Investor Services

Opportunity Costs for Rental Investments

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By Paul Branton, Director of Investor Services for Home Rental Services

Since starting out with HRS back in 2010, I have seen on a regular basis how opportunity cost impacts rental properties. In some circumstances, it can be quite obvious. In others, it’s a bit more subtle. Before we get into a few examples, lets open up our Econ textbooks and revisit the definition… 

What is opportunity cost?

In reading numerous definitions, I really liked how Investopedia puts it: “Opportunity costs represent the potential benefits that an individual, investor, or business misses out on when choosing one alternative over another.” (Source) 

In my own words, I would put it as: “Spending your time and money on one thing vs. another and missing out on what could have been had you done the other thing.”

For example, I love ice cream and would be willing to stand in line for a free ice cream cone… but is it really free? No, it is not. The cost of what I could be doing with my time is part of the equation. When you understand this concept, you get to the realization that there really is no such thing as a free ice cream cone. I know it’s sad, but it’s true.

The impact of opportunity costs on your rental investments.

So, here are four big ways that we see opportunity costs impacting your rental investments:

Acquisitions and Financing:

Does using cash to purchase or leaving equity in your rentals provide you the best return on that money?  

  • This can be boiled down to the difference of debt vs. leverage. 
    • If you borrow money and it doesn’t bring a return or costs you more money, that is a liability or debt.
    • If you borrow money and it brings you a return greater than the costs of borrowing, that is an asset or leverage.
  • This is why you see folks out there that could easily pay cash choosing to finance. 
    • This allows them to leverage the banks capital and continue utilizing their own capital for additional/better return opportunities. 

Property Management vs. Self Managing:

This goes back to my ice cream example above. Is self-management really the best use of your time? 

If you make $50/hr and spend 4 hours per month managing the property, you would likely view the cost as $200/m. But what if you’re spending those 4 hours away from your family. What is that added cost? Is it more or less than what a property manager would cost? 

The answer is almost always that it costs you more…  and this is due to another economic concept called “specialization” that says the return on your time is best when spent in your area of expertise.

Rental Pricing:

If you price the property above market rental rates and it takes longer to place tenants, the opportunity cost is the increased vacancy and whether or not that higher rental rate will offset that vacancy. Generally speaking, it will bring a higher net return to price the property right in line with market rents or even slightly lower to lessen your vacancy costs.

Repair Quotes and Turnover:

Let’s say you have multiple bids for the same repair work. One of the quotes is cheaper, but will take two times longer to get done. And there is a chance it could be inferior work. Those are the opportunity costs of a cheaper quote. 

With your rental property, you can calculate the daily cost of vacancy and factor that into your decision when considering turnover work. If one vendor will get the work done two weeks quicker, but costs $1000 more, is it really more expensive? 

Stepping Over Dollars to Pick Up Dimes

When we see folks wanting to “save money” by obtaining numerous quotes or raising the rent too high, we often refer to this as “stepping over dollars to pick up dimes”. This is due to the very real, but oftentimes less obvious, opportunity costs. The associated opportunity costs are: increased vacancy, inferior results, disgruntled tenants, potential turnover, etc.

These opportunity costs should be considered as you contemplate which approach is really the best. I think you might be surprised to find that what you thought to be the less expensive option could actually be more expensive in the long run!