UNDERSTANDING THE "WHY" OF REAL ESTATE
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
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
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 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
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
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 . . .
Copyright © 2006 by Sharon L. Lechter, C.P.A. and Garrett Sutton, Esq.