Rich Dad Fundamentals: OPM
A couple weeks ago, I wrote on how I use debt to get rich. Today, I’m going to write about how I use Other People’s Money (OPM) to get even richer.
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. The downside to debt is that you can generally only borrow a certain percentage of an asset’s purchase price. In keeping with our real estate example from my previous post on good debt, that is generally around 70 to 80 percent of the purchase price.
Because of this, you have two choices when you find a worthy investment: use your own money or use other people’s money. Provided you structure the deal well, the more you can use other people’s money, the higher your return will be.
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.
My real estate advisor, Ken McElroy, has perfected using OPM. His company, MC Companies, buys apartment buildings. He does all the hard work of finding deals, doing the due diligence, negotiating with owners and lenders, and handling management. In return, people line up hoping to invest their money with him. Here is a graphic representation (PDF) of all the work his company does to pull together a deal.
Today, Ken does big deals that require a certain type of investor. Not just anyone can invest with Ken. But he started with small deals, like the ones I’m writing about today and worked his way up to big deals.
Using my example from the last post, in real estate I can buy investment properties with debt. The bank will give me a loan for 80 percent of the purchase price. I then have to use my money or someone else’s for 20 percent of the purchase price. My job is to find a deal that pays the bank the interest on the 80 percent while still providing a decent return on the 20 percent. I then must find investors to invest their money (OPM) in my deal.
The Power of Good Debt
As I talked about a couple weeks ago, using the bank to leverage my investments, I can leverage my money. So, again using simple math, let’s assume I have $100,000 and am looking to invest it in a $100,000 property that rents for around $800 per month. You can find many properties like this if you look diligently, especially now with foreclosures and short sales.
I could use all my money to purchase one property for $100,000, or I could use good debt to buy five $100,000 properties.
The bank would lend me $80,000 for each property and I would divide my $100,000 into five $20,000 down payments. At 5 percent interest, the payment on the loans would be around $500, including taxes and insurance. So, my cash flow on each property would be $300 a month ($800 in rent – $500 in debt payment = $300 per month) for a total of $1,500 ($300 x 5 = $1,500) per month—an 18 percent annual return.
The Power of OPM
Using OPM, however, I can increase my return and secure even more assets. Let’s say that instead of having to put down 20 percent on five properties, I can use my $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’s 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. Investing with OPM takes a high level of financial intelligence. But both Ken McElroy and I both started small and worked into the big apartment deals we do today. You can do the same.
Be diligent. Continue to increase your financial education. Work hard. And master the fundamentals of good debt and OPM, and you will become wealthy.
You can learn more about real estate investing from two books in the Rich Dad series: The Real Book of Real Estate and The ABC’s of Real Estate Investing. You can also learn more about OPM by reading OPM: How to Attract Other People’s Money for Your Investments—The Ultimate Leverage.