Chapter One
UNDERSTANDING THE "WHY" OF REAL ESTATE
The CASHFLOW Quadrant above appeared in the second book in the Rich Dad series, Rich Dad's CASHFLOW Quadrant: Rich Dad's Guide to Financial Freedom. The "E-S" on the left side of the Quadrant stands for employees and self-employed. These two types of income earners manage personal finances the way almost all of us have been trained to do by our parents and society in general: to forge a career in an income-producing occupation and plow paycheck savings into (1) paying off bills, loans, and mortgages, (2) buying a home, and (3) investing in stocks, bonds, and retirement funds.
This financial pattern is the status quo. Our educational system doesn't teach us how to handle money. Our culture teaches us to go to school, go to work, save for retirement. So that's what most of us do. We "park" our money. If you're like most people, you remain on the left side of the Quadrant, working for your money. Other people's money isn't working for you. Your earned income-what you bring in from your job-is paying off bills and debt; what's left over goes into investments to generate portfolio income. You're not doing what those on the right side of the Quadrant do: enjoy the benefits of passive income, as described in the introduction to Part One.
Your goal, if you want to grow your wealth as quickly as possible, is to move to the right side of the Quadrant. "B-I" stands for business owners and investors. These income earners have their money working for them. Their assets are diversified among businesses, real estate, and paper (stocks and bonds). The businesses and properties in these investors' portfolios are generating passive income-meaning that other people's money, time, and energy are working for these investors, as is their own money.
This chart illustrates why the rich are getting richer. It delineates the different mentality between the two groups of investors. The employees and self-employed on the left side rely on their jobs to slowly build their estates. The business owners and investors on the right-hand side rely on their dynamic assets to accelerate their wealth. This doesn't mean that your goal in moving to the right side is to give up your primary career as an employee or self-employee. Rather, the goal is to begin putting your income into assets on the right side that will transform your earning ability and pull you out of the rat race.
Real Estate Is a Pillar of Your Investments
The three asset classes on the right-hand side of the "Why the Rich Get Richer" chart are Business, Real Estate, and Paper. Robert T. Kiyosaki's rich dad's formula for getting wealthy was to start a business, use the cash flow from that business (primarily after-tax monies) to invest in real estate, and hold that wealth in real estate and paper assets, where it will increase. All three asset classes worked for Kiyosaki's rich dad. (For those of you who don't know, Robert's "rich dad" was the father of Robert's best friend, and became Robert's financial mentor and a very rich man. Robert's father, "poor dad," was a salary earner who believed in education and company or government pensions and invested only in long-term, low-appreciating paper assets; he died poor.)
In the Accelerator column are the different methods by which you can accelerate your wealth within each asset class. An explanation of chart abbreviations: OPM is "other people's money"-that is, money from lenders, such as banks or investment partners. OPT is "other people's time." (In a business, you have employees working for you, benefiting your bottom line.) "OPM-$1:$9" refers to a real estate investor's ability to borrow from a bank or other lender nine-tenths of the cost of an investment, while using the investor's own money to cover the remaining one-tenth-an example of leveraging "good debt." PPM is "private placement memorandum," which young companies use to attract investment capital, and which can pay off handsomely. IPO is "initial public offering," which includes an attractive opening price for stock that a company issues for the first time for purchase by investors outside the company.
This book deals with the accelerators that specifically relate to real estate. You may wonder, from reading Rich Dad's Who Took My Money?, if you must start a business before investing in real estate. The answer is no. You can funnel after-tax earnings from your job (on the left side of the Quadrant) into real estate. Some people eventually make real estate investing itself their business.
As was noted in the introduction to this part, real estate as an asset can accelerate income much faster than other assets, such as paper. Real estate also affords special tax benefits. Note that Depreciation and Passive Loss are shown as accelerators in the Real Estate asset class in the chart. Passive loss-when passive income is negative-allows the property owner to write off a deduction (accountants call it a paper loss) every year based on business expenses plus the calculated cost (depreciation) of repairing a structural component or piece of personal property used in the building on your land, since these items deteriorate over time.
In sum, investing in real estate can be the key to moving you from the left side of the Quadrant to the right side. It can be the key to building your estate. But it requires educating yourself.
The easiest method of investing, albeit not usually the most successful, to build an estate is through portfolio income-simply putting your earnings into stocks, bonds, and mutual funds, either on your own or by using a tax-deferred retirement plan or by entrusting your earnings to a financial planner. That's what investors on the left side of the Quadrant do.
The most difficult method of investing is running your own business (such as a franchise, store, restaurant, or personal services company) with employees. This requires education and a time commitment, but offers a potentially far greater rate of return than portfolio (or even real estate) income. Yet running a business also entails a much greater risk. (Nine out of ten businesses fail within their first five years.)
Investing in real estate requires a bit more education than investing for portfolio income, but much less education than running a business. Also, as we'll discuss, real estate income typically provides a much greater return (as well as tax savings) than portfolio income.
To succeed in real estate, you must be prepared to wade into the water and learn from your mistakes. And you need to consider building a team of experts in order to minimize your mistakes.
When you are ready to do so, you can start realizing the benefits of leverage to amass wealth in real estate. Let's take a look at that right now in our first case.
Case No. 1 Jerry and Justin
Jerry and Justin were twin brothers. While they looked alike, had the exact same mannerisms, and could fool not only their teachers in school but their girlfriends as well, they differed in one big respect.
Justin wanted security in all things. And when it came to investing, Justin would put his money only in funds indexed to the Standard & Poor's 500, a compilation of large companies representing the U.S. stock market known as the S&P 500.
This strategy worked well for Justin because he was not forced to ever worry about extraneous issues. Yes, if the U.S. and/or global economy went into recession, his investment would be affected. But so would everyone else's investment. That was a risk we all took. Nevertheless, Justin felt safe because he was not subject to the investment risks that Jerry took.
Jerry believed in real estate. He liked the fact that he could put $10,000 down on a house and the bank would loan him another $90,000 to buy a $100,000 house. He appreciated that there were additional risks to owning real estate. He knew that while he could be sued by tenants, neighbors, and vendors, brother Justin would never be sued for owning his paper assets. But Jerry understood that asset protection strategies could limit his liability and reduce his exposure. And Jerry felt confident that the leverage of real estate would exceed his brother's return. Through the leverage offered by real estate, Jerry could own a $100,000 house asset compared to Justin's $10,000 S&P 500 fund account.
In the book a chart chronicles how well the brothers did from 1992 to 2002, a ten-year period.
While Justin's $10,000 grew to $17,397, albeit with no extraneous risk, Jerry's $10,000 investment (with the $90,000 loan) was valued at $158,673. Clearly, the benefits of leverage are worthy of further exploration ...
(Continues...)
Excerpted from Rich Dad's Real Estate Advantagesby Sharon L. Lechter Garrett Sutton Copyright © 2006 by Sharon L. Lechter, C.P.A. and Garrett Sutton, Esq.. Excerpted by permission.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site.
