Other People's Money

On today’s show we are talking about how to use other people’s money. As real estate investors we are trained to use other people’s money. We use the bank’s money. We might joint venture and leverage a partner’s money. We might syndicate a project and bring investors along for the journey.

Robert Kiyosaki is famous for his assertion that your home is not an asset. An asset is something that puts money in your pocket. A liability is something that takes money out of your pocket.

But what do you do in markets that are over priced?

Everyone needs a place to live. I hear that mantra over and over again. What if you want to live in an expensive city like NY, San Francisco, Toronto or Vancouver?

Let’s look at Vancouver where the median sales price for a 4BR detached home was $2.5M last month.

Even a 1,000 SF 2 BR condo in Vancouver averaged $985,000 last month. That represents a price decline compared with a year ago.

But you can often rent that same condo for $2,500 a month.

Unless you believe that the 2BR condo is going to further inflate to $1.2M in the market, why would you ever take the financial risk of buying something that generates zero income at that price.

Some people justify the purchase price of their personal home by saying that they deserve a nice place to live.

I get that.

So let’s look at the cost of owning that 1,000 SF condo in Vancouver.

If you finance 80% at a 3.6% interest rate over 25 years, you would be looking at a monthly loan payment of almost $4,000 a month. When you add property tax and insurance you’re now at $5,000 a month and you have to tie up about $200,000 in equity just for the privilege of paying that $5,000 a month in holding cost. But wait, there’s more.

The owner of the condo has $600 a month in condo fee. The monthly cost of ownership is a whopping $5,600 a month, for a 2 BR condo. That comes to $67,200 a year.

Now on the other hand, let’s imagine that you could rent that same condo for $2,500 a month. All other things being equal, you would save $3,100 a month by renting instead of owning.

That 2BR rental would cost you $30,000 a year. You would have zero maintenance responsibility. If the condo Corp isn’t properly capitalized and the owner faces a special assessment to replace windows or make repairs to the underground parking, you pay none of that.

Imagine now that you took the $200,000 you would have tied up in equity and invested it in real estate, at a modest 10% annual rate of return. You would have $20,000 a year in income and could use the after tax portion of that income to further offset your monthly living expenses. You could probably reduce your monthly housing expense by another 50%.

What I’m describing is heresy to many of my listeners.

“Live where you want to live and invest where the numbers make sense.”

I know that for some of you, what I’m saying is going to challenge some deeply held beliefs. Some of you will rationalize your belief by saying, you can’t rent a place that will be a nice as one that you would buy.

Today’s show is based on real world apples to apples comparisons. The truth is, there are foreign investors who are looking for places to park cash in real estate. They are buying brand new construction condos, off of the builder’s plans and then putting those brand new properties into the rental market. It is happening every day.

The concept of other people’s money doesn’t just apply to investing. It can also apply to your own home if you want to live in an expensive market where the numbers don’t make sense.