results provided by the model. The latter is developed by applying a transaction cost framework to the context of income structures in investment properties and their management. Findings – The optimization model shows that profit maximization for the manger (agent) depends on an optimum number of properties to be managed. It is further shown that the compensation methods customary in small real estate management contracts are inappropriate for the manager to control and cover the transaction costs, which result from the fact that more than one location is managed. The result is a kind of impossibility theorem, stating that management of small investment properties based on customary compensation structures is unprofitable as the number of properties and their distance rises. Practical implications – The analysis shows that industry practice for the compensation of management of small investment properties does not address the inherent principle‐agent problem. Consequently, additional compensation and incentive mechanisms as well as control structures need to be employed by the owner. The paper, therefore, provides a starting point to review and improve industry practice. Originality/value – The paper expands the existing literature of the agency problem in real estate by providing an optimization model for management of investment properties. The model and findings are of interest to academics for its analytical treatment of agency relationships; as well as to practitioners, as the analysis reveals inefficiencies in industry practice.