Real Estate Investing Basics

Are You Choosing to be Poor?

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Cash Flow Game

Several months ago, I was watching my six-year-old grandson for the weekend, and we were playing “Cash Flow for Kids” by Robert Kiyosaki. That’s when I noticed a small book had come with the game called, “Raising Your Child’s Financial IQ,” featuring Sharon L. Lechter (CPA) and Ann Nevin (PhD in Educational Psychology).  It’s just a small paperback, and although I’ve read many of Robert Kiyosaki’s books that were published in the series, this, harder to find, book really struck a chord.

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Although I’ve been poor, middle class, and wealthy throughout my life, I never really knew why.  To some extent we choose to be poor, middle class, or rich depending on the choices we make when each dollar comes through our hands.  This simple explanation was literally an “Ah Ha” moment for a guy who likes to think he’s a pretty sophisticated and savvy investor.

It really all begins with our personal financial statement, which is really identical to a P&L (Profit and Loss Statement) and a Balance Sheet.  The P&L displays one’s income and expenses. The balance sheet, on the other hand, displays one’s assets and liabilities. Now, the decisions made when a dollar of income comes in and is used for an expense, a liability, or an asset, determines whether we are choosing to be poor, middle class, or rich, respectively. See graphs:

poorcashflow

When I was poor, all of my income went to expenses, mainly rent. My housing was by far my biggest expense. All I focused on was my job, getting a better job, or taking on more hours at work. I didn’t have any assets or even liabilities that I thought were assets.

middlecashflow

When I became a homeowner, my job paid for the house, which was an expense and a liability. Every month, I spent money out of pocket on the mortgage, taxes, insurance, etc. I was paying for the house, but the house wasn’t making any money for me. I was working two jobs. I would live off of one income, saving the other. I began purchasing rental properties, which were assets.

richcashflow

By the time I was 42, though, I had 20 properties. The money coming in from these assets paid all of my expenses. The assets could potentially replace my income, and I was financially free. Now, when I want to purchase some type of luxury, I think about what assets I need to acquire in order to pay for the expense. For example, if I get two notes, they’ll cash flow enough to cover a Mercedes payment for my wife.

To summarize, the poor tend to spend all their money on expenses, or bills. The middle class tend to invest in things they think are assets, but they are really liabilities. And, the wealthy invest in assets that Cash Flow like real estate, notes, tax liens, businesses, startups, stocks and bonds, insurance policies, precious metals, etc.

Assets and Liabilities

I, like many people, believed that my house was my biggest asset. But, it is really the bank’s asset. The confusion is a direct result of not understanding the difference between an asset and a liability.

Liability: an entity that requires money spent each month.

Asset: an entity that produces money each month.

Question to Ponder: “If you pay off your primary residence, is it really considered an asset now?  No.  It still costs you money (taxes, insurance, and repairs), and it doesn’t make you any money (Cash Flow wise).

When I went from being poor to rich, I shifted my focus on the type of income I was bringing in and how it was being taxed. When I was a painting contractor, my $100,000 income, for that year, would be taxed approximately $30,000. The $100,000 income I made from rentals in the same year would only be taxed approximately $15,000. Up until this point, I really didn't understand the three types of income:

  1. Earned Income: You work for Money (taxed the highest, Example: Job)
  2. Portfolio Income: Money works for You (can depreciate assets, Example: Real Estate)
  3. Passive Income: Money works for You (no FICA, Example: Interest, dividends)

My priorities also shifted as I moved from poor, to middle class, to wealthy.

Poor and Middle Class                                                              Rich

#1.  Employment                                                                  #1.  Investment Portfolio

#2 . Consumption for Life’s Comfort                              #2.  Professional Satisfaction

#3.  Savings                                                                           #3.  Savings

#4.  Investing                                                                        #4.  Consumption

Some might say we really need to start teaching our kids, and grandkids, the priorities of the rich.  If you don’t have a plan for your money, someone else will.  We really need two plans for our money.  Many of us (myself included) were taught: do your homework and get good grades, so you can get a good job and earn more money.  Now that’s plan number one for your money, but where’s plan number two?

Related: BiggerPockets Presents : The Best Real Estate Books Ever

Are You Planning to Be Rich?

The reason I feel these types of games, whether for kids or adults, are so important is so one will have a plan (#2) for their money after they make it.  Have you ever heard people say, “I know I should save, but I don’t have any money left”?  Or, “I know I should invest, but investing is too risky.”  These are really just symptoms of people (like myself at one time) who have a plan #1 to make money but have no plan #2 of what to do with that money. Plan #1 would be – how to earn income, then Plan #2 – how to convert income into passive or portfolio income.  The common philosophy is that our wealth accumulation is determined by how much money we make, but it is what you do with the money and what you get the money to do for you that really matters. Income is not the real factor in becoming wealthy.

The concept of Financial Intelligence is about how much money (and assets) you keep. It’s not just the understanding of an income statement or a balance sheet, nor is it just theoretical book learning. It requires the real world application of accounting principles. I never understood it; my six year old grandson got me to understand it. When a dollar hits your hand, you determine your financial destiny.  So, what are you choosing to be?

Photo: svet

Since 2007, Dave Van Horn has served as president and CEO of PPR The Note Co., a holding company that manages several funds that buy, sell, and hold residential mortgages nationwide. Dave’s expertise is derived from over 30 years of residential and commercial real estate experience as a licensed Realtor, a real estate investor, and a fundraiser. As the latter, Dave has raised over $100 million in both notes and commercial real estate. In addition to his investments and role as CEO, Dave’s biggest passion is to teach others how to share, build, and preserve wealth. He authored Real Estate Note Investing, an introduction to the note investing business, helping investors enter the “other side” of the real estate business.

    Pablo E Guzman
    Replied over 6 years ago
    This is a phenomenal article! It’s very useful and has made a strong impact in my life just by reading it. Thank you for adding value to my day and my future.
    Pablo E Guzman
    Replied over 6 years ago
    This is a phenomenal article! It’s very useful and has made a strong impact in my life just by reading it. Thank you for adding value to my day and my future. Reply Report comment
    Pablo E Guzman
    Replied over 6 years ago
    This is a phenomenal article! It’s very useful and has made a strong impact in my life just by reading it. Thank you for adding value to my day and my future.
    Dave Van Horn
    Replied over 6 years ago
    Hi Pablo, Thank you for your feedback! I’m glad to have offered you something of value. Best, Dave
    Scott
    Replied over 6 years ago
    Excellent article Dave, thank you very much! Scott
    Tony Tran
    Replied over 6 years ago
    Dave, This is a great article! This details the concept from Rich Dad, Poor Dad quite well. When I was reading Rich Dad, Poor Dad, the concept of class: Poor, Middle, and Rich came to light. The concept of priorities made sense. The concept of class seemed so definite at one point until I ask myself the question, “How?”. That is, how to change my priorities to change class? Once a person is able to define these vehicles to changing class, the process of “transitioning” priorities come into light. Another thing to consider is the mindset change, it can be very difficult to change if people are comfortable. It is also difficult to change if people fear risks. This is why one of my philosophies is “Never be too comfortable!”. This is applicable in many scenarios. Thank you, Tony
    Dave Van Horn
    Replied over 6 years ago
    Hi Tony, I agree with much of what you said here. I go by a similar philosophy, and I’m a firm believer that the mindset change must come first. Thanks for reading! Best, Dave Reply Report comment
    Dave Van Horn
    Replied over 6 years ago
    Hi Tony, I agree with much of what you said here. I go by a similar philosophy, and I’m a firm believer that the mindset change must come first. Thanks for reading! Best, Dave
    Ben Phillips
    Replied over 6 years ago
    Well said, Dave.
    Junior S
    Replied over 6 years ago
    Great article, Dave! I’m just now learning this in my own life at the age of 24. There’s no telling what I coud’ve done had I had this mindset from day one! Great stuff!
    Dave Van Horn
    Replied over 6 years ago
    Thanks! Don’t feel too bad, I often wonder the same thing since I learned to apply this in my life MUCH later than 24! Best of luck, Dave
    Terry Pratt
    Replied over 6 years ago
    Concise and well-written summary of some major concepts in Rich Dad, Poor Dad, as well as in Cash Flow for Kids. I’m a big fan of Kiyosaki and have read most of his books including these two. But I rolled my eyes when I read Kiyosaki’s explanation for kids of the difference between renting and owning. As I recall – and I don’t think I’ve got this quite correct – he said something to the effect that renting is like buying a home, except that you don’t own it. Say what?
    Karin DiMauro
    Replied over 6 years ago
    Terry, could it maybe be that, in either scenario, the house is a liability? Whether you rent or own, you’re shelling out money and the house isn’t cash flowing for you. Just a guess. Someone far smarter than me will come along and explain soon enough. 🙂 Reply Report comment
    Karin DiMauro
    Replied over 6 years ago
    Terry, could it maybe be that, in either scenario, the house is a liability? Whether you rent or own, you’re shelling out money and the house isn’t cash flowing for you. Just a guess. Someone far smarter than me will come along and explain soon enough. 🙂
    Dave Van Horn
    Replied over 6 years ago
    Hi Terry, Thanks for reading! What I take from Kiosaki is that my renters are “buying” the property for me. Their rent pays off my mortgages. So they are, in essence, buying a home, but it’s not for them–its for their landlord. Best, Dave
    Terry Pratt
    Replied over 6 years ago
    Concise and well-written summary of some major concepts in Rich Dad, Poor Dad, as well as in Cash Flow for Kids. I’m a big fan of Kiyosaki and have read most of his books including these two. But I rolled my eyes when I read Kiyosaki’s explanation for kids of the difference between renting and owning. As I recall – and I don’t think I’ve got this quite correct – he said something to the effect that renting is like buying a home, except that you don’t own it. Say what?
    Ryan Ebanks
    Replied over 6 years ago
    Dave, I think you hit a home run with this one. How can we advance the next generation – by educating them the right way putting them on the correct side of the cash flow quadrant. It requires migration from the typical socialization — which takes time. So the earlier the better.
    Dave Van Horn
    Replied over 6 years ago
    Couldn’t agree more! Thanks for reading, Dave
    Karen Rittenhouse
    Replied over 6 years ago
    Fabulous post! I remember the first time I really understood the concept that, “your income is not important, so stop thinking about it.” What matters is what you keep, not what you make. When our conversation transformed from “what do you make in a year” to “how much do you increase your net worth in a year”, our lives changed. Thanks, Dave. Great job.
    Dave Van Horn
    Replied over 6 years ago
    Thanks Karen, appreciate the positive feedback! It’s good to hear other people are having that conversation. Best, Dave
    Rob
    Replied over 6 years ago
    Great post, I definitely agree we focus too much on how much we make, rather than what we could make. Thanks for sharing!
    Deepta Hiremath
    Replied over 6 years ago
    Dave: Excellent article. My kids already love the interest concept. Very well said. Still love playing the cash flow game which is available online. Deepta.
    Dave Van Horn
    Replied over 6 years ago
    Deepta, Good point. I think this is the link for anyone who’s interested: http://www.richdad.com/Rich-Dad-Games/cashflow-for-kids.aspx Dave Reply Report comment
    Dave Van Horn
    Replied over 6 years ago
    Deepta, Good point. I think this is the link for anyone who’s interested: http://www.richdad.com/Rich-Dad-Games/cashflow-for-kids.aspx Dave
    Jeff Brown
    Replied over 6 years ago
    You’ve helped a lotta people, Dave.
    Kent Anderson
    Replied over 6 years ago
    Well said and solid information for all to learn from. Thanks David.
    Laurie Tardif
    Replied over 6 years ago
    I learned this later in life than most of the folks posting here. But it’s never too late to change, improve and grow. Now I’m teaching my kids. Kiyosaki’s book “Why A Students Work for C Students” is also very good. What a great concept – with every dollar that passes through your hand, you make a choice to be richer or poorer. Thanks for the article.
    Dave Van Horn
    Replied over 6 years ago
    Hi Laurie, Same here, and you’re right on the money about it never being too late. And I haven’t read that one by Kiyosaki, I’ll definitely have to check it out. Thanks for the recommendation! – Dave
    Louis Chris Orona
    Replied over 6 years ago
    Dave, Awesome article. I read Robert Kiyosaki’s series of books starting when I was 16. At the time my parents were dabbling in MLM, and I have fallen into certain MLM patterns due to the ease of running a business with OPM and a setup company structure. Now, I’m really seeing my problem in starting and running my business: no plan #2. 🙂 Got me thinking, as I already knew that I think “poor”, but constantly look for outlet to move up in this economic class status. Thanks again! -Chris
    Adrian
    Replied over 6 years ago
    Dave, Thanks for the post. I agree with the others that this is a good summary of RDPD. However, I disagree with that book’s analysis in every aspect. First, an asset is (in relevant part, from Dictionary.com): 1.a useful and desirable thing or quality: Organizational ability is an asset. 2.a single item of ownership having exchange value. Note that a house qualifies under this definition. A liability is (again in part and from Dictionary.com): 1.liabilities. a.moneys owed; debts or pecuniary obligations (opposed to assets ). b.Accounting. liabilities as detailed on a balance sheet, especially in relation to assets and capital. Note that the house does NOT qualify as a liability. The mortgage on a house may qualify. Maintenance on a house may qualify. But not the house itself. In addition, the implication from RDPD is that a house is a bad thing to have. Given that you have to live somewhere, I think most would agree that it is better to own than rent. With regard to the descriptions of the balance sheets of the poor, middle class, and rich, they are correct as far as cash flow goes, but imply that all you have to do to be rich is stop spending money on expenses and spend it on cashflowing assets instead. This is a great idea, but someone at the bottom of the economic ladder doesn’t necessarily have the ability to do that. I think the better advice for that person relates to increasing income and lowering expenditures to start saving up for those desirable cashflowing assets. Finally, to clarify, your taxation example may be read to imply that all real estate income is taxed at a lower rate. Although it MAY be, for someone doing flips in their spare time, turning houses over in 90 or 120 days, it will probably be taxed as ordinary income. Hope this doesn’t come across as a rant or criticism; I do like your post. Adrian
    Dave Van Horn
    Replied over 6 years ago
    Hi Adrian, I appreciate your honest feedback. I certainly agree that there are multiple definitions of what an “asset” could be, but I think that in regards to Kiyosaki’s philosophy he means only cash flowing assets. Maybe it’s just a matter of semantics, but if he said “cash flowing assets” instead, his definition may have been more appropriate. You are also right that a house can be an asset, but it can also be a liability in my opinion. Example: one of the houses I own costs me more than it’s worth. If a house is upside down, how is it not a liability? I don’t quite recall RDPD saying that having a house is bad thing to have, I think he was stating the common idea of many people feeling like their house is their biggest or only asset and that can be a problem. I also don’t necessarily believe that owning is better than renting—in fact, I rent the house I live in now rather than owning it for a multitude of reasons (I wrote an article on the very subject: https://www.biggerpockets.com/renewsblog/2013/04/17/renting-owning/). With regards to the income statements and balance sheets, I wanted to stress these cash flow patterns because I do feel that many people (as I was) are unaware of how much the placement of their money can affect their overall financial growth. I think that to an extent, we do decide where the money goes, but this is not to say that this decision is not influenced by many factors. And this is also not to say that everyone is afforded the ability to change their lifestyle. One of the drawbacks of Kiyosaki’s writing is that he talks in generalities, but it’s hard to write such a broad book without doing so. Once again, thanks for your comment and I’m glad that you liked the article. Best, Dave
    Dave Van Horn
    Replied over 6 years ago
    Hi Adrian, I appreciate your honest feedback. I certainly agree that there are multiple definitions of what an “asset” could be, but I think that in regards to Kiyosaki’s philosophy he means only cash flowing assets. Maybe it’s just a matter of semantics, but if he said “cash flowing assets” instead, his definition may have been more appropriate. You are also right that a house can be an asset, but it can also be a liability in my opinion. Example: one of the houses I own costs me more than it’s worth. If a house is upside down, how is it not a liability? I don’t quite recall RDPD saying that having a house is bad thing to have, I think he was stating the common idea of many people feeling like their house is their biggest or only asset and that can be a problem. I also don’t necessarily believe that owning is better than renting—in fact, I rent the house I live in now rather than owning it for a multitude of reasons (I wrote an article on the very subject: https://www.biggerpockets.com/renewsblog/2013/04/17/renting-owning/). With regards to the income statements and balance sheets, I wanted to stress these cash flow patterns because I do feel that many people (as I was) are unaware of how much the placement of their money can affect their overall financial growth. I think that to an extent, we do decide where the money goes, but this is not to say that this decision is not influenced by many factors. And this is also not to say that everyone is afforded the ability to change their lifestyle. One of the drawbacks of Kiyosaki’s writing is that he talks in generalities, but it’s hard to write such a broad book without doing so. Once again, thanks for your comment and I’m glad that you liked the article. Best, Dave
    Adrian
    Replied over 6 years ago
    Dave, I think the distinction is that the house itself is an asset, while the mortgage (which may be more than the value of the house) is a liability. I agree that sometimes renting can make more sense than owning, but I think those are special cases. As in your article, banks generally are not requiring 50% down (at least here in Colorado), and I can’t understand why a place that costs $1m to own would rent for $2300/mo. The owner is obviously taking a huge loss. Adrian
    Matthew
    Replied over 6 years ago
    The Rich Dad, Poor Dad books are an oversimplification, but that simplicity allows him to drive his points home much more clearly. Yes, technically a house is an asset as it generates value for the owner (place to live, can be sold). As far as renting versus being an owner-occupant, when many people convert from renting to owning their own home, they typically buy a larger home with larger expenses (mortgage interest, taxes, association fees, insurance, etc), partly because they view these payments as an investment, not consumption. I’ve seen this pattern with almost everyone I’ve known in their 20’s or 30’s. For example, a couple goes from a 2/2 townhouse renting for $750 to a small 3/2 sf house with monthly expenses of $1200. Either way, as you point out, they need a place to live. It’s just that now they are paying more to live in a nicer place. If the couple were to buy a place similar to what they were previously renting, they would probably save some money each month due to no longer paying rent. Ironically, for expensive houses, renting probably does make more sense than owning. You gave a good example with the $1 million house renting for $2300 per month. For very expensive houses, the rental market is small compared to the owner-occupant market, so the costs of owning tend to be higher than the costs of renting. As you noted, that means the landlord is taking a bath each month, basically subsidizing their tenants. This situation occurs because the owner needed to move but can’t or doesn’t want to sell their house. They may have moved for a job, and the house is under water or they plan to return in a few years. Again, you are correct that Rich Dad/ Poor Dad books are an oversimplification and his definitions do not completely match those used in accounting. But that simplification allows him to drive his points home.
    Robert Steele
    Replied over 6 years ago
    “And, the wealthy invest in assets that Cash Flow like real estate, notes, tax liens, businesses, startups, stocks and bonds, insurance policies, precious metals, etc.” I have a bunch of precious metals. Please tell me how I can make them cash flow 🙂
    Robert Steele
    Replied over 6 years ago
    “And, the wealthy invest in assets that Cash Flow like real estate, notes, tax liens, businesses, startups, stocks and bonds, insurance policies, precious metals, etc.” I have a bunch of precious metals. Please tell me how I can make them cash flow 🙂 Reply Report comment
    Robert Steele
    Replied over 6 years ago
    “And, the wealthy invest in assets that Cash Flow like real estate, notes, tax liens, businesses, startups, stocks and bonds, insurance policies, precious metals, etc.” I have a bunch of precious metals. Please tell me how I can make them cash flow 🙂
    Dave Van Horn
    Replied over 6 years ago
    Robert, I agree with you that precious metals usually don’t cash flow in the true sense of the word (although it is possible to borrow against them and invest that capital, or receive dividends from a precious metal fund) But, on their own, they are still a hedge against inflation and a good thing to have in your portfolio. Best, Dave
    djopgenort
    Replied over 6 years ago
    Other “poor person” traits are having no idea where all the money went, every dime is spent BEFORE it arrives, and if there is any extra money it gets spent (quickly! irretrievably!) before anyone can guilt them into being responsible with it.
    Toshia
    Replied over 6 years ago
    Thank you for the this!
    Lenny Longo
    Replied over 6 years ago
    Awesome article, thank you. I will share this with a few people! Reply Report comment
    Lenny Longo
    Replied over 6 years ago
    Awesome article, thank you. I will share this with a few people!
    Lenny Longo
    Replied over 6 years ago
    Awesome article, thank you. I will share this with a few people!
    Dave Van Horn
    Replied over 6 years ago
    Thanks Lenny! Please do! Best, Dave
    Shaun
    Replied over 6 years ago
    I really enjoyed this. It has been a long time since I’ve read RDPD and this reminded me of eloquently simple he makes these basic concepts to adjust your thinking away from the poor person mindset. That won’t get you to great wealth alone but is a critical first step in the process. Little of Kiosakyi’s stuff gives great “how to” information and isn’t intended to. If you want to criticize him for that or get all Merriman- Webster on him you are missing the point and aren’t reading the right stuff for you.
    Shaun
    Replied over 6 years ago
    I really enjoyed this. It has been a long time since I’ve read RDPD and this reminded me of eloquently simple he makes these basic concepts to adjust your thinking away from the poor person mindset. That won’t get you to great wealth alone but is a critical first step in the process. Little of Kiosakyi’s stuff gives great “how to” information and isn’t intended to. If you want to criticize him for that or get all Merriman- Webster on him you are missing the point and aren’t reading the right stuff for you.
    Nathan Buss from Columbia, Illinois
    Replied about 5 years ago
    Thanks. This was very useful. Rudimentary concepts like these somehow seem to pass by all of us as we get through grade school and high school. Even many college graduates do not understand these concepts let alone apply them to their own life.