When it comes to real estate investing, most people immediately picture late night phone calls regarding overflowing toilets (I don’t know what it is but it’s always toilets people think of), busted water pipes, or power outages. While this does happen occasionally, it’s not the issue most people think it is. The reality is, almost every type of issue a rental property can produce that would affect your personal life can be handled by someone else you’ve paid to handle it. The best part about this is, the person is paid from the rent generated by the house. It’s a win-win for all parties involved. While every homeowner knows eventually things will break or need to be replaced, there is nothing written in stone that says you yourself need to be the one to do it. In fact, I would say that unless you’re handy or have absolutely nothing better to do, it makes more sense to let someone else do it who’s good at it.
I’m a cop. My skill set is unique to police work. Investigating crimes, taking criminals into custody, thinking on the fly and reading between the lines are all skills that come in handy when working patrol. They are not skills that come in handy being a landlord. So I spend my time being a cop and I pay someone else to spend their time being a landlord on my behalf.
The argument against this is I’m paying them. This cuts into profits and removes the comfort of the false sense of control we have when we do something ourselves. My counter to this argument is I’m paying them with money that is not mine (property management is paid for by the rent the property accumulates). What’s even more incredible is the property itself was paid for by money that isn’t mine (properties are usually purchased with a loan from the bank). Not only did I buy the property with money that isn’t mine, and manage the property with money that isn’t mine, but I also pay the loan back with money that isn’t mine (rent)! Are you seeing the trend here?
Now if you’re like most people, warnings bells are going off as you begin to sense a scam. What I just said seems too good to be true, and everyone but a fool knows there is no such thing as a free lunch. I agree with that. The thing that makes real estate different is that everybody is benefitting from this situation in some ways, and everyone is paying for it in another. Lets take a look at the major players in the game.
Banks are in the business of making money. Most banks do this primarily by paying members to keep money in the bank (interest paid out). The bank then lends this money out to other customers at a rate higher than they are paying the customers they borrowed it from. If a book can borrow money at 2% and lend it out at 8%, the bank makes money right? Would you call this a scam? It may sound like one, but the reason the bank makes that 6% is because of
A) The risk the bank takes if it goes wrong, and
B) The work the bank had to put in to finding the deal.
If the loan the bank makes goes bad, the bank eats the losses. They still have to pay the member their promised 2%. The bank also has to pay the employees who did the work to find the customer for the loan, as well as the employee who researched the deal and put it together. Banks spend money on advertising, marketing, and planning to come up with lending programs customers will want. This all costs money. In order to make it profitable for the bank, they need to be earning money and making a profit.
The tenant is the one paying the homeowner to use the house. While it costs the tenant money to rent the house, the tenant gets a house and all that the house provides in return. While some people believe homeownership is a preferable to renting, many others enjoy the freedom that comes with renting a home. A renter can pick up and move whenever their lease is up if they don’t want to stay in that area anymore. They don’t need to pay for home maintenance or costly repairs, they don’t need to pay property takes or homeowners insurance, and often times the rent being paid is less than a mortgage would be. While some tenants rent by choice, others rent by necessity. Not everyone manages money well and for some people, qualifying for a loan or saving up a down payment is not a realistic option. As long as there are tenants, there will be a demand for rental property. As long as there is demand, real estate investors will have opportunities to build wealth. This bring us to the final piece of the puzzle.
The landlord/homeowner is the person who puts it all together.
When the real estate investor finds a property they like, they go to the bank for a loan. As we’ve already discussed, banks like this. The bank gets to make money on the interest they charge the homeowner for the loan. Banks need loans like this in order to continue paying their members the interest on their savings accounts. Members need interest on their money in order to encourage them to save and help their money grow. When a homeowner takes out a loan to buy a rental property, the bank wins.
When a landlord/homeowner puts a rental property on the market for rent, tenants apply to live there. People looking for shelter and a place to call home need landlords. When a tenant is able to find a property they like, in a location they desire, at a rent rate they can afford, the tenant wins too. If the tenant is able to pay less for rent than they would to own the home, they win there also.
HOW IT ALL TIES TOGETHER
Once you understand how all the individual pieces work, you can begin to understand how wealth is created for all three. Banks create wealth by charging more interest for the loan than they pay to use the money. Tenants create wealth by saving on a mortgage payment, taxes, insurance, and home repairs. Now about those landlords…
The landlord has the best stake in this game. When done correctly, the shrewd investor can purchase a home with most of the banks money (in the form of a loan) and a little of his/her own (the down payment). The investor then uses the rent money to pay back the mortgage on this loan (as well as any other expenses the property generates). With the money left over after all expenses are paid, the real estate investor saves up to cover the down payment of his next rental property.
The beauty of this is it is all done with other people’s money. In the real estate world, we refer to this as OPM. OPM is the best kind of money. It allows an individual to gain wealth at a rate that would never be possible if they were to use only their own. When the home appreciates in value, the home owner keeps that value. When the loan is slowly paid off and equity is built, the homeowner keeps that equity. When the rent slowly goes up and the profit increases with it, the home owner keeps that profit. When tax benefits are attributed by the government for the home, the home owner keeps those benefits. The home owner gains in many ways from rental property ownership, and the things he/she has to pay for the right to collect them is done with other people’s money.
Learn how to harness the power of OPM and use it to your advantage. Banks need people to lend to. Tenants need people to rent from. Property managers need properties to manage. Governments need property taxes paid and insurance companies need homes to insure. Use other people’s money to keep all these players happy and earn a handsome profit for yourself in the process.
A good man learns from his mistakes, while a wise man learns from the mistakes of others. In the same way, a good man earns profit from his money, while a wise man earns profit from the money of others.
Be the wise man. Use OPM to benefit everybody including yourself.