Real-Life Example
I’m pulling this example from a project Kim and I have with our
real estate partner, Ken McElroy. Ken and his partner, Ross McAllister,
put the deal together, did the work, and manage the property. Kim
and I are financial partners in the project.
Project:
144 apartment units + 10 acres vacant land
Location:
Tucson, Arizona
Tucson is a city with strong job growth from the University of
Arizona, the military, and government agencies such as the U.S.
Border Patrol. Since many jobs are transient, there is a high
demand for rental housing.
The property was not listed with real estate agents. Ken and Ross
were the property managers of the property. When the owner said
he wanted to sell, the project changed hands to Ken, Ross, Kim,
me, and two other investors.
As you may know, most great deals are not listed. Most great deals
go to insiders.
Price:
$7.6 million ($7.1 million for the 144 units and $500,000
for the vacant land)
Financing:
$2.6 million in equity from investors $5 million via a
new loan
Plan:
Build 108 new units on the 10 acres.
Financing for addition:
$5 million to build the 108 new units
The existing property and the 10 acres were used as collateral for
the new $5 million construction loan.
Total units:
252 units when complete
Total package:
$2.6 million equity + $10 million debt
New basis:
$12.6 million
New appraisal:
$18 million.
An increase in rents increased the appraisal.
Why Are So Many People in Trouble?
FAQ
Why are so many people in trouble with debt?
Short Answer
They use debt to buy liabilities. The rich use debt to buy assets.
Explanation
In Rich Dad Poor Dad, I stated that your house is not an asset. The
reason most homes are not assets is simply because the owner pays
the mortgage, taxes, insurance, and upkeep. With our properties, the
tenants pay for those expenses, plus our profit.
We use debt to finance assets, things that put money in our pockets.
It doesn’t have to be real estate. For example, Kim and I own a 58-foot
sailboat. For most people, a boat is a big liability, a hole in the water
you pour money into. Our boat is an asset because the boat is in a
charter business, so tourists pay for the debt, insurance, upkeep, and
boat slip rental. We make money every month and use the boat when
we please.
Remember, it is not the asset class that determines if something
(a house, boat, business, oil, or gold) is an asset or a liability. What
determines if something is an asset is the direction of the cash flow.
If cash flows into your pocket, it’s an asset. If cash flows out of your
pocket, it’s a liability. It’s that simple, in theory. In practice is where the
challenge lies.
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