The OPM Principle - Leveraging

The OPM, or OTHER PEOPLE'S MONEY Principle is about leveraging your out of pocket expenses to maximize your financial gain. Your objective is to control as much real estate as possible while using as little of your own capital as possible.

Why is this important? Maybe you think you want to make a high down payment, or pay cash for a rental property. Please reconsider. The reason for leveraging is to achieve high returns on your capital investments. You also must consider the negative tax implications of having a cash producing property with little or no interest payment deductions to shield your income.

Let's use a simplified example to demonstrate the power of leveraging. Suppose you pay cash for a $100,000 rental property that produces a net operating income (gross income minus operating expenses) of $10,000 a year.  Your cash on cash return is 10%.

Now let's assume you only made a $10,000 down payment.  You financed the remaining $90,000 at 8 percent for 30 years.  You pay $7.34 for each $1000 borrowed, making your yearly mortgage payment $7,927.  You only have $2,073 left over.  But your initial cash investment was only $10,000.  Your cash on cash return in this scenario is 20.7%!

This is a simplified example.  A more thorough analysis would take into consideration taxes paid on income or shielded, principle reduction of your loan, and appreciation of your property to fully calculate your return on investment (ROI).