If you’re looking to invest, say in real estate, one of the most common tricks of the trade is to do so using other people’s money (OPM). While taking on OPM as leverage can bring the promise of great opportunity, the pitfalls and perils are potentially every bit as calamitous. The proverbial grand unified theory of OPM is simple enough: you borrow money, use it to boost your investment, and everybody benefits from the results.
This is incredibly easy to see in concept: all you have to do is use OPM to help you buy, and perhaps improve, a property, and then you can turn around and rent/lease it to produce more revenue for you and for your investors than you would have had without that leverage. When done well, the use of OPM to buy properties and profit from them can work out very well for all concerned. The person doing the investing gets access to more money than they would have otherwise, the person or persons fronting the cash get the benefit of the wisdom and expertise of the investor, and everyone ends up richer, just as the theory suggests.
It’s a lovely concept in theory, but as is so often the case, reality is often more complex, and some of those complexities hold great pitfalls. The most obvious pitfall, of course, is that not every investment is a success. When you take on OPM, you are also taking on the very real risk that your investment will fail, and you will be left holding the bag. There are a variety of ways to invest using OPM, ranging from seller financing to equity partners to private money. What all of them have in common is that you, the person who is doing the investing, is getting the benefit of someone else’s money. True, when you take on OPM and make a good investment you can make a great deal of money for all concerned, but the thing to always keep in mind is that this is a two-edged sword.
It’s all too easy to think that a real estate investment – a single-story family house, for example – is a sure thing, a slam dunk investment. The reality is that properties can fail at much higher rates than one might think, and with much greater speed. Take the cautionary tale of Joseph Hogue, equity analyst and economist and former real estate baron. Hogue built a real estate empire which came to include five rental properties, plus his own home, and he did it all in a few years in the early-mid 2000s.
What did Hogue in was failing to anticipate the hard work associated with managing so many properties. He fell behind, particularly on the crucial tasks of evicting non-paying tenants and getting properties back on the market, and his hard-won real estate empire started to crumble. Hogue had sold a couple of properties and was actively trying to offload others when the stock market crashed, ruining him. Now, what if Hogue had taken on OPM? It was bad enough that he was ruined. How much worse would it have been if he had also managed to wipe out money invested by other people, people who had trusted him?
This is why OPM is a two-edged sword. Invest well, and you’ll make great proceeds and everyone will be happy. Invest poorly, and you’ll damage everyone’s finances, your own credibility, and the trust that you might have once enjoyed with the people who were counting on you. In fact, the perils and pitfalls go deeper. What if the people whose money you are using have unrealistic expectations? People are not always reasonable and sensible about these things. They sometimes expect more than is really reasonable for you to deliver. There’s an insight from the entrepreneurial world that is invaluable here: the importance of customer service, value, and growth.
As Lee Jacobs of AngelList has said: “Startups should focus on delivering great customer experiences, differentiated value propositions, and sustainable growth channels.” The same is true of investors, particularly investors taking on OPM. In the end, there is only one true pitfall associated with taking on OPM: the risk of losing it and damaging the expectations and trust of the people who provided it originally. If you are going to take on OPM, take the time to make sure you do it professionally, legally, and in a way that apprises all parties of the risks involved and cultivates reasonable expectations. Doing so is in your own best interests, both financially and in terms of maintaining good relations with the people who choose to trust you.