Every decision we make comes with an opportunity cost. The opportunity costs of your decisions are the benefits that you could have received by choosing another alternative. For example, if you went to college, one of your opportunity costs is the amount of money that you could have made during those 4 or 5 years had you not gone to school. However, if you make the right decision, the benefits will outweigh the opportunity cost, such as the extra income you will earn during your lifetime because of your degree.
Almost every decision we make is influenced by the benefits of our choice versus the opportunity cost. This also applies in real estate investing. While this particular aspect of real estate investment is often overlooked, a few different forms of opportunity cost apply and should play a significant role in the decision-making process.
Opportunity Cost – Time
When deciding to invest in real estate, it’s important to understand that some sacrifices will need to be made. While it is entirely possible to successfully work full-time and buy and sell real estate, there will be some significant time opportunity cost involved. Deciding to invest means that you will be dedicating a considerate portion of your time and attention to the project. This may mean that you will have to give up time with your family or your weekly golf game. It’s important to understand these non-monetary costs exist, and you must decide if the benefits from investing are worth the time you are going to put into the project.
Opportunity Cost – Capital
Once you’ve decided that you have enough time to dedicate to the real estate investing process, you need to consider another opportunity cost. The money that you put into the investment is something that you are giving up in order to acquire the property. If you are prepared to put a certain amount of money into an investment, consider how else that money could be working for you. Real estate investment is a risky business. Is the benefit from that deal worth the cost difference of what you could make by investing your money in a no-risk United States Treasury Bond? If the investment is high-risk or not likely to bring a decent profit, you may be better off seeking another alternative.
Opportunity Cost – Choices
There are a multitude of choices that will need to be made when investing in real estate that can mean the difference between a good or bad investment. When you choose a property to invest in, your opportunity cost includes the benefits of the next best choice. If you choose house A, will the benefits of that choice outweigh the benefits you could receive from choosing house B? Also, choosing a location involves opportunity cost. Will purchasing a property in another town provide a big enough return to compensate for choosing it over a property closer to your home?
Opportunity Cost is something that we unknowingly consider on a daily basis. While you might not realize you are calculating the opportunity cost when you choose whether or not to use mid-grade or premium gas, it is essentially what you are doing. In real estate investment, it’s important to consider all forms of opportunity cost in order to ensure you make the right choices and get the most out of your time and money.