What no one says about using OPM (other people's money)

29 Replies

If you read real estate investment books, articles on BP, listen to podcasts or just generally find yourself learning about real estate investment then you will notice a common thing that is almost invariably mentioned, the use of other people’s money. A term so frequently referenced that it even has it’s own acronym, ‘OPM’.

It’s a simple, brilliant concept really. Basically you fund most, if not all, of a given venture with funds that don’t actually belong to you. Some of the often cited benefits include less personal money out of pocket, the ability to leverage more assets then you otherwise could, potential increased returns for yourself, ect… Gratuitous amounts of ink have been expended in many ‘how to’ style real estate books about the art of asking for money from others. You are supposed to present your deal as an opportunity, as opposed to a financial favor. You can motivate potential investors by creating a veneer of ‘act now or you might miss out’. The list could go on for a while.

This is all well and good but its only half of the story, and the less important half at that. I don't think that I have ever read one chapter, blog post or even word about the responsibility you take on when investing with money that is not your own. This silence is deafening and feels profoundly misguided. If I were approached by someone asking me to part with my funds for thier project the very first, and I mean VERY first thing I'd want to know is if this person takes seriously the responsibility implicit in what they are asking of me. I wouldn't ask them this, its hard to imagine an answer other than 'absolutely'. Rather, I'd let their knowledge (or lack thereof) inform my assessment. Sure, I'd want to know the basics of the investment. I'd want to know the IRR for myself and any other partners, whether or not the person asking for money actually has any skin in the game, the plausibility of any forecasts or pro-forma details, the background of the person asking for money, ect…. These details, taken as a whole, can begin to offer clues as to whether or not those with a hand out respect the responsibility they are asking to carry when suggesting that you part with your dollars upon their request. For example, someone could present to me an investment with very attractive pro forma returns but, if the predictions include rent increases beyond what evidence supports, I would question whether this person takes their responsibility seriously. Sure, they may have crunched the numbers on an offering memorandum, but have they bothered to learn what is behind those numbers and why? Does this knowledge blind spot suggest a lack of respect for what they are attempting to undertake?

The real estate entrepreneur is someone whom must posses a great deal of knowledge and expertise to reasonably asses what their projects are likely to return, in the real world. Foregoing this necessary learning process and jumping right to the part of asking others for capital is not only risky to everyone involved, its also an obvious rookie move to the seasoned investor.  You're not going to get turned down because the investor misunderstand the opportunity presented, you're going to get turned down because you misunderstand what you are asking for....unjustified trust.

I write this because its personal to me. I’ve been a student of real estate for a long time, I’ve assembled a portfolio of a dozen houses that performs pretty darn well, I’ve studied economics at the university level and ran a business basically my entire adult life. Not too long ago it occurred to me that I want to really begin to grow in real estate. There is obvious and large opportunity for those that play the game well. It seems like a fun, challenging industry that requires a breadth of knowledge and rewards those who put forth the necessary effort. But another thing occurred to me as well. I didn’t yet feel comfortable enough with my own knowledge to ask other people to allow me to take risks with their hard earned cash. I’ll bet I could have pretty easily persuaded any number of people I know to invest with me in whatever projects I wanted to put together. I’m fortunate in the sense that I think I have a reputation, among some people that know me well, as someone who is trustworthy enough to invest with. BUT, despite my desire to get started, I chose to put on the brakes and educate myself, to forego possible short-term paydays in favor of long-term risk mitigation. I think I’m now, after much preparation, nearly ready to started.  Any unrealized profits I could have made in the meanwhile notwithstanding, I'm very happy to have made the decision I did.  

Nuance, planning and knowledge form the backbone of any investment. It worries me to see so much about how great OPM is and yet so little about how important it is to actually know what you’re doing before you ring up your friends and family with a hand out. The people who you ask for money likely spent their finite time on this earth earning what you are asking for. Don’t take their time or money for granted.

Bad deals chase capital, but capital chases good deals.  Truly good investments do not require great sales techniques.  I'd contend that your time is better spent learning what makes a great deal than learning how to persuade others to fund a mediocre one.  If you think using OPM is a great way to rake in cash, you’re in plentiful company. If you truly respect the very real responsibility in doing so, however, it appears you may be a needle in a haystack. 

Very good.  I prefer "APM" - Any Peoples Money.  That includes banks, credit cards, crowd funding, private lending, etc. - Basically ANYWAY you can get it.

An investor I work with has done very well borrowing OPM over the years for his projects that make 10%+ per year. But even he has found the last few years that people are tighter with their money. He finds it harder to borrow private funds, and he's done hundreds of profitable deals in his career, has a long track record. 

Ron, good post, but I have to say that we have brought up borrower's responsibilities on BP. I think you hit the nail on the head a lack of respect, prudent judgment and just plain old greed influence those seeking funds. Most are inexperienced, many try to bite off more than they are ready for, the due diligence also goes on any lender to recognize that.

New "investors" (actually most all are real estate operators, not investors) take a very casual approach trying to deal in an industry that is pretty well regulated and getting into  financing matters with a cavalier approach is just plain dangerous.

Another aspect is the more experienced operator who has the lingo down, a marketing ploy, a "success" record of some deals done but really has no financial background or legal training. These types will pool investors' money, give fractionalized interests, have no reserves and carry out risky deals with a smile, slap on the back,  a dash of hype on a promise. I've seen these folks unravel and get into trouble.

I know good and well that someone starting out without really understanding real estate and that is following some step by step guru program asking family for money will most likely lose the family money. Hopefully, mom and dad or their grandmother will not lend them funds that will hurt them. :)   

@Ron Thomas

Good post.

Better to identify pain then provide a solution. Where do you have your money now, what kind of return are you getting are you happy with that, what would you like to get for a return...

If you educate about how real estate if a very good investment and why the will offer. Money offered is far stronger than money you ask for.

Paul

Thanks for the good comments guys.

@Bill Gulley I've never came across an article about this topic on here but I am pretty new to this site, so its good to know this has been addressed before on here.

Thats an interesting distinction you make about operator v. investor.  I appreciate the catch22 of wanting to get into real estate but having no money to get started.  Been there, and if people would have thrown cash my way back then I probably would have lost if for them.  But, if someone really has the skills necessary to excel in this field they should have at least SOME skin of their own to put in the game.  If they haven't managed to get that far on their own, I'd hesitate to be the one that funds their learning experience.  If they do have some money but simply choose not to it for an investment they are offering you, that may clue you in to what they actually think of the investment they are requesting money for.  If they flat out dont have the money that also may tell you something.  It could very well be that the operator's funds are tied up in some other deal when an amazing one fell in their lap that they can't pass up.  At the very least, I'd want to know the details.

Greetings Ron. You make a lot of valid points and I agree that an investor needs to be very knowledgeable before asking friends and family for private loans. That's why I personally started with Hard money lenders because they know how to accurately assess real estate deals. If your numbers are wrong and you can't resell or refinance the property then they will have to take it. Many HML are current or former rehabbers so they can run comps, evaluate rehab budgets and draw schedules for accuracy. Once I have done a bunch of these deals and fine tune my numbers then I can show my private lenders a track record of success . Investments of any type are risky but I do put my own money plus a lot of time and energy into every deal. Hopefully this installs confidence in my friends and family when I come around with my hands out.

Cheers to you @Tarik Larue , that seems like a great approach because the people providing the financing are in a position to judge the risks for themselves and may even be able to help with advice in addition to just capital.

I have been getting approached the last 2 years or so from passive investors wanting to invest with me.

I have not set up a fund but I am doing so this year. I have been busy with my regular commercial transactions for clients wanting to own directly.

My model I am going to deploy is commission / consulting fee going in, 20% equity for myself, cash flow to me AFTER investors have been paid and proper reserves for the property are in place, and an exit fee / commission. If the property has lost value then I will not charge an exit fee upon disposition.

I think the problem is some syndicators view people's investments as play money. If a deal goes south oh well. I understand that people's money and investment is very serious. If anyone is guaranteeing someone a return they need to run from that individual or company. There are no absolutes in investing. You can try through experience and knowledge to make an educated decision to limit risk but ultimately there are things even the most experienced investor has not run across before. The key is to make them small blips that can be handled and still have a profitable property rather than large mistakes that take the whole investment under.

The smaller investors wanting to be passive becomes a nightmare to deal with for 25k to 50k investment slices. From talking to lot's of experienced syndicators you want a small group of high net worth investors you can go to time and time again for the syndicates. If you have to re-invent the wheel each time and keep up with hundreds of people it can be real cumbersome and take away from the velocity of doing quality deals. Another issue is CONTROL. Some new passive investors will want total control of the project thinking it gives them safety when it hampers the whole investment because of micro-managing. I have heard TIC issues where every investor has a controlling voting interest. Imagine trying to get them all to agree on a refinance or disposing of the property when they all have a say and there are 30 of them etc.

So when I look at someone investing I want to know what I am getting myself into with the relationship long term. It is not for me just about accepting their money for a syndicate.  

hi Joel- your statement that syndicators don't care if an investment goes south goes completely against all my experience, which is considerable.  This is my field.  I work in DSTs, TICs, funds, etc, all structured as private placements for accredited investors.

There is an entire industry in this space, and the players care very much whether their investors get good returns.  I work with firms that have 12,18, 30 and 38 years in the space.  They've achieved IRRs of 13-15% for their investors on average over their years and years in the business.

Some of your other comments are correct.

In TICs, there can be up to 35 owners, and each has a deed and voting rights on major issues. Some issues require a simple majority. Selling or refinancing usually require 100% agreement. It's important to note, however, that if an investor or two are dragging the process along and making a decision is proving impossible, the TIC agreements allow for those dissenting investors to be bought out by others so that the group may move everything forward.

If you'd like to learn more about how the industry works, please give me a call.  It is not at all how you've characterized it.

@Ron Thomas - great post!  Definitely thought provoking.  I am a heavy user of OPM.  That was born as a result of me starting out with none of my own to work with.  I started using Hard money because it seemed like my only real option.  Since then, I have expanded to include loans from family, owner financing, and other creative deal structures and money sources.

Before I was able to close my first deal, I tried to get several to go. One HML told me something that I will never forget - if you find a truly good/great deal, finding the money to close will never be a problem. By that, he meant that it is fairly easy to get lenders of any type to underwrite a deal that has a great chance of success.

Another lesson (actually several) taught by another HML came from seeing my proposal tossed into the garbage can right after I presented it. I always turned rejection into education. I would ask the lender WHY they said no and I would listen to what they had to say. Yes, I was sore over the rejection, but I was persistent in trying to learn how to get better at finding good/great deals that I could close. My persistence and attitude eventually led to somebody taking a chance on me. I treated that lender and that deal with a tremendous amount of respect. I gave regular updates. I told the lender what was working and I also told them what I missed or projected wrong. I shared the successes and failures within the deal to learn more, as well as to show the lender that I was being very real with the deal. Real deals are not all candy and roses!

I wanted to chime in and say thanks for a great post.  This may also be worth posting as a blog on BP.

When you guys talk about investors how would that differ from getting hard money? 

I've never used someone that has ever asked about the progress of the property.  All they want is their 14%

I always use hard money for my down payment.  Now its at a rate of 14% but I can get it any time I want it. I take it out for 18 months and refinance or to pay it back.

 So essentially I have an unlimited supply of capital.  Not to mention I'm on m own. 

What is the advantage of using an actually investor?

@Justin S. an investor could be your friend or coworker. They would be happy to make 10% interest or maybe less on their savings and don't require monthly payments or points. They also tend to know little or nothing about real estate except HGTV. 

Great post Ron.  As a new member I am eager to get started and try to make deals, but I realize that I do not have nearly enough knowledge to actually go out and do anything yet.  For now I am happy to be able to learn from all of you and eager to keep reading.

interesting discussion.OPM ought to be treated with respect.The deal must be well researched for safety of principal

I'm very new to Real Estate and I've heard for the last year that other people's money is the way to go when starting out just because I'm learning. But, in your post you bring up subjects that never crossed m mind but of course I'm starting out in this career with knowledge from the internet and from my mistakes.

Thank you.

THANK YOU! I'm so tired of hearing about the "own nothing, control everything" attitude. Especially in buy and hold. First of all, how can you call yourself an investor if you don't actually own anything? You're just a property manager for your lender. Second, if you're constantly refinancing (or "harvesting your equity", what a stupid term), that's like being a minority partner in a business, buying yourself a majority stake, then selling back to your partner so you can buy another business while still managing the first.

Maybe this stuff works for rehabbers or whoever, but it seems counterintuitive for long term landlords.

Originally posted by @Johnny Mack :

THANK YOU! I'm so tired of hearing about the "own nothing, control everything" attitude. Especially in buy and hold. First of all, how can you call yourself an investor if you don't actually own anything? You're just a property manager for your lender. Second, if you're constantly refinancing (or "harvesting your equity", what a stupid term), that's like being a minority partner in a business, buying yourself a majority stake, then selling back to your partner so you can buy another business while still managing the first.

Maybe this stuff works for rehabbers or whoever, but it seems counterintuitive for long term landlords.

 Not really, I think it just has to be done in an intelligent manner. You make some good points, and I would be fearful of having all properties leveraged - that said, I think it makes absolute sense to "harvest", as you put it, your equity in something that is paid for/largely paid for in order to obtain more properties, especially if you plan to hold the properties. Why? Because of the nature of compounding. If everyone was immortal, and could work forever, you could simply save your way into never working again. But there is a real limit as to how long you have to make the numbers work - this is why every investment professional I know of recommends people start heavy-duty saving/investing as young as possible; you need the magic of compounding returns to end up with anything at the end. Let's say you save up enough money to put $30k down on a $100k house that you are going to rent out. If you keep working to pay it off, and use whatever rent you get to pay it off, and then once that is done save up another $30k to put down on another house, you are going to be constantly running to catch returns until such point as you are too old to keep working to put your own money into the pot. The point of real estate investing should be, primarily, to make money. If you can make 1.5% the return by splitting your money into two pots, with low risk, why wouldn't you? 

All that has to happen at the end of the day is that the numbers have to work. If you have a fixed mortgage of $500 on a property that easily market rents for $2k, you have a whole lot of room to play with before you are in a negative cash situation. Where most people, I suspect, get into trouble is that they do not bankroll the wads for a rainy day, and instead use the returns to either create an empire with too many risky properties, or use it to fuel a consumption lifestyle that isn't warranted with a decent amount of debt to service. The saying that you can't eat equity works both ways - it doesn't make a lot of financial sense, unless you are at your final point, to have loads of equity in houses sitting there, but if you don't have lots of equity you better have lots of cash.  

Many asset protection attorneys talk about stripping equity out of the house rental in case you're sued

Having a balance of owning property in owning private first mortgages I think makes a lot of sense

Having some private mortgages in an IRA makes a lot of sense

If you don't have anything as far as rental properties or notes it's all meaningless

Regarding owning property, I don't like the liability of tenants suing me or other people suing me because I have attachable assets

@Jay Hinrichs might want to post something on this matter

Originally posted by @Ron Thomas:

If you read real estate investment books, articles on BP, listen to podcasts or just generally find yourself learning about real estate investment then you will notice a common thing that is almost invariably mentioned, the use of other people’s money. A term so frequently referenced that it even has it’s own acronym, ‘OPM’.

It’s a simple, brilliant concept really. Basically you fund most, if not all, of a given venture with funds that don’t actually belong to you. Some of the often cited benefits include less personal money out of pocket, the ability to leverage more assets then you otherwise could, potential increased returns for yourself, ect… Gratuitous amounts of ink have been expended in many ‘how to’ style real estate books about the art of asking for money from others. You are supposed to present your deal as an opportunity, as opposed to a financial favor. You can motivate potential investors by creating a veneer of ‘act now or you might miss out’. The list could go on for a while.

This is all well and good but its only half of the story, and the less important half at that. I don't think that I have ever read one chapter, blog post or even word about the responsibility you take on when investing with money that is not your own. This silence is deafening and feels profoundly misguided. If I were approached by someone asking me to part with my funds for thier project the very first, and I mean VERY first thing I'd want to know is if this person takes seriously the responsibility implicit in what they are asking of me. I wouldn't ask them this, its hard to imagine an answer other than 'absolutely'. Rather, I'd let their knowledge (or lack thereof) inform my assessment. Sure, I'd want to know the basics of the investment. I'd want to know the IRR for myself and any other partners, whether or not the person asking for money actually has any skin in the game, the plausibility of any forecasts or pro-forma details, the background of the person asking for money, ect…. These details, taken as a whole, can begin to offer clues as to whether or not those with a hand out respect the responsibility they are asking to carry when suggesting that you part with your dollars upon their request. For example, someone could present to me an investment with very attractive pro forma returns but, if the predictions include rent increases beyond what evidence supports, I would question whether this person takes their responsibility seriously. Sure, they may have crunched the numbers on an offering memorandum, but have they bothered to learn what is behind those numbers and why? Does this knowledge blind spot suggest a lack of respect for what they are attempting to undertake?

The real estate entrepreneur is someone whom must posses a great deal of knowledge and expertise to reasonably asses what their projects are likely to return, in the real world. Foregoing this necessary learning process and jumping right to the part of asking others for capital is not only risky to everyone involved, its also an obvious rookie move to the seasoned investor.  You're not going to get turned down because the investor misunderstand the opportunity presented, you're going to get turned down because you misunderstand what you are asking for....unjustified trust.

I write this because its personal to me. I’ve been a student of real estate for a long time, I’ve assembled a portfolio of a dozen houses that performs pretty darn well, I’ve studied economics at the university level and ran a business basically my entire adult life. Not too long ago it occurred to me that I want to really begin to grow in real estate. There is obvious and large opportunity for those that play the game well. It seems like a fun, challenging industry that requires a breadth of knowledge and rewards those who put forth the necessary effort. But another thing occurred to me as well. I didn’t yet feel comfortable enough with my own knowledge to ask other people to allow me to take risks with their hard earned cash. I’ll bet I could have pretty easily persuaded any number of people I know to invest with me in whatever projects I wanted to put together. I’m fortunate in the sense that I think I have a reputation, among some people that know me well, as someone who is trustworthy enough to invest with. BUT, despite my desire to get started, I chose to put on the brakes and educate myself, to forego possible short-term paydays in favor of long-term risk mitigation. I think I’m now, after much preparation, nearly ready to started.  Any unrealized profits I could have made in the meanwhile notwithstanding, I'm very happy to have made the decision I did.  

Nuance, planning and knowledge form the backbone of any investment. It worries me to see so much about how great OPM is and yet so little about how important it is to actually know what you’re doing before you ring up your friends and family with a hand out. The people who you ask for money likely spent their finite time on this earth earning what you are asking for. Don’t take their time or money for granted.

Bad deals chase capital, but capital chases good deals.  Truly good investments do not require great sales techniques.  I'd contend that your time is better spent learning what makes a great deal than learning how to persuade others to fund a mediocre one.  If you think using OPM is a great way to rake in cash, you’re in plentiful company. If you truly respect the very real responsibility in doing so, however, it appears you may be a needle in a haystack. 

Kind of like the chicken and egg question. How do you get real estate experience unless you do it? Now a days, you can get a pretty good education wih books, podcasts and Biggerpockets. These were only available through expensive Gurus when I started 15 years ago. I think the only way out of the "chicken and egg" problem is get someone to mentor with or seasoned vet to partner with. Since OPM is a big responsibility, a new investor should not use OPM unless they have a mentor or JV with a very seasoned investor.

I think the danger in real estate is if you use OPM and think you know it all. 

If you understand how to analyze real estate and understand how the market cycles work, real estate can be one of the safest investments in the world. What makes Real Estate such a powerful wealth vehicle is OPM. Use OPM responsibility when you have a margin of safety in either cash flow or equity.

When you use OPM and if you do lose money, what you next will define your investing future. Do you try to pay back your OPM?

@Brian Gibbons - good point. I was thinking exactly the same thing but sat on the sidelines not commenting about it. I have been advised the same way. You don't have to be necessarily leveraged to the max, but enough that it doesn't leave a lot of juicy equity available to an attorney to go after in the event of a lawsuit. I don't know that there is a "magic number", but in my head being leveraged to 60% LTV or more takes a lot of the fun out of it for somebody trying to sue. Since I hold properties in LLC's, doing a refi to cash out some equity, then drawing out the cash until I have somewhere to put it and then reinvesting it back into the LLC just before closing on another property helps to protect my valuable equity. My bankers like it too because I try very hard to be a "good risk".

Not giving legal advice, just sharing a thought.

@Adam Johnson

Used to live in Westchester County New York, around Bedford Hills, and I specialize in estate planning

FLPs or family limited partnerships make it easier to own assets and make it difficult for charging order from creditors

@clint coons is awesome at entity structuring for real estate investors

Very good post and definitely true, I never hear the other side of OPM mentioned either.

I used to be a financial planner, so I get CPAs and Financial Planners thinking.

Raising private money is an important part of real estate investing.  I don't like PG'ing (personal guaranteeing) my life away.  I don't like banks.  I don't like 20% down.  I don't like filling out 1003 apps. :)

Here is a great post by attorney Clint Coons

http://www.biggerpockets.com/renewsblog/2011/1/6/r...

I believe you need:

  • Wholesaling Skills (finding wholesaling deals and finding cash buyers)
  • Good builders at your disposal for retailing - rehabbing
  • Great RMLO for seller financing
  • A good creative contract attorney
  • Creative Financing Skills (buy on terms: lease option, lease purchase, sub2, land contract, installment sale on free and clear properties, jv with home seller re: minor rehab and using private money, cash-credit partnering with business people, etc)
  • SDIRA education - look up www.TrustEtc.com
  • Great marketing advice (see the marketing forum here on BP)
  • Knowledge of Negotiating with Home Sellers

@Bryan Hancock

@Brian Burke

@Dev Horn

@Michael Quarles

@Jerry Puckett

Perhaps you guys could say a few words.

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