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Understanding the Concept of "Opportunity Cost"
Very few people who invest in homes understand the concept of “Opportunity Cost.” Making profits through leverage, capital growth or high yields are of course factors that create opportunity in the Real Estate business. But knowing the importance of opportunity cost is also a priority.
According to the encyclopedia, “Opportunity cost is a term used in economics, to mean the cost of something in terms of an opportunity foregone (and the benefits that could be received from that opportunity), or the most valuable foregone alternative. For example, if a city decides to build a hospital on vacant land that it owns, the opportunity cost is some other thing that might have been done with the land and construction funds instead. In building the hospital, the city has forgone the opportunity to build a sporting center on that land, or a parking lot, or the ability to sell the land to reduce the city's debt, and so on.”
Understanding the Concept
Let us try to understand this concept with respect to investments in homes. If you decide to invest money in a property in England, for example, opportunity cost would be what you could have made by investing in any other place say Germany, Italy or even Antarctica! Similarly if you decide to maintain £50k as equity in property, the opportunity cost is what you could have alternatively invested in, with this £50k, and the resultant value.
My philosophy has always been to work my money hard. This is a strategy wherein, when I feel my money/investment has made significant returns and the returns are likely to drop off, I will look out for better opportunities for investment; ventures through which I can generate more money. I find people who acquire one or more property investments and hold on to it for a long period of time, say 15 – 20 years, to be used as pension, maybe. I feel that this strategy does not make optimum use of the opportunities available, and is too risky. Why do we invest in property? Is it not to be able to enjoy maximum profits out of it? Whether you own it or not is secondary.
In this business of buying and selling homes, another positive factor is you do not have to sell property for further investment. You can always refinance it and generate money to invest elsewhere. Always study market trends while investing in property. Do not be complacent after investing. When you find better opportunities, sell or refinance and invest anew!
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