“I rent a house for $7,000 per month.”
Does this sound crazy to you?
Can you imagine writing monthly rent cheques for half of what it costs to buy a small car?
As outrageous as it may seem, people do it. There are two sides to every coin, so allow me to explain what these “crazy” people are thinking.
I had a client who was a very good friend of mine tell me that he wanted to lease a house for $7,000 per month. I thought he was insane. He told me it made perfect sense, and that it was ME who was insane, along with the other 99% of people who normally would agree with me.
He told me to read the book “Rich Dad, Poor Dad” to undersand where he was coming from. The book is very simple, very straighforward, and only 200 or so pages.
So I read the book, and I learned a few things. Actually, I learned more than a few things, and I learned how to look at business, money, and the world in a completely contrarian way.
Here is how my friend rationalized his decision: He told me that this house for lease at “only” $7,000 per month is worth about $2,000,000. The cost to carry a $2,000,000 mortgage (two years ago) would be about $12,000 per month, or substantially more with associated CMHC fees on a no-money-down mortgage. For simplicity, let’s say that it costs $14,000 per month. My friend argues that if he were to purchase this house, he would be paying TWICE what he would pay if he were to lease it!
“David, I’m living here for half price!!” he said to me the day he took posession after we did the deal.
Wow, this really made me think.
Okay, so he’s right on the surface. This house is available for lease at $7,000/month, and if he purchased it for $2,000,000, he would be paying $14,000 monthly into a mortgage. So he IS effectively bucking the system.
But what are the caveats with this plan?
Well, when you pay a mortgage, it consists of two portions: interest and principal. Assuming that a small portion of his $14,000 monthly mortgage payment was recovered in the form of equity (maybe $3,000/month of interest to go with $11,000/month as principal), after leasing for two years he would have paid off $72,000 of principal, or earned that much in equity.
In addition, house values have gone up in the past two years! Perhaps this $2,000,000 house is now worth $2,300,000!
From his point of view: He paid $7,000/month instead of $14,000/month. He saved $168,000 over the course of two years.
From my point of view: He lost out on the $300,000 increase in house value, and the $72,000 of principal he would have paid down.
Hindsight is 20/20, and if house values went down, we’d all be singing a different tune.
In my very, very simple illustration, I’ve shown why I think this theory is flawed. But many people still subscribe to it regardless.
Oh and do yourself a favor: read the book “Rich Dad, Poor Dad.” Even if you don’t believe anything the author says, you’ll still gain some insight into how many people in the business world think…