Chapter Eighteen

Owner Financing

The purpose of almost any commercial enterprise is to make money. Construction entails the constant spending of money. I always considered my earnings to be part of the money I saved by careful monitoring of my spending, which establishes the value of my equity.

Equity is determined by subtracting the total cost from the value of the finished project.

If the total cost is $150,000 and the property is appraised at a value of $200,000, the equity is $50,000.

The single most important item in the Real Estate Development field is money. The greatest obstacle to success is indebtedness.

The surest road to success is to eliminate debt. Use one's own money to operate. If one owns 100% of any project, he has complete control.

He has no one "breathing down his neck" for loan payments and will not be forced to sell disadvantageously.

Another very important consideration is that he will not be sharing his profits with a lending institution. A construction loan for a speculative house today would cost about 11% or 12%. Thus, one must make 11% or 12% for the bank, before he makes anything for himself.

If one provides his own financing, he has a distinct advantage over competitors.

At selling time one may add 12% to the price, as an overhead cost for use of his own money. His competitors will add 12% as a cost, because they must pay it to the bank as interest. The spread between paying out 12% or receiving 12% is 24%.

We are so accustomed to buying on credit that most of us never stop to think of the cost. We will trip merrily into a store, make a purchase and whip out our credit cards as payment. Some of us have enough cash in our pockets to make the payment but do not do so. Others have savings accounts, which are paying 6% interest.

We hesitate to draw any money from our savings accounts because it will interrupt the flow of interest. The bank has issued credit cards which are simple to use.

We ignore the fact that the bank is using our money at a cost of 6% to lend back to us, by way of a credit card, for a charge of 18%, more or less. Another view of the matter would show that every time one adds a dollar to his savings account and charges a dollar to his credit card, he has lost 12% as against paying cash.

If a person cannot afford to pay cash for a purchase, how can he afford to charge it for 18% more than it is worth? The time will come to "pay the piper" and financial strangulation will set in. "Over use" of credit is probably the greatest single cause for business or marital problems.

I began to dwell on this matter in the early 1950's when I was occupied in the construction of a U.S. Air Force Base near the city of Tripoli, Libya.

My barber was an Italian, who arrived there with the Mussolini occupation of the country, but spoke understandable English. He offered a shampoo, haircut, massage, shave and shine. Each service cost seven cents. Thus the most that a customer could spend in his shop was 35 cents for all five treatments.

I asked him one day if he had ever thought of moving to the United States. Being an American, I assumed that everyone wanted to live in the U.S.A. He surprised me, when he said he was completely happy with his present situation.

He told me he owned a real fine house that was nicely furnished. He and his wife and son had good clothes and everything they could want to eat. He had a new bicycle and intended to buy one for his son soon.

He invited me to his home for a Sunday dinner and his lifestyle was all that he reputed it to be.

The amazing part of the whole story is that he didn't owe a dime to anyone for anything.

He never made a purchase until he had saved enough cash to pay for it. In fact, he didn't know of any other way to do it. He was no financial genius, but unintentionally he was practicing the soundest method of operating.

When he started to accumulate money to buy a home, his savings were increased by the interest they earned. If he resorted to a mortgage, his money would be depleted by the amount of interest charged for the use of the mortgage money.

Of course, the party with the mortgaged property would have use of the property sooner, but he would be paying through the nose for it.

For example, if a person obtained a 30-year mortgage for $100,000 at 11% and remained in the property for the entire 30 years, he would have paid $342,720 principal and interest, with payments of $952 per month.

There is a great advantage in having money working for you, as opposed to you working to pay for the use of money. I mention the above instances in the hope that you will begin to think in terms of being your own banker as soon as possible.

Copyright ©1995 Robert A. MacDonald, All Rights Reserved.
Last revised: May 10, 1998.