[CEO. Freedom from Bad Debt]. Lesson #4: What Asset Does Your Banker Love the Most? A radio host asked me, “What do you invest in?” I replied, “I began investing in real estate in my twenties, so the bulk of my investments is in real estate today. I also own businesses and some paper assets such as stocks and bonds.” The interviewer then said, “I don’t like real estate. I don’t want to fix toilets and receive phone calls late at night from tenants. That is why I don’t invest in real estate. Everything I have is in stocks or mutual funds.” He then ended the interview, cut to a commercial break, and I was ushered out of the studio. An Expensive Idea Later that evening, I reflected on that interview. I said to myself, “What an expensive decision that radio interviewer has made. He does not want to invest in real estate because he does not want to fix toilets or receive phone calls late at night. I wonder if he knows how much that single idea is costing him?” The four primary asset classes a person can invest in are: 1. Businesses 2. Real estate 3. Paper assets 4. Commodities As I sat there quietly that evening, I could hear rich dad saying to me, “Which one of the four asset classes does my banker love the most?” The answer is real estate. Of the four asset classes, it is very difficult to receive a loan to start a small business. You might get a small-business loan, but those loans often require you to pledge your other assets as security. It is also very difficult to get your banker to lend you money to buy paper assets or commodities, especially for 30 years at a low interest rate. But your banker will loan you the money to buy real estate. Years ago, rich dad said to Mike and me, “If you want to be rich, you must give your banker what he wants. First, your banker wants to see your financial statements. Second, a banker wants to lend you money to buy real estate. Just know what your banker wants, and you’ll find it easier to become rich.” The radio host’s prejudice against real estate was an expensive idea because he will have to use his own, after-tax dollars to buy his stocks, bonds, and mutual funds without being able to leverage his banker’s money. He has to use the most expensive money of all, his own money that comes from his own labor, and only after the government has taken its share in taxes. Let’s use a $10,000 example to illustrate this point. If the radio host buys mutual funds, all he can buy is $10,000 worth. If the host were to buy real estate, he could buy a $100,000 property with the same $10,000 and $90,000 borrowed from the bank. If the property has a positive cash flow, the tenants’ payments will cover all expenses and the cost of the bank’s mortgage and will also provide some monthly income. Let’s say the markets are good and each asset goes up 10 percent that year. The mutual funds will gain $1,000 for that investor. The real estate will gain $10,000 for the investor, plus the monthly income from cash flow, plus depreciation. If the investor chooses to sell the property, there is no capital-gains tax in America if a tax-deferred exchange is used at the time of sale. The mutual fund probably does not have any cash flow, is not entitled to depreciation benefits, and is taxed at a capital-gains tax rate if it is outside a retirement plan. (If it is inside a retirement plan, it will be taxed at the highest tax rate of all, the ordinary earned income-tax rate, when it is finally withdrawn.) This is not to say that paper assets are bad, but to illustrate the cost of an idea such as, “I don’t invest in real estate.” To me, the biggest expense of all is personal freedom. For Kim and me, the best thing about real estate is the monthly passive cash-flow income, taxed at a lower rate than ordinary earned income, which allows us to be financially free. In other words, real estate allows us to have good debt, and good debt is debt that makes us richer quicker. But in utilizing leverage, the bank’s money, to get richer quicker, there is a price to pay. If you look at the returns on your capital using no leverage, your return on $10,000 is 10 percent. But by using the bank’s money, your return is 100 percent on your money. The real estate market would need to go up by only 1 percent to have the same return as the paper market going up by 10 percent. When you factor in the tax advantages, the real estate market can improve by less than 1 percent and have the same net return as a paper market improving by 10 percent. Those are some of the reasons why rich dad said, “Always give the banker what he wants.” And why he also issued these words of caution, “Always treat any debt as you.
Posted on: Sat, 03 Aug 2013 02:41:39 +0000
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