The Power of Being Able to Use Other People’s Money
One of the lessons that my rich dad explained was about people who try to become rich by being cheap, being frugal, not spending money, living below their means, and scrimping. Most people do not become financially strong with that type of behavior. A person needs to spend more if they want to become rich, but they must know how to spend and what to spend on in order to become rich.
A Simple Example
The following is an example of how we invested and then borrowed money to invest in other assets. In 1990, Kim and I noticed a house for sale in a beautiful neighborhood in Portland, Oregon. The owner was asking $95,000, but the property did not sell.
The economy was bad, people were being downsized, and there were many houses on the market. We would have put in an offer earlier, but this house did not fit our investment profile. It was too expensive and too nice a house to be considered a long-term rental property. If this house were in San Francisco, it would have been a $450,000 home. Yet we watched this property because we could see it had a lot of value and potential.
On our way to and from the airport, we would drive by the house to see if it was still for sale. After about six months, we finally knocked on the door and found that the owner was very anxious to sell and ready to listen to any offers. He owed $56,000, so I offered $60,000 and we settled on $66,000. I gave him $10,000, and we took over his existing mortgage. A month later, the owner and family had moved out and were on their way to California, happy to have sold their home.
They did not make much money, and they did not lose much money. The house rented immediately, and we wound up making about $75 a month positive cash flow after paying all debt and expenses. About two years later, the market had improved and many people were making us offers to buy it, the best offer being $86,000. Kim and I did not take the offer, although it was tempting. If we had sold, we would have realized approximately a 100 percent per annum return on our down payment as illustrated by the following numbers.
Although the 100-percent return was attractive, we did not sell. The house was in a great neighborhood, and we felt the house could eventually reach the $150,000 range in three to five years. Instead of selling this house, we decided to begin buying more, now that the market was turning in price and also rental income.
Given the strong market indications, Kim and I applied for a home-equity loan. The balance on the mortgage was now less than $55,000, and the appraisal came in at around $95,000. The rent could cover a mortgage of around $70,000, so we refinanced the house and put approximately $15,000 in our pocket. We had gotten our initial money back, and we still had the asset. The dog had gotten the bird, and we could now go out and find another bird. On top of that, the dog was now worth $15,000.
Within a few months, after looking at several hundred properties, we found our new target. It was a great house in the same neighborhood. The house did not show well since the owner had let his children live in it rent-free for years. The asking price was $98,000. After several offers and counteroffers, we purchased it for $72,000, put $4,000 into paint and repairs, and put it up for rent.
Late in 1994, we sold both houses for just under $150,000 each and took that money to buy a larger apartment house in Arizona, where the market prices were still depressed.
There are two ways to get rich. One way is to use your own money. The other way is to use other people’s money, or as we call it at Rich Dad, OPM. One (using your own money) provides small-to-modest returns, takes a long time to pan out, and requires some financial intelligence. The other (OPM) provides large-to-infinite returns, creates incredible velocity of money, and requires a high financial intelligence.
Which one would you prefer to use?
Other people’s money (OPM) is a fundamental concept of Rich Dad and a sign of high financial intelligence. By using both good debt and OPM, you can dramatically increase your Return on Investment (ROI)—and you can even achieve infinite returns.
Good debt is a type of OPM. By way of reminder, good debt is any debt that puts money in your pocket. By contrast, debt you don’t want takes money out. So, a car loan, for instance, is debt you don’t want. You pay for it each month while the car provides no income and in fact depreciates the minute you drive it off the lot. Good debt, by contrast, would be a loan for an investment property where the rental income pays for the expense of the property, including the debt service, while also providing monthly income.
The downside to good debt is that you can generally only borrow a certain percentage of an asset’s purchase price. In keeping with our real estate example, that is generally around 70 to 80 percent of the purchase price.
Many people think it’s a fantasy world that people would just give you money to invest, but that couldn’t be further from the truth. The reality is that most people don’t have time to find good deals. Instead, they rely on people with the proper financial education, skill set, and drive to bring deals to them.
The Power Of Other People’s Money At Scale
As I mentioned, you can use OPM to substantially increase your returns and secure even more assets at scale. Let me show you an example of how that works.
Let’s say that I have $100,000 to invest. I could use that to put down 20 percent on five properties. But using the concept of OPM, I’d rather use that $100,000 to put down 5 percent on 20 properties. I can do this by finding 20 great deals and lining up investors to invest in them.
Here’s How The Math Works Out
The bank would lend $80,000 for each property, and I would divide my $100,000 into twenty $5,000 segments, using OPM to raise the other $15,000 needed for each property. Again, at 5 percent interest, the payment on the loans would be around $500 per month. Let’s assume that we’ll pay a little more for our investors’ money and give them 7 percent interest. The money owed to them would be a little less than $100 per month—but we’ll go with $100 to make it simple. So, our total costs would be about $600 per month.
That means we’ll have a cash flow of about $200 per month, which we’ll split with our investors 50/50.
We’ll pocket $100 per month, or $1,200 per year, and our investors will pocket $100 per month, or $1,200 per year.
Adding up the total return for all 20 deals, that’s $24,000 per year cash flow, a return of 24 percent. Not only am I making 6 percent more per year than if I just used my money, but I also have ownership in 20 assets instead of just 5.
Later I can refinance these properties, pay off my investors, get my investment back, and continue to receive cash flow from the 20 properties—an infinite return.
Again, I’m using very simple math here. In real life, the numbers are more complicated and much larger.
But the principles are the same.
Editor, Rich Dad Poor Dad Daily