Understanding the opportunity cost of investing in property


While most investors got involved in real estate investing because they understand the opportunities to make money through leverage and capital growth or high returns, I see and hear still talk about many who do not fully understand the opportunity cost.

Remember that anyone who enters the property is usually there to generate money or income – the number of transactions / properties you own is insignificant.

So what does the opportunity cost mean?

Well, according to the encyclopedia, “opportunity cost is a term used in economics, to refer to the cost of something in terms of the opportunity given up (and the benefits that could be derived from that opportunity), or the most valuable abandoned alternative. For example, if a city decides to build a hospital on vacant land it owns, the opportunity cost is another thing that could have been done with the land and building funds instead. By building the hospital, the city gave up the possibility of building a sports center on this land, or a parking lot, or the possibility of selling the land to reduce the city’s debt, etc. “

So, in terms of real estate investing, if an investor decides to invest £ 50k in a property in Wales for example, the opportunity cost would be what he could have gained by investing in Spain, Ireland or Ireland. Dubai. Or similarly, if an investor decides to keep 50k equity worth in a property, the opportunity cost is the one in which he could have invested that money and the resulting value.

Now again this will depend on your specific strategy – and a lot of people aren’t too concerned about the opportunity cost, they’re just keen to buy 1-2 properties that can hold for 15-25 years to be used. as a pension. It’s fine if this is your strategy – but for me it is too broad a strategy, which involves risk and does not maximize the available opportunities.

For me, I’ve always had a philosophy, rightly or wrongly, that I should always work hard on my money. What does it mean? Well, as soon as I feel that my money has made a significant return and returns are likely to drop, relative to other possibilities, then I will look to make a profit and invest elsewhere, i.e. say when I feel the opportunity elsewhere is greater than the current. opportunity.

The great thing with home ownership is that it doesn’t necessarily mean selling because you can refinance and invest the money elsewhere.

This is no different from any other type of investing, like buying stocks and shares – you make / lose your money based on how much you paid and how much you sold – although the property is clearly a good opportunity to earn a regular income. too – if you stick with it for 15-25 years you should be making some money, but there will likely be a few scares along the way!

To be a successful investor, you have to know when to enter the market and when to exit the market. And the best people buy low and sell high!

I’ll give an example – while off plan buying now has a bit of a stick in the UK – I’ve done this successfully over the past few years – but the key is to have a clear strategy.

For example, by doing all my due diligence, I was able to buy a property for the right price in the right place, but then resold it within a year of completion because I thought it was was the time when I would see the maximum return – and the opportunities would. be more important elsewhere over the next 3 years.

So to go over the numbers, I just sold one that I bought off plan last year 12 months before completion. I bought at a price that was already £ 10,000 below market value based on my research in an area where there was little buying to let the competition. This was secured with only a £ 5k deposit. In the end I put another £ 28k on deposit – so I tied up £ 33k of my own money. There was no stamp duty in this area.

I then put it on the market at the end, now even with things slowing down in the area I just sold it for a profit of £ 23k. So I tied up £ 5,000 for 1 year, and an additional £ 28,000 for 6 months, to recover £ 56,000.

Why did I sell? Have I considered refinancing?

My first choice would have been to refinance and lease, but the lease would not have accrued. So while the rental would have accrued at the price I paid for the property, I would have had 56k in equity sitting around doing little for me. So, since I don’t foresee huge capital growth in the region in the next 3-5 years and the return was not attractive enough for me, it was better for me to release that equity and find another investment – that is, I felt there were better opportunities. for me to spend my £ 56,000 to generate more money.

Now it is clear that looking to the future is an element of risk and speculation and there is no definitive answer – so you need to plan as well as you can with the data currently available, that is. i.e. how you forecast interest rates, buying / selling costs, supply and demand, employment, the overall economy and market sentiment over the next period over the markets / regions in which you invest / seek to invest.

Although the opportunity cost can be difficult to quantify, its effect is universal and very real at the individual level. The principle of the economic concept of opportunity cost applies to all decisions, not just economics, for example when Steven Gerrard decided to stay with Liverpool last summer, his home club and where he is captain, the cost of opportunity was what he could have achieved. if he had moved to Chelsea. It will be interesting to see what he decides this summer – he may now think the opportunity cost is too high to turn down.

Hope this makes sense and don’t forget to factor the opportunity cost into your next investment decision.

Source by Alan Forsyth

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