A formula for investing in real-estate …

People are always looking for “magic formulas” to get rich. Even I’ve had a go at sharing mine

But, when it comes to real-estate, the formula is simple: buy/hold/reinvest.

That means:

1. Buy positive cashflow ‘20% down’ real-estate in an area that can appreciate

2. Hold on to it until it does appreciate

3. Refinance using the extra equity plus any accumulated rental profits to create your next deposit

4. Goto 1.

Here is a guy who has a very conservative (and, sensible I might add) real-estate investing strategy [AJC: for those who take the trouble to read the whole post, they will find the ‘magic formula’ they are looking for]:

I went from zero to more than one hundred units between 1977 and the early eighties by seeking tired rental property owners with free and clear buildings who were willing to finance the sales.

The early eighties was a financial climate not too unlike that today in there was really no mainstream lending occurring. It was the savings and loan crisis, Jimmy Carter and 18%+ FHA mortgages.

At the time I paid a bit more than the properties were “worth” in cash. But I operated with a buy and hold strategy so the properties became free and clear off the rents while providing me an above average income. We still own almost every property we purchased in the past 33 years.

In the early 2000’s every kid entering the business had Excel spreadsheets with estimated returns that would have them richer than Bill Gates in a decade. Every waiter, barber and auto mechanic you ran into was on their way to be the next Donald Trump or so it seemed.

Even buddies of mine called me a “dirt farmer” because I wasn’t taking advantage of easy lending and apparent ever expanding market, rather I stuck with the hard work of landlording. But the prices were unsustainable compared to rent. So I kept with what I knew worked and withdrew from buying. Between 2002 and 2010 I bought just three properties, two of which were commercial units for our own businesses. I’m still here and they all went belly up.

Usually you can’t go wrong if you are headed in the opposite direction of the majority. So that means today, with everyone shunning real estate it is probably a good time to buy, just as it was in 1982.

This year I reentered the market , but only on limited basis as there are some good deals, but for the most part the market still is in somewhat of a free fall.

My math in the beginning, which remains so today is: Assuming that you financed the whole purchase at 12% for 15 years, even if you paid cash, the property had to net $100 per month per unit after all expenses including at least $100/unit/month for maintenance. Did I get every deal? No, but why own if ownership will not help you reach a financial goal.

[AJC: 12% is very conservative; if you used 8% in the USA and 10% in Australia you would still have plenty of margin for error; remember, this guy was investing in an era with 18%+ interest rates]

It may not be ‘get rich quick’, but it is sensible 🙂

You don’t need to become a barber to become rich …

Darwin’s Money shares a story about his barber that shows how anybody can become rich; here’s a trimmed down version of Darwin’s assessment of how his barber became rich:

  • Real Estate Mogul – He owns multiple rental properties.  He started off small and kept rolling his profits into more and larger properties.
  • Business Savvy… and Patient – He knows the real estate market very well and he waits for deals to come around.  He’s patient.
  • Frugal – Just through some casual observations, it’s evident he’s a frugal guy.  He dresses modestly, he doesn’t take extravagant vacations, and he doesn’t drive a fancy car.  The combination of multiple streams of income and frugality make for a huge net worth in your later years.
  • Small Business Owner– Like all smart business owners, he gets other people to work for him and generate income and offset his costs.  Rather than just running a one man barbershop, he has a couple other barbers working there.

This looks likes an great observational report … I’m not certain that Darwin actually asked his barber how much money he has or how he made it?

I’ll do the reverse; I’ll tell you how I made my money … it’s much the same as the barber, but I think it’s the order that’s critical:

Business Savvy, Impatient, Small Business Owner – I started by becoming a small business owner, then trying to become business savvy. But, it was a slow path. When I finally hit rock bottom (business-wise) and found my Life’s Purpose, hence my Number, I suddenly became impatient. In fact, this was the turning point for me: as I accelerated my business growth, I accelerated my income, which is the first key to becoming rich.

Frugal – Now, this is where most high income earners go wrong: as their income increases, they become looser with their money. It should be quite the reverse: in dollar terms it’s OK to (in fact, you should) reward yourself by increasing your expenditure [slightly] in $ terms. But, and this is the secret, you should be decreasing your expenditure in % terms. While it’s fine and dandy to be frugal while you are still on a low and/or fixed income (i.e. job), it’s actually critical to become more frugal in relative terms as your income increases.

… and Patient Real-Estate Mogul – What to do with the rapidly increasing bank balance? Well, you could put it in mutual funds (but the fees are too high and/or the returns are too slow), stocks (but, they are not leveraged enough), or other businesses (but, you run the risk of spreading yourself too thin). For me, the best compromise between the leverage of a true business and a passive investment is – and remains – investment-grade real-estate. This is where being patient finally kicks in, because buy/hold real-estate is subject to the vagaries of the market. But, I had a primary source of growing income, so I didn’t need to touch my real-estate investment income until I finally began Life After Work.

So, my assessment is that Darwin is right, but the order is wrong.

Oh, I also think that you can substitute small business ownership for any high income potential (e.g. highly-paid professional; CxO-level employee; consultant; etc.) with the only catch being that you miss out on the potential capital gains that owning a business may offer – on the other hand, you may be able to negotiate yourself a nice golden parachute …

How well do you think this simple strategy could work for you?

The 0% ‘safe’ withdrawal rate …

What % of your retirement ‘nest egg’ can you safely withdraw each year, to make sure that you money lasts as long as you do?

Many would say that this is a question best answered by highly educated practitioners of the highly specialized field of Retirement Economics, who will give you an answer – or, more likely, a range of answers – accurate to many decimal places.

But, I can give you a single answer …

… one that is accurate to at least 17 decimal places, yet I am not an economist of any kind.

You see, Retirement Economics is an oxymoron.


First, let me give you an excellent example of what retirement economics is …

In his blog dedicated to pensions, retirement plans, and economics, Wade Pfau provides the following chart:

It superimposes two charts:

– one shows descending survival rates for men, women and couples who retire at age 65.

For example, if you retire at 65, there’s only a roughly 18% chance that at least one of you will live past the age of 95. Reduce that to 90, and there’s a 40% chance that one of you will survive.

– The other is an increasing probability that your money will run out before you do the larger the % you withdraw from your retirement portfolio.

For example, if you only withdraw 3% from your portfolio (if invested in the exact 40%/60% mix of stocks and bonds assumed by Wade) then there’s almost 0% chance that you’ll run out of money by the time you reach 95 (and a small chance thereafter).

But, there’s a 30% chance that you’ll run out of money by age 95 if you increase that ‘safe’ withdrawal rate to just 5%.

You’re supposed to use these ‘retirement economics’ to make decisions like:

“Well it’s very likely that either my wife or I will live to 95 and we don’t want our money to run out, so we’ll invest all of our savings in a 40% stocks / 60% bonds portfolio, and we’ll only withdraw 3% of it each year just to be sure that our money won’t run out.”

That seems like sound economical judgement for the average person …

… BUT, you are not average!

For better or worse, you are … well … you.

Besides the obvious [AJC: who says you want to wait until you’re 65 to retire?!], when YOU are 95 (albeit in the 10th percentile), how happy will you be if your money has either either already run out or there’s a reasonable chance that you will soon be out of money, hence out of care?

I would argue that only a 100% chance of your money outliving you is acceptable.

Even then, only with a LARGE buffer, so you never need to worry about even the possibility of your money running out!

In my opinion:

Only a 0.00000000000000000% withdrawal rate is acceptable.

Now, 0% does not mean withdrawal nothing, but it does mean having a sustainable, self-regenerating supply of income; this is not as hard to achieve as you might think.

For example, you can create an ongoing stream of income from:

1. Inflation protected annuities (albeit expensive)

2. TIPS (albeit a low return)

3. 100% owned real-estate (albeit, needs management)

4. Dividend stocks (my least preferred as they are sometimes a sub-par investment that tends to rise-fall with the markets).

Remember, when you retire, you want not only ZERO chance that your money runs out, but you don’t even want to get anywhere near to zero by a wide margin.

Don’t you?

Avoid wiggly-line investments!

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Bet you wished that you had entered 😉

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LAST CHANCE to enter my free contest: CONTEST OVER: in just ONE more today, I am giving away $700 cash to one lucky reader (drawn at random) as part of my $700 in 7 Days No Strings Attached promotion. It’s free to enter simply by clicking here.


CNNMoney fields a question from a reader who’s scared that her money will run out before she does:

Question: I recently had to take early retirement at age 57 because of back problems. I’m now looking for a safe place to invest my retirement money where I’ll have no risk losing it. Any suggestions? — Donald H., Morris, Alabama

Yes, I have a suggestion: don’t post your questions to a financial ‘expert’ who still works for a living!

If you do, you’ll get answers like:

Answer: If the threat of losing principal were the only financial risk you had to protect yourself against in retirement, then finding a safe haven for your money would be pretty simple. You could plow your entire nest egg into Treasury bills or spread it among FDIC-insured savings accounts and CDs (taking care to stay within the FDIC coverage limits).

But while doing this would insure that you would never lose a cent of your money, it would also insure that your retirement stash earned a pretty measly return.

Good, so far … so, no cash. Got it!

What should she do instead (?):

If you want to have a decent shot at your retirement savings lasting as long as you do, you also want to invest in a way that has at least some potential for long-term growth.

[Keep some in cash and the] rest of your savings you want to keep in a diversified portfolio of stock and bond funds. Again, there’s no single correct mix. Typically, though, someone just entering retirement might have 50% or so of his or her portfolio in stocks and the rest in bonds.


Question: If you are aiming to retire, why do you want long-term growth?!

Answer: Because, you expect to lose some significant proportion of your capital to:

– Spending too much,

– Inflation,

– Market downturns.

In other words, the expert recommends to invest in a ‘wiggly line’ investment, hoping that the upswings outweigh all the downswings + spending after inflation is taken into account.

How well has that been working out for the past, oh, 20 years?

So, can you think of an investment that tends to grow with inflation, and provides income that also tends to grow with inflation?

Well those treasury-protected bonds certainly have principal that keeps up with inflation, but the returns are so low that income will become a real problem.

But, what about real-estate?

It’s where ‘the rich’ have kept the bulk of their retirement savings since time immemorial … I wonder why? 😉

A great retirement plan executed badly …

I have a good friend who had a successful business; while not exactly a retirement plan (as he still had the business), it would work as one:

He would buy a commercial property (e.g. office or warehouse) in a good near-downtown area, refurbish as necessary and put in place good tenants.

The next year he would buy another.

And, for the next three years after that he would buy another … until he had 5 such quality properties (purchase price around $1 million each).

Then he would do something pretty neat: he would sell the first (i.e. 5 year old property), taking about $1 million out to buy another property worth $1 million, and use the excess capital appreciation to fund his lifestyle.

Nice … except it didn’t make sense.

Because he was simply trading down one property (bought for $1 million 5 years ago so, hopefully, worth a little more now) for another (worth $1 million today), incurring all sorts of changeover costs and possibly even capital gains (unless he could qualify for a tax-free exchange).

He did this until I pointed out the obvious; I said: “Instead of selling one to buy another, why don’t you simply refinance the oldest property each year to release the capital appreciation, tax free?”


And, that’s what he did from then on …

People often come up with great, innovative ways to do things … but, it doesn’t mean that they’re the right way.

For example, in our former family finance company, my Dad used to give our clients a check for the full face value of their loan, and ask for a check back to cover our up-front commission.

His reasoning was that we would have the commission money in our hand and earn extra interest on it. Neat, until I pointed out that it was exactly the same as giving the client the net amount (i.e. face value of loan MINUS our commission): One check. Sensible.

Needless to say, that’s exactly what we did from then on.

Always evaluate what you are doing and how you are doing it, even if you are successful … you may be leaving (a lot) of money on the table.

BTW: I’m wondering if you picked it? There seems to be another flaw in the retirement plan executed by my friend and promoted my many a financial spruiker that I have listened to …

These real-estate investment ‘gurus’ say: “Buy lots of real-estate and when you retire you will have a LOT of equity available to fund your own retirement … simply take out a loan against this property every time that you need more money. Because it’s a loan and not income, you pay NO INCOME TAX on it, so it’s worth more to you than taking the money as rent; and, the excess rents will cover the mortgage payments. Of course, because it’s an investment loan, it’s tax deductible.”

Now, there’s so  many things wrong with this strategy that I wouldn’t even know where to start (how about vacancies, as one example?), yet I have been to at least half a dozen seminars where this exact strategy and tax-effectiveness argument was put forth.

However, I take issue with the last statement:

Just because a loan is taken out on an investment property, does NOT necessarily make it tax deductible.

In many countries, the real test is “what’s the PURPOSE of the money that you are borrowing?”

If it’s to refurbish the property to increase rents (hence, so that you can pay the IRS more tax … you win, they win!), more power to you!

But, in this case, it’s not to derive more investment income … it’s so that you can go out and have a good time!

Q: Why would a government want to subsidize your personal spending habits?

A: They probably wouldn’t!

Find a good tax advisor before implementing this strategy … oh, and take what you hear from financial spruikers with a kilo-grain of salt 😉

Suffer any bad beats lately?

I have to admit that it’s very exciting seeing my two real-estate development projects coming to fruition [AJC: this is the architect’s rendition of just one of my two condo projects … click on the image to enlarge it … go ahead … do it … I’ll love you for it].

I’ll get back to that in a sec’ …

… first, let me tell you about a conversation that I just had with a friend, while we were playing poker today:

FRIEND: Do you find any parallels between business and poker?

AJC: It’s uncanny, but yes I do … and, it’s caused me to totally rethink the way that I think about money

Well, not so much ‘totally rethink’ as remind me about some important Making Money 301 lessons that I seem to have forgotten …

…. but, I keep getting side-tracked; back to the poker:

Case in point: I had quickly tripled my starting stack in a cash game but, just as quickly lost it on a series of bad beats; bad calls (by them, not me); and bad luck.

When you’re running hot, you feel invincible.

When you’re running cold, nothing that you do turns out right.

… and, your poker bankroll quickly slips away.

Well, it’s pretty much the same thing in business and personal finance:

Your investments and/or businesses are ‘on fire’ … the market’s running hot, and – if you’re smart – you cash out at the peak, building up quite a bankroll.

Maybe you even reach your Number.

What should you do then? STOP and smell the roses!

But, the trouble is, greed and the adrenalin kicks in … you believe that you’ve got the Midas Touch. And, you push for the next project.

… and, that’s the one that gets you.

You know, market downturn, bad luck, bad advisers, etc., etc. sob, sob, sob.

Which is, perhaps, why Ill Liquidity asked me:

I don’t get it. You make a tidy sum and retire from the rat race, paying yourself a salary… why go forth and try new money making ventures?

Given my own ‘stop and smell the roses’ advice in that regard, I agree, it’s hard to understand. Sometimes, it’s even hard for me to understand 😉

So, let me take a stab at explaining it; the story so far:

I made my $7 million in 7 years (mainly through reinvesting the profits of my businesses into buy/hold real-estate), and then made a heap more (by selling those businesses just before the 2008 crash), but ….

… then the crash hit, and here’s where my money went:

1. $1.5 million cash into my house in the US (you know I can’t sell that, right?)

2. $5 million cash into my house in Australia

3. 25% of what I sold the businesses for in taxes [AJC: sheesh!]

4. Lost 100% of my $3 million bonus on company stock price crash + taxes paid on the full $3 million [AJC: double sheesh! … but, it’s nice to know that I have a heap of capital gains tax credits to use for the rest of my life]

5. Gave my accountant $1 million to invest in the Aussie stock market for me … he promptly lost 75% in about 6 weeks. My fault for trying to time the market, not his 🙁

Don’t feel too sorry for me: when others try to get to sleep by counting sheep, I count millions!

My problem is this:

All of this bad luck and bad management has left me with assets – not including my $5 million primary residence – that I consider just enough to live my Life’s Purpose.

But, I am an über-pessimist and I really want a large margin for error.

Now, in my rational moments, I realize that my house provides me that i.e. as soon as the kids move out, in approx. 10 to 15 years, we will sell down into a, say, $2 million apartment, which would free up another $3 million (all in today’s dollars, but the price differential should still hold true).

But, even that’s not good enough for me.

So the question that I am wresting with – and, have decided to put off answering until I have building permits for both projects in my hands:

Will I take my own advice and sell both development sites (with permits) for a tidy profit (if all goes well), or will I pull the trigger and dump most of my net worth into these developments to get the Really Big Bucks?

Only time will tell … but, you will be amongst the first to know 🙂

In the meantime, have you suffered any ‘bad beats’ lately?

The Zero Dollar Emergency Fund!

Last week I asked How many months do you have in your emergency fund?

Earlier, my blogging friend JD Roth at get Rich Slowly (GRS) asked the same question of his readers, and this is what he found:

How many months do you have in your emergency fund?
GRS 7m7y
less than 3 months 38% 29%
3-6 months 26% 24%
7-12 months 13% 24%
more than 12 months 14% 16%

This shows that more 7m7y readers have 3+ months living expenses in their ’emergency funds’ than GRS readers, which means …

I’ve done a terrible job 🙁

On the other hand, if you answered “what’s an emergency fund?” good for you, you’re already a step ahead of the pack … you see, not everybody – including me – thinks that you need to have an emergency fund at all!

[AJC: At least not until after you reach Your Number]

For instance, Liz Pulliam Weston writes at MSN Money that you should have a $0 emergency fund, replacing it with a concept that she calls ‘financial flexibility’:

The whole idea that everyone needs a big pile of cash, and needs it right now, should be rethought. In reality, the failure to have a fat emergency fund isn’t inevitably a crisis. At the same time, those who feel safe because they have three or even six months’ expenses saved up might be kidding themselves.

Let’s say your take-home pay is about $4,000 a month. Although you have been spending every dime, you make a concerted effort to trim your expenses by 10%. This not only frees up money for your emergency savings but lowers the total amount you need to save from $12,000 to $10,800.

Still, it will take you 27 months — more than two years — to scrape together your emergency fund. And that assumes nothing comes up that forces you to raid your cache.

Let’s explore this a litter further: JD Roth has $10,000 in his emergency fund, but that doesn’t just represent $10,000 today …

…. it represents the future value of $10,000:

Let’s say that you intend to retire in 20 years, if you earn 9% on your money (say, invested in Index Funds) then you are giving up, say, 2% bank interest (by having your emergency fund sit in an ordinary savings account for quick ’emergency’ access) to earn 9% – or, a net of 7%.

That extra 7% earned represents about $8k in extra interest/profit that you are giving up for the benefit of ‘peace of mind’ in an emergency. But, we aren’t investing our money in Index Funds, because we are on a mission: we want to reach $7 Million in just 7 Years!

To us – that is, those of us on a steep financial trajectory – this $10k pile of cash represents seed capital for your new business venture or next real-estate acquisition [AJC: and, don’t tell me that an extra $10k wouldn’t be a big help for either of these endeavors] …

… now, $10k ‘invested’ at:

  • 15% (stocks) grows to $35,000 after just 10 years
  • 30% (real-estate) grows to $106,000 after just 10 years
  • 50% (business) grows to $384,000 after just 10 years

… a slightly larger price to pay for peace of mind 🙂

The timeless secret to making money in real-estate!

OK, so if the ‘secret’ to making money hasn’t changed in 50 years …

[AJC: if you didn’t read yesterday’s post, it’s simple: buy a rental property with about 25% down; renovate; trade up and start again; repeat until rich!]

… why are there so few people doing it?

It could be market fever: “the market’s too [insert excuse of choice: hot, cold, near, far, etc.]”; but, I suspect it’s the age old reason: you simply don’t know HOW.

Ok, so let me make it simple: save up a reasonable deposit (15% to 25% works for me), and do the most cost-effective renovation (also called remodeling or rehabbing, depending on what country you live in) possible.

The question is, what are the best ‘bang for buck’ renovations to do?

Well, here is a national summary of typical renovation/remodeling projects (including their average cost and how much resale value that they add to the project):

Despite this, I would not go about replacing all of the wooden front doors in my condos with steel doors! In fact, I would still look at:

1. Repaint / recarpet,

2. New blinds, door handles, light fittings (all of these can be quite cheap, as long as they work/look OK),

3. Kitchen remodel (you may be able to resurface the existing cabinets)

4. Bathroom remodel (you may be able to resurface the existing tiles, baths, and vanities)

5. Also, if it’s a house (not a condo), then you should paint the exterior and fix up the garden

6. Again, if it’s a house, perhaps the MOST ‘bang for buck’ rehab that you can do is to add another bedroom (especially to change a two-bedroom house into a three-bedroom house).

If you think it’s expensive, think again … just be very wary of your budget!

Here’s how it panned out for us:

We purchased one condo a street or two away from the beach:

– We bought for about $220k,

– Spent $15k on a rehab (paint/carpet, kitchen/bathroom remodel, door knobs and light fittings),

– Rented it out (we didn’t need to sell it).

It’s now worth $450k to $550k a mere 6 or 7 years later.

We then repeated with a block of 4 condos:

– Bought all 4 for $1.25 million,

– Rehabbed for $200k ($50k each condo), including the fees necessary to retitle from apartments (rental) to condos (rental or individual sale)

– It’s now worth $1.8 million to $2.25 million, a mere 6 years later.

For the four condo’s, we spent $50k in renovations (each condo: $200k total)), which bought us: paint inside/outside, new kitchen bathroom carpet, light fittings, security entrance for the building AND conversion of the front of the building into a private courtyard for one of the apartments, and conversion of the rear laundry into an ensuite bathroom for another condo in the block!

If you think the work is hard and/or time-consuming, we didn’t do the rehab on either project and didn’t even see the second project until 5 years after it was finished! We believe in outsourcing everything 🙂

How successful are they?

You’ve  heard the pitches, seen the ads, and even read the books …

… but, how successful are those ‘best-selling’ real-estate authors, anyway?

John T Reed is the guru-basher – rightly or wrongly, he reads, judges, and publishes his views on his web-site. Click on this link to read what he has to say about some of those real-estate gurus, then come back here.

You see, I want to point you to the very first ‘guru’ that he mentions: it’s William Nickerson. William Nickerson was unique in that he really was successful, and interesting for two reasons:

1. He actually wrote a best-selling book on real-estate that is the genuine article, and

2. He wrote (or commissioned) perhaps the very first real newspaper ‘advertorial’ (see the image, above).

According to John T Reed, an accomplished and genuine real-estate investor in his own right, William Nickerson:

… told the truth – but he did that back in 1959. His book, which is excellent, says to save money, put 25% down on rental property, renovate it, and exchange up to a bigger one and repeat the process.

Simple, but effective!

BTW: I now remember that Rich Dad, Poor Dad was NOT the first personal finance book that I ever read. It was, in fact, an old book that I found in my Dad’s book shelf. It was called something like: How I Made $1 Million In Real-Estate and was written by a Hungarian ballet dancer who either moved or defected to the USA and somehow found a lucrative ‘hobby’ in real-estate.

His system was very similar: buy one rental property, rehab, and trade up for a duplex. Repeat and trade up to a quadraplex. And, keep going!

I can’t believe that I forgot about this book, as it was the one that really fired my imagination, after which I promptly did NOTHING towards investing in real-estate for at least the next 10 years 🙁

A question I’m not sure I should answer …

Sometimes, I’m posed a question that I’m not sure that I should answer.

Case in point: Drew asked a question about my 7 Million Dollar Journey :

What were the terms of your first $1.25 million building purchase in 2001? You mentioned you had been in debt and had been losing money in your business until sometime in 2000 when you began to turn a profit. You had to have had a lot of profits quickly to put together the down payment for the building and be approved for a loan in such a short time period after years of money losing operations.

A straight-forward question, but the answer isn’t straight-forward … there’s a question of ethics and also a question of giving my readers potentially dangerous strategies.

After much uhmm’ing and aah’ing, I’ve decided that honesty is the best policy and to throw it to my readers to decide on the issues of ethics and danger:

As I mentioned, I had only recently become profitable, yet I managed to:

1. Stump up the 25% deposit on a $1.25 million commercial real-estate purchase,

2. Make the mortgage payments,

3. Make the additional lease payments on the $400k rehab and fit-out required.

Quite a tall order, so here’s how I managed it:

First, I made sure that I was profitable enough to:

i) Make the mortgage payments as and when due,

ii) Keep up with the lease payments,

iii) Pay back the deposit

Did you catch that?

Number (iii), I said: “Pay back the deposit”

You see, I actually borrowed 100%+ (i.e. the deposit, the mortgage set up fees, and the closing costs), but here is where the question of ethics and danger come into it …

… I borrowed the deposit and the closing costs from my customers!

And, here’s where ‘ethics’ come into the picture – my customers didn’t know!

You see, one of the easiest, best, but most dangerous ways to raise money, is to raise it from your customers.


It’s actually quite simple: most businesses have large inventories (the goods that you hold in stock), accounts payable (money that you owe your suppliers) and accounts receivable (money that your customers owe you).

Any and all of these have value.

For example, it’s quite a normal/accepted practice to borrow against the value of your inventory; unfortunately, your bank may not want to take the risk, and your finance broker may only give you a little money at a high interest cost because of the perceived risk (after all, do they really know how to sell the inventory if you default?).

It’s also quite normal to leverage the value in your receivables by approaching a specialist finance company to ‘factor’ those debts: that means that instead of waiting 4 to 6 weeks for your customers to pay, the finance company may advance you up to 80% of the value of those debts (i.e. your total receivables). This is, in fact, one of the businesses that I still own.

But, there is a third method that requires no bank or finance company to get involved: it’s simply to pay your suppliers slower than your customers pay you!

My business, being a services business had no stock (so no inventory finance opportunity), and factoring can have the stigma of a weak business so I didn’t want to go that route with my ‘Fortune 500’ corporate clients.

But, I did have a very tight contract that saw my largest clients paying my invoices in just 7 days (really!), yet I was only obligated to pay my suppliers in 30 to 60 days. Further, my turnover was huge (compared to my fees) because of the nature of my business.

This meant, effectively, that I had a line of finance equal to 3 to 7 weeks of my sales/turnover!

That was more than enough to raise the deposit for the building.

OK, back to my initial reticence to share this with you:

1. In most businesses, the turnover isn’t large enough, and the negotiated spread between accounts payable/receivable large enough to raise very much cash,

2. I think it’s ethical to use these funds for your business (unless you have lead your customers to believe that these funds are to be, somehow, quarantined and/or held in trust), borderline to use them for the building that houses the business (for example is the building going to be bought in the name of the business, or in a separate entity as I would normally recommend?), and unethical to use them for personal use / purchases outside the business … but, ethics is in the eye of the beholder, so YOU tell me what you think?!

3. I think it’s dangerous because your business MUST have the necessary solvency (not just profitability) to not only keep up with the payments (both mortgage and lease) as well as to ‘buy back’ the deposit over a relatively short period of time (in my case, 12 to 18 months).

So, now you are armed with a powerful – and dangerous – business financing tool. Use it wisely … and, sparingly!