Calculating Opportunity Cost in real estate.

Calculating Opportunity Cost in real estate.

There is no specifically defined or agreed upon mathematical formula to calculate opportunity cost, but there are ways to think about opportunity costs in a mathematical way. Opportunity cost is the benefit of the next best alternative or option. You can measure this benefit in money. As such, one formula for calculating opportunity cost is the ratio of the returns from the alternative you’re sacrificing to the returns you’re gaining from the chosen investment opportunity. When you think about it this way, then the opportunity cost formula becomes very straightforward:

Opportunity Costs = Sacrificed Returns / Gained Returns  

A real estate investor can use this very simple formula to make educated decisions in different situations. We should note, however, that you should take certain variables into account before making an investment decision and calculating opportunity costs. These include your investment goals, risks associated with each alternative, as well as your ability to afford investment losses (i.e. the level of your risk tolerance). Take a look at the following examples to better understand how to calculate the opportunity cost of investing in real estate.

Examples of Opportunity Cost for Real Estate

- Investing vs Not Investing in Real Estate

As you start your journey to become a real estate investor, you’ll realize there are many critical decisions that need to be made. Some beginner investors feel overwhelmed by the number of choices and information and can’t decide, so they just stay put. This, however, can have terrible consequences – we all know how valuable time is when it comes to investing! It’s easy to miss out on great opportunities if you’re afraid to make an investment, especially in the real estate world.

When you think about it, not doing anything has an opportunity cost. For example, say you’ve saved for investments but then changed your mind and decided to keep the money in your savings account. In this case, you sacrifice the benefits of buying an investment property and the ROI you could have earned, but you avoid the risks of investing in real estate.

- Investing in One Location vs Another  

Say you decided to invest what you have saved in real estate – let’s see how to find opportunity cost to make different decisions. One of the first choices a real estate investor is presented with is regarding WHERE to invest or buy a property. As you know, the location of a rental property plays a major role in what returns you can expect it to generate. Different factors (like appreciation rate, rental demand, rental rate, job growth, etc.) differ across locations. This explains why some cities are considered better than others for real estate investing.

- Buying One Investment Property vs Another

Similarly, if you decide to invest your money in one property type, the opportunity cost is the returns you could have alternatively made if you’d invested in another type. For example, you’re torn between buying a duplex or a flat apartment for real estate investment. The flat apartment will generate a more positive cash flow than the duplex from calculation. However, you’re not the type of investor who wants to deal with multiple tenants and manage one tenant. So you have to weigh the opportunity cost against each other and analyze the best opportunities of any property type of choice.

Never Lose Out on an Investment Opportunity

How can you ensure that you’re choosing the right real estate investment option that will both fit your criteria and reward you with maximum profits? Some might tell you that you can’t have a definite answer and that it’s all about forecasting as best as you can. However, there are tools you can use to stop guessing and start making informed decisions based on predictive analytics and reliable real estate data!

Some of this tool gives you an overview of different markets in your selected city along with how strong they’re performing based on your investment criteria. Such tool would allow you to choose the investment opportunity in the best locations for real estate investing.

There are other tools too that are backed by predictive analytics and timely data, this tool shows investors projections of the returns they can expect from rental properties. After finding real estate deals, you can use this tool to run the numbers and get a comprehensive analysis of the property’s rental income, cash flow, cap rate, cash on cash return, and more! With this tool, not only will you be able to do an investment property analysis on different properties to pick the most profitable one, but you’ll also be able to see which rental strategy is optimal to earn maximum profits!

In case you’re looking for off-market properties, where you can find real estate deals before anyone else. Use professionals to search the Property Market place to find properties including distressed sales, bank-owned P, auctioned homes, and foreclosures. You can also get access to data and use the aforementioned tools to analyze the properties and their locations to pinpoint the best real estate investment opportunities.

In conclusion

Opportunities are always there and opportunity costs occur with every decision made, big or small. Knowing how to calculate opportunity cost and looking at the ratio between available alternatives is important to make the correct investment decision. While simple, the opportunity cost formula should always be used in your decision-making process to weigh the pros and cons in simple, mathematical terms.