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Six Types of Other People’s Money (OPM) for Real Estate Investing

How to put OPM to work for you in real estate

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How to put OPM to work for you in real estate

Summary

  • There are two ways to get rich, but OPM reaps the highest reward

  • There are six types of OPM that you can use for successful real estate investing

  • Success with OPM for real estate requires a strong financial education


In the blog post, "Money Myths and How To Really Get Rich In Real Estate (In 3 Simple Steps)," Robert Kiyosaki talks about the importance of understanding good debt and how to put it to work for you. At Rich Dad, we call this using OPM, or Other People's Money.

In short, there are two ways to get rich. One way is to use your own money. The other way is to use 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?

Good debt and Other People’s Money?

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, bad debt takes money out. So, a car loan, for instance, is bad debt. 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, on the other hand, 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.

Breaking this down, let’s use an example of a $100,000 property for simplicity sake. In a traditional deal with a bank, you can only borrow around $70-$80K towards the property. The rest of the money must be made up of equity from another source.

OMP for higher ROI

Because of this, you have two choices when you find a worthy investment: use your own money or use other people’s money for the equity needed above and beyond the loan. Provided you structure the deal well, the more you can use other people’s money, the higher your return will be.

In the case of our real estate example, let’s run a few scenarios.

Scenario 1

$100,000 purchase price

$80,000 loan at 5% interest

$20,000 of your own money for equity

Running through a simple mortgage calculator, your annual cost for this loan would be about $8,500.

Assuming you have an income from the property of $11,000 a year, after expenses are paid, your total net income would be $2,500 ($11,000 - $8,500).

Your return on investment for this would be $2,500/$20,000 = 12.5%.

Scenario 2

$100,000 purchase price

$80,000 loan at 5% interest

$20,000 OPM at 7% interest

You get paid 50% of net operating income as the finder of the deal.

In this case, your annual loan costs would still be $8,500, but you’d also have an additional cost of around $1,500 for the other people’s money you borrowed for equity based on an assumed 7%. So, total loan and OPM costs would be $10,000.

Again, assuming you have an income from the property of $11,000 a year, after expenses are paid, your total net income would be $1,000 ($11,000 - $10,000).

Your fee for putting the deal together would be 50% of the NOI, in this case $500 (50% x $1,000).

Your return on investment for this would be infinite because you’re making $500 without any money in the deal.

These, of course, are just small numbers for example. In the real world of investment, you can do this at scale and make massive returns and also, as in this example, infinite returns. But it takes high financial intelligence.

Acquiring OPM might seem intimidating

When discussing the idea of OPM, most people are on board with it—and excited even about the possibilities. But then they become intimidated by how exactly to find and use OPM.

This is normal for people. When we learn new ideas, our mind does its best to create reasons why the idea is wrong or it won't work. Our mind tells us things like:

  • "No one would ever give you money."

  • "You can't find good enough investments to attract OPM."

  • "Using OPM is taking on too much risk. Better off just putting money into your retirement account."

In reality, the hardest part of OPM is knowing how to find the right real estate investment to attract money, but even that isn't difficult if you take the time to learn how to do it.

For example, real estate advisor, Ken McElroy, has perfected using OPM. His company, MC Companies, buys apartment buildings; and while he does all the hard work of finding deals, doing the due diligence, negotiating with owners and lenders, and handling management, people, in return, line up hoping to invest their money with him. 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, just like you will.

Here are a couple posts to help you get started:

Once you have the right property, securing OPM becomes quite easy—if you know where to look. And when you begin to build your real estate portfolio and a track record of success, it gets even easier.

Below are six solid sources of OPM you can put to work for you and your real estate investments.

OPM for real estate #1: Banks

This one should be obvious. If you own a house, you know what it's like to go to a bank to apply for a mortgage. Most people don't think of it this way, but a mortgage is a form of OPM. Generally, with a single-family home, a bank will cover up to 80% of a home's value. You, as the purchaser, will pony up the other 20%.

This isn't always the case, however. For first-time homebuyers, an FHA loan can cover up to 97% of the purchase price with the buyer only having to contribute the other 3%. Of course, there are stipulations on this, such as you have to live in the home for a certain number of years before you can rent it out.

When it comes to real estate investing, when a property gets to a certain size, it no longer is viewed as a residential property but instead as a commercial property. This means that any bank looking to make a loan will base the loan criteria on the operating income of the property, not on the "market value" like they do for a home.

Often, if you can make the business case for a loan to cover not only a portion of the purchase price but also for the execution of the business plan to grow the property's value, you can fund a lot of your capital costs with the bank's money.

Banks are notoriously conservative, so if you're looking to have little-to-no money in a deal, a bank might not be your best option. But it can be a good place to start.

OPM for real estate #2: Private lenders

While banks are generally public institutions that have high regulatory requirements, you can work with private lenders and equity firms that are willing to invest in real estate. These could be angel funds, investment groups, and more.

You'd be surprised how many institutions are out there with the sole purpose of finding good investments to pour money into. You can find these lenders by either asking other investors you know or by doing some searches on the internet, where you can find things like private lender associations. These loans can be a bit more expensive with higher interest rates, so weigh your options.

OPM for real estate #3: Seller carryback

A seller carryback is where the seller of a property acts as the lender. There are a number of reasons why a seller might do this. Perhaps they are tired of the work required to operate a piece of property, or maybe they are looking for a steady return by collecting set interest on their money rather than rely on rental income ups and downs.

Because a seller carryback is a private transaction, there are many options and it just depends on your negotiating skills. The seller could finance all or part of the property. The rate could be at market, or it could be higher than market depending on risk. The seller could participate in part of the profit in exchange for a lower rate and you doing the work and management to execute the business plan. The options are nearly limitless.

You never know if a seller will be willing to carryback, but as with all things, it never hurts to ask.

OPM for real estate #4: Investors

If you have a good investment property, it will be easy to line up private investors who will want to provide the equity money for the property. This is often how you can raise the money for the percentage of the purchase price that a bank will require you to pay.

So, for instance, if you are buying a four-plex and the bank requires you to put down 25%, you would use private lenders to raise most or all of the equity money needed for that 25%.

This means you need to put together a solid investment prospectus that shows the potential of return for the investors. Ideally, you would have done that for the bank as well, so it should be ready to shop.

This is how Ken McElroy does his deals, and he has grown his portfolio from one apartment building to thousands of units in multiple states.

OPM for real estate #5: Government Tax Credits

If you are interested in investing in properties that the government subsidies, like affordable housing, you can utilize a slew of tax credits to help fund your real estate investment. Here are two explained by PocketSense:

Rehabilitation Credit

Investors who choose properties related to gentrification may get some relief from the Rehabilitation Tax Credit. This one is designed to encourage developers to renovate, restore and reconstruct older buildings. It applies to structures initially put into service before 1936, offering a ​10 percent​ credit. If a building is classified as historic in the tax year in question, it may qualify for a ​20 percent​ tax credit.

Freddie Mac Tax-Exempt Loan

The government offers tax exemptions in order to encourage certain behaviors. Municipal bonds can be exempt from taxes on interest earned, as can some loans issued by the federal government. The government allows certain loans to be exempted through Freddie Mac.

The government kicked off a Freddie Mac tax-exempt loan program designed to help multifamily property owners. This program applies specifically to those purchasing, refinancing or renovating an affordable housing property. It provides financing with ​4 percent​ Low-Income Housing Tax Credits, referred to as LIHTCs.

These types of investments require a high-level of financial intelligence, so you don't want to just jump in. But if you do the work to become a pro, you can make a very good living.

Additionally, you can find tax credits for building or retrofitting properties with environmentally friendly enhancements. It varies from marketing to market, so do your homework and see what you can get.

OPM for real estate #6: Cash flow on operations

This is where things get very fun and why real estate is believed to be one of the best ways to accelerate the velocity of your money. Once you have a good real estate investment property and a plan for growing its value, you can utilize that property itself as a means to generate cash out of thin air for other real estate deals.

What Ken McElroy and his partners do is find apartment buildings that underperform. Because the value of a commercial real estate asset like an apartment is based on the Net Operating Income (income after expenses), any opportunity to increase NOI is an opportunity to see a healthy return.

For Ken and his team, a variety of factors could help with this. For instance, the current landlord could be renting units well-below market rates. Turning those units and raising the rent could dramatically increase NOI. Or perhaps retrofitting units with washers and dryers, as well as a cosmetic facelift could increase rents by anywhere from $25 to $50 a month. Multiply that by hundreds of units and you'll see a lot of lift in income.

Since the bank values a property on the Net Operating Income, not on "market value", a lift in income is a sizable lift in value. You can use this higher value to do a refinance, pull money out of a property tax-free, and then redeploy it into another real estate investment. Continuing the cycle over and over again over many years exponentially grows your portfolio-and your wealth. And it's all done with OPM.

Start with a financial education

Investing with Other People’s Money takes a high level of financial intelligence. Investors like Ken and Robert start small and work into the big apartment deals they 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”.

Original publish date: June 07, 2011

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