The idea of Other People’s Money – OPM
Using other peoples money (debt) to make money and to build wealth is a commonly used concept. It has risks though if not done properly, but it also has incredible advantages.
Let’s look at a very simple example to explain the concept.
Don’t over analyse it though, just look at the underlying concept.
Imagine you know of an investment that offers a 10% growth (and let’s say you will get the growth within a week).
If you invest R100, you will get R110 back next week. A 10% growth on your money.
If you however pay R50 of your own money and borrow R50 from a friend (for a fee of R2), let’s see what happens.
- Jointly, you have R100 for the investment, and you’ll still get R110
- After paying your friend the R50 + R2 back you will have R58.
- Your overall profit is only R8 which is less than in the first example
Your percentage profit is 16% because you used R50 of your own money and you now have R58.
It’s not the rand-value profit that will make you rich; it’s the percentage of growth!
Because in this example you could have made the investment twice if you did actually have R100. And you could have ended with R116 by using Other People’s Money.
Let’s take it a step further though…
What if you could use your credit card for this example.
So you use none of your own money now and use R100 of the banks money. You still end up with R110.
You then pay for credit card back as soon as you receive the money and that transaction costs your R3.50. You now turned R3.50 (of your own money) into R6.50 – that’s around 87% return!
Note that in the credit card example you only made R6.50, but again it’s the return on your investment that’s important. You only used R3.50 for the bank fee and yet you ended up with R6.50. That’s an incredible concept.
If you have R100 at your disposal and the opportunities existed, you could do this same transaction 28 times and make R182. (In theory)
So that’s where the power is!
And what if you could borrow the full 100% (use none of your own money) and get someone else to pay the money back (perhaps with a rental property), could could turn nothing into money!
A real example
Although this may seem fascinating, you should be sceptical to say the very least. If it was this easy to make money from nothing then surely everyone would be doing it. You’re partly right, it isn’t that easy.
It can however be done with a lot a patience, a little luck, some sound experience and the right circumstances. You need to always be open and ready though in case the opportunity arises.
Here’s a plausible example:
You have Property A which was refinanced a year or two ago and you have R150,000 left from the loan. This is part of the cash payout you received when refinancing.
You now find Property B which costs R600,000.
- You can put down a deposit of R100k (from previous loan).
- Pay R35k in fees for transfers, bond and attorneys.
- The monthly bond payment is R4,825
- Property levies: R800
- Rental income R5,800
So in this example it costs you zero money from your own pocket and you can make R175 profit from Month 1.
How can you get this right in the current property market?
I will only invest in a property if it can make me money from day 1. My friends think I’m mad though.
So how do I do it?
- I’m forever looking at online sites and newspapers to see property prices in various areas that I follow. Always looking, very seldom doing anything more.
- I look at areas that are not considered the best. I would rather own a flat or house with an affordable rent and have a waiting list of tenants, than have a place limited to the upper-income only.
- You can definitely find apartments in the R400k – R600k range where you can almost break even from day 1. Some negotiation will take you the rest of the way.
- I always look at the monthly levies if it’s an apartment or in a secure complex. If it’s too expensive I move on.
- Find sellers who are emigrating (or who have already left). They’re afraid of the market, afraid of Expropriation without Compensation and are usually a little desperate.
- Be patient. There is no rush! It is worth waiting 2 or 3 years for the high income yielding property. Especially if you can make money without using any of your own money. Just wait, watch and keep your ears open.
- I only buy a property if I can use 100% of the banks money. This always requires money left-over from a previous financing deal.
The best deal that I got is a 2-bedroom flat in Strand that I bought in November 2016 for R380,000.
It had a tenant paying R4,800 per month and the levies were just under R900.
The property is current valued at R560,000 which means the asset has appreciated by 14% each year.
So why did the seller give it away?
- The seller had already moved to Australia and was probably “over it”. Not sure exactly why, but she was desperate to get rid of it.
- There was a tenant issue over a R3,000 payment.
- There was around R15,000 worth of maintenance to be done.
- The complex is not fancy and it’s hard to find buyers.
These were easily resolved and the unit is now looking great and the rental in currently R5,800.
The risks of using Other People’s Money
Using Other People’s Money to make money is a really great concept and a strategy used by many property investors around the world. There are however some risks (big risks) and you need to know how to manage them.
It’s best to use extremely conservative calculations and plan for the worst. And if the numbers don’t add up, don’t invest.
- The interest rates could increase dramatically.
- You could have trouble finding a tenants and have a vacant property for 3 – 4 months.
- Tenant issues could lead to litigation.
- A special levy could be announced in a complex and you suddenly need to fork out R20k.
- A cash-flow issue on one property can easily affect the others in your portfolio and have a domino effect.
A large emergency fund will certainly help!
There are some great books, courses, online content and seminars that one can attend to learn more about the concept of using debt to build wealth.
Don’t just jump into something blindly!
Do you research, pay for courses and books and invest in yourself first!
Learn how home loan instalments work and see how the interest is calculated, as well the capital. This is important to understand when you’re paying the loan off from your on pocket.