The most compelling reason for people to go into the real estate investing business is to make money. Not just any amount of money, but more money than they are currently earning. This is why real estate investors and everyone in this business are always after the opportunities that will give them the highest returns for their time and efforts.
The question however is, you might be working hard enough for money but is your money working hard enough for you This may seem a bit vague to you right now so, let me go over a few things to bring some light on the question stated above.
The Race between ROI (Return Of Investment) and IR (Inflation Rates)
Most people disregard the effects of inflation rates to their long term financial goals. Your return of investments can be viewed as the amount your money has grown over time while inflation rates can be viewed as the buying power your money has lost over time. The most common manifestation of inflation is the rising prices of staple goods. Here’s an example. 5 years ago, you could’ve bought 12 eggs for a dollar while now you can only buy 8. This means that in a span of five years, the dollar has lost 13 of its value or buying power.
Similarly, a savings of 100,000 dollars in an account that has an interest rate of 4% a year means that this will become 104,000 dollars a year from now. Factor in an inflation rate of seven percent and you will see that your 104,000 dollars is actually only worth 96,720 dollars in buying power. So you may have worked hard for your money, but your money was not working for you. Rule of thumb is, always keep your money in an investment vehicle that gives you a rate of return higher than the inflation rate. For real estate investors, this goes for those real estate properties that give you an ROI rate of less than the IR.
Opportunity Cost as a Hidden Cost in Real Estate Investing
According to the principle of opportunity cost in real estate investing, it doesn’t even end there because according to this hidden cost, you lose money as well when you forego an opportunity that could’ve earned you more. For example, to buy a real estate property, you took out capital worth $100,000 from your stock that earns you 15% a year. Now, say the property was sold at the price of $110,000, which means that your money in real estate investing earned you 10% in ROI; you lost 5% or $5,000 in opportunity costs. This is the amount of extra money you could’ve earned if you didn’t buy the property in the first place. Similarly, if another investment opportunity having an ROI of 30% was available during that time; your cost for not taking this opportunity instead then becomes 20% or $20,000.
Minimizing opportunity costs therefore means putting your money in investments that earns you the highest returns regardless of the fact that you are already making money from your present investments. In simpler terms, it just means that you have to make your money work the hardest that it can to make more money for you.