Understanding the Opportunity Costs of Real Estate Investing
Every investor needs to understand the “Opportunity Cost” of their investments. This is especially true for new real estate investors. In fact real estate investors need to understand their opportunity cost from two different perspectives.
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Before we move on let’s review a simple definition.
Opportunity Cost is defined as the cost or value of the next best alternative not selected.
Using this as a baseline I recommend that all new real estate investors review their decisions based first on time and second on capital.
Real estate investors have both time and capital as constrained resources and thus they should review all decisions by answering the following question. What is the cost or value of my time or my capital compared to the next best alternative not selected?
Said another way, real estate investors need to answer the following question:
What is the most valuable thing I am giving up in exchange for this time or capital commitment?
As an investor who happens to hold a full time job, I know first-hand that my opportunity cost often involves my family. What I mean by this is, by investing time or capital into my real estate business my opportunity cost is the loss of another family trip, a long weekend with the wife and kids or simply dinner and a movie. Real Estate investing can get in the way of other family commitments.
Holding a full time job while learning the real estate business means you have to invest time and capital around your work schedule, which by definition means you have even less time (at least in the short term) with your family.
I know that this is a tremendous cost for most families; I believe it to be so great, that most people can’t make the sacrifice long term. It takes real family commitment and understanding of the opportunity cost to learn and thrive in this business. The first year while you are learning the business is the hardest and requires the greatest family sacrifice.
Why? The answer is unfortunately really simple.
Everyone gets the same amount of hours in a week, month or year and by definition the folks with a full time job have already committed a significant portion of their hours to working and commuting. This commitment is flanked by family and friend commitments that can’t be skipped or avoided. These facts significantly restrict access to the extra hours required to learn real estate investing.
As I have shared before, I believe it is vital that people put in the time required to learn their market and the opportunities the market is giving them. If real estate investors don’t put in the time or they simply trust others they are risking their hard earned capital because they can’t find the time to do the initial work and that is just a bad idea.
For example I suggest new investors learn their rental market, the cost of average repairs, the current inventory, the local trends, details about specific neighborhoods, etc. This is only a partial list for the buy and hold investor; the list is twice as long for investors who chose to flip properties while holding a full time job. Flipping properties while holding a full time job is like holding two full time jobs at a minimum.
In the end you can’t be successful long term if you’re not willing to put in the time and effort required. If the cost is too high make that decision early on.
Reasons Why “Opportunity Cost” for New Real Estate Investors is Important
First I believe most new investors who have a full time job fail to realize the initial time commitment required to learn the real estate investing business. I suspect that it is this surprise cost that knocks most new investors out of the market, which is unfortunate. I want new investors to be successful in this great business and to be successful you need to have your eyes wide open to all the costs.
Second if you are a new investor and you realize that the opportunity cost of time and capital just doesn’t fit your current family, work or lifestyle, then you do have other options. You should look into being a passive investor and establish a relationship with an investor that has a proven track record. You can lock in nice steady returns with downside protection and not suffer the same level of time and capital commitments.
In the end if you have a full time job and family commitments that leave very little free time you might want to consider becoming a passive investor.