There is a common misconception in the investing world: debt is the enemy of both personal and business finances. After all, if you are saddled with debt, you will not have resources available to grow, and will subsequently collapse. While convincing in theory, there is one flaw: not all debt is the same. There is a huge difference in paying for a luxury automobile that you only use in the summer months and paying for a work truck that helps create income. Bad debt is what will drag your business down, but good debt can help grow your business.
A debt is an obligation to someone or something for a service already received. In the case of mortgage, school or car payments, you have already received the goods and you will repay them for years to come. In its simplest form, any debt should be evaluated in terms of what you receive from it. The most successful people in real estate understand that a good property, even with its debt, is not considered bad debt. If you have a rental property, you have your tenants paying down the debt for you in the hopes that you will eventually be freed of this obligation years down the road. Instead of having a massive expense, you are leveraging your debt into an asset.
Regardless of what business you are in, you are going to have expenses. Some expenses, should directly or indirectly lead to revenue in the form of sales. It is the items such as rent space, automobiles, lavish meals and other poor spending habits that will leave you with nothing to show for them except a large monthly payment obligation. It is not the expenses that cause a business to take a step backwards, but the type of expenses. Before you spend any money on your business, you need to evaluate exactly what you are getting out of it. This doesn’t mean you are cheap or frugal, but you know where every dollar in your business is going. Just by trimming the fat, so to speak, and avoiding expenses that offer nothing in real value, you will have more money to allocate.
Real estate, for all intents and purposes, is a good debt, as it should turn into an asset. When the mortgage market collapsed and the housing crisis started, many investors were forced to walk away from the business because they did not plan for the worst and were overextended on their liabilities. Once their tenants stopped paying, they had no other means to pay the mortgage and quickly lost their properties. The debt became a bad one because they were no longer making money on the property and the risk greatly outweighed the reward. In today’s market, the mortgage programs require you to put money down on the property in order to purchase. This leads to instant equity, but it also leads to lower monthly payments and increased cash flow. You now have a much greater chance at your payments being much lower than your monthly income. The best part is that you are not limited in doing this only once. You can buy as many properties as your lender will allow, or many more if you have access to private money lending. There is no cap on the amount of good real estate debt you can have and you can constantly keep the cycle going.
As much as good debt can afford you wealth and cash flow, bad debt will tear your business apart. If you open a new credit card to put furniture in your office or lease a new car in order to boost your status, this debt is like a black hole. You are getting absolutely nothing from these items, but paying them every month. Once this debt is opened, you now need to work twice as hard and generate more revenue just to offset these expenses. In order to stay afloat, you will take from other areas that may need the money to help your business grow. These items have no appreciable value and you will get nothing for them. You can make the case that a business lunch or dinner with a potential work partner will give you some return, but there is little justification for furniture or an automobile. There are better ways to spend your money.
Once you have excessive debt, it opens the door to get caught in a debt cycle that could prove to be too difficult for you to get out of. If you are behind on your payments, you will look to open more debt to pay liabilities. There is nothing wrong with treating yourself and rewarding a successful deal, but this should only be done with excess capital and not with debt that will become a long term burden. Business is all about the choices you make. If you do not think about what long term debt problems you may be creating, you can find yourself in trouble down the road.