How I Built My Ark

CASHFLOW 101 not only teaches the basics of financial literacy, but the edu cational game also points out the four different levels of investing found in the real world. In building our ark, Kim and I followed the real-life invest ment plan found in the game itself.

On the CASHFLOW game board small deal investment cards and big deal investment cards are found. When most investors start out, they start out with small deals. Of course there is always the egotist, just as in real life, who wants to start with a big deal, even though they do not have any money.

In real life, in the early 1970s, I purchased my first piece of investment real estate. It was an $18,000 condominium on the island of Maui. Even though I did not have much money, I was able to buy three of those $18,000 condominiums, raising investor money for the down payment. I then sold them for $48,000 each in less than a year, netting me $90,000, which was split between myself and my investors. I made more that year from my investments than I did at my job at Xerox and, from then on, I was hooked on learning to become a better investor.

In real life, Kim purchased her first investment property in 1989. It was a two-bedroom, one-bath rental home that sold for $45,000. It took a $5,000 down payment and she made approximately $25 a month positive cash flow.

Although Kim was very nervous, she gained a tremendous amount of expe rience, experience that serves her well today.

Today, we continue to do a few small deals. I wrote earlier about investing in municipal mortgage REITs, which pay a 7.75 percent tax free return on our money. While most people are only receiving 2 percent taxable interest from their banks, we receive nearly a 12 percent effective return on our money. In order to play this investment, you must watch stock market trends and the short-term interest rates dictated by the Federal Reserve Bank. That means every time someone like Alan Greenspan talks, you had best listen.

Once a CASHFLOW player has made some money from investing in small deals, they are now ready to take on bigger deals.

Kim and I did this in real life. After we had purchased nearly twelve small properties, we were ready to sell them through a tax-deferred 1031 exchange, which means we did not have to pay the capital gains tax that stock investors often have to pay. After we sold our twelve small deals we were ready to move on to bigger deals. With the proceeds from those small deals we purchased two larger apartment houses and we were able to retire in 1994. In other words, it took Kim and me less than five years to move from small deals to big deals and retire.

After we retired we began looking for other big deals, capitalizing on our experience. Following are examples of other types of big deals:

PREPs. Kim and I like to invest in private real estate partnerships, or what we call PREPs. No one else calls them that. It is simply a code name we gave to this form of real estate investing. A PREP is more often called a real estate syndication and is simply a private partnership that is formed to buy a large real estate investment.

The following is an example of a PREP. In an earlier book I wrote about wanting to buy a new Porsche for $50,000. Instead of wasting my money on the Porsche, which is a liability, Kim and I pooled our money with nine other investors, raising $500,000 equity, and purchased a mini-storage warehouse with the mortgage financing coming from a bank.

That warehouse paid each partner approximately $1,000 to $1,400 a month in cash flow. I do not know what the other partners did with their monthly cash flow check but Kim and I used our checks to make the monthly payments for the Porsche. After three years, the mini-storage warehouse was refinanced. We then got our initial $50,000 back, which we reinvested in another PREP. And we continue to receive our monthly cash flow, which has grown to approximately $2,000 a month, since the rents went up. If the property were sold today, we stand to make an additional $100,000 to $200,000 from capital gains . . . and I still have the Porsche. This is an example of an asset buying our liability and helping us with our early retirement. Since we no longer have any money in the investment, and we still receive our $2,000 a month, what is our new ROI (return on investment)? Infinite.

Kim and I invest in one or two of these types of PREPs a year. Our aver age returns are 15 percent to 25 percent cash-on-cash returns, plus the off setting depreciation deductions, which are not really losses but phantom cash flow. This can easily put our returns in the 50 percent or more range. Try doing that with most mutual funds.

We like these investments because the risk is shared, we use our banker's money, the investment is secured to real estate, we receive monthly cash flow, there is a strong potential for capital gains if the property goes up in value, the income is tax-advantaged, and the capital gains are tax-advantaged at the time of sale. Most stocks and mutual funds do not offer such tax advantages, steady cash flow, or security.

The latest PREP Kim and I invested in was a 240-unit apartment building that pays a 15 percent tax-advantaged return, which is comparable to a 30 percent taxable return, with capital gains potential. We are in this partner ship with three other investors.

But best of all, in a little over three years we will have all of our initial in vestment back, we will still own the property, still receive the monthly cash flow, and then be able to go out and use the same initial investment money to do it all again on another property!

Triple net lease real estate. A similar big deal, but a slightly different invest ment, is called a triple net lease. Kim and I like these investments for many reasons. The reasons are:

1. Triple net lease investments are often in excellent commercial loca tions, such as a street corner of a busy intersection.

2. The tenant is often a public company such as a major drugstore, fast food franchise, or national retail chain. That means the cash flow is often steady and secure.

3. The tenant is responsible for everything. Triple net means that in addi-tion to their lease payment, the tenant pays for the maintenance of the building, the insurance, the taxes, and structural repairs. For those who hate the idea of managing and maintaining real estate, these triple net investments are the best. The problem is, these investments require a rich investor.

While the steady cash flow is excellent, the risk is low and the tax advantages are great. But the main reason Kim and I invest in such properties is to own the land at the corner of the intersection. Once the lease is up, in fifteen to twenty years, that piece of corner land at the busy intersection should have increased tremendously in value. One of the reasons McDonald's is such a rich company is not because it sells a lot of burgers but because it owns the land at some of the best intersections in the world.

A friend of mine recently took an early retirement and cashed in his 401 (k) with $3 million in it, prior to the crash of 2000. He took $1 million and purchased a publicly traded famous hamburger franchise (not McDonald's) triple net lease property. He did not take out a loan. He simply paid the $1 million dollar price and retired. His $1 million dollar investment pays an 8.5 percent annual return, which means he receives approximately $85,000 a year tax-advantaged cash flow, which increases every five years. In other words, his 8.5 percent tax-advantaged return is similar to receiving a 17 percent return from the stock market each and every year.

The difference is, because he can count on this money regardless of whether the stock market goes up or down, he sleeps well. Each month the money is wired to his bank account, and at the end of twenty years, he will own a great piece of real estate he can pass on to his children and grandchildren. While 8.5 percent is not a great return to me, for him it is a smart and secure return. I do not know what he did with the remaining $2 million but I think most went to pay taxes and to pay for his new boat.

If you are tired of the ups and downs of the stock market, and wondering how the rich feel secure, just drive to a busy intersection and look at the commercial buildings on each corner. The chances are the buildings (including the drugstore, the supermarket, and the fast food franchise) are owned by a single investor. They do not own the business, just the build ing and often the land under the business, without the headache of run ning the business or maintaining the property. Instead, each month while millions watch the ups and downs of the stock market, that triple net in vestor is having a check wired to his or her bank account each month. To me, that makes much more investment sense.

The beauty of this type of investment is that you receive the monthly cash flow, your tenants pay for the debt on the property, and in the end you own the underlying real estate so you also benefit from the appreciation dur ing the term of the lease.

There are two issues with triple net lease purchases. One is that they usually require a substantial down payment. The second problem is that most financial planners who sell mutual funds and insurance do not recommend them because they do not make a commission on such investments. I have heard financial planners say that these real estate investments are risky and instead they recommend a diversified mutual fund portfolio . . . which to me is extremely risky. To invest in these investments, you will need to find an experienced commercial real estate broker with at least five years of experience, and do not be afraid to ask to speak to satisfied clients, if he or she has any. As with any investment, there are good and bad triple net lease purchases.

A real-life investment we just turned down. The following is an example of an investment I recently looked at but turned down because it did not return enough money.

The real estate was a newly built supermarket in the Midwest. The tenant is a public company with excellent credit. The company does $15 billion in sales, it has three thousand grocery stores and two thousand conve-nience stores.

Although this was a very safe and secure investment, Kim and I turned it down because it was not a great investment. We turned it down because we can find investments with higher returns sitting on better pieces of real es tate. The location of this property was not as solid as we like to see in a triple net lease. If you have a prime location, even if your tenant defaults, you should have an easier time releasing the property.

A point to remember here is that both Kim and I started with small deals. But as our wealth grew, so did our experience and hence the size of the investments, the security, and the higher returns. In other words, it is education and experience that ultimately makes a person richer and richer. Kim and I tend to add two such investments to our ark each year so our passive income increases each year. That is the power of education and experience. Many mutual fund investors would love to receive $200,000 passive income each year for twenty years, rather than sweat the ups and downs of the stock market. If you can do just five of these big deals in your lifetime, you could easily earn over $1 million a year for as long as you live.

As many of you know, the CASHFLOW board game has two tracks. One is the rat race and the second track is the fast track. In real life, investments on the fast track are by law reserved only for the rich. The following are some reallife examples of investments Kim and I have added to our ark since our retirement in 1994.

Being entrepreneurs, we also like investing in small start-up companies that have the potential of going public. Along the way we have invested in two oil companies, one silver company, a gold company, and a consumer products company. One oil company ran into trouble when it failed to strike oil and ran out of money. The other oil company discovered gas and is now being acquired by a publicly listed company. The silver company was acquired by a company listed on the Toronto Stock Exchange in 2001 and is beginning to attract investor attention. It is in production and has cash flow from the ore it sells. The gold company has secured rights to an advanced exploration project with a resource of 3 million ounces of gold and is set to go public in 2003 through an IPO. The consumer products company is also set to go pub lic in 2002 through a reverse merger.

Most of these small start-up companies have taken four to five years to develop, to get them ready to bring to the market. I wrote about this process of starting companies and getting them ready for the public markets in book number three, Rich Dad's Guide to Investing. I remember after the book came out in 1999 a few people commented that I was wasting my time starting gold, silver, and oil companies. The reason was because the hightech boom and dot.com boom was on. Today, due to changes in market conditions, gold, silver, and oil are coming back into favor. Again, an en-trepreneur must have vision and be able to build a company for a market five years out.

Going Public: The advantage to building a company and taking it public is that because the founders receive the largest blocks of shares at very favor-able prices, prices as low as $.02 a share to $.25 a share. One may be able to buy a substantial percentage of the company at that price. After the stock goes public—and let's say the share price hits $3 a share—the founders can begin to sell a few shares to recoup their initial investment and go on to reap the benefits of a growing public company. Of course, these are the riskiest of all investments in the stock market and only the very rich or the very savvy should invest in such companies. This end of the stock market is where most of the crooks and con men hang out. That is why if you should venture into this market, your business and investment training must be the best. If your business and investment skills are limited, you may fall prey to these crooks and con men or, even worse, become one of them.

After a person has their millions securely stored in their ark, they are ready to move on to CASHFLOW 202, the game that introduces the fundamentals of technical investing. Although many people who are not rich play the options market, I chose to follow my rich dad's advice and waited until I had a steady source of cash flow before playing this high-speed game involving paper assets.

I personally feel picking stock and mutual funds is the riskiest of all in vestment strategies. I would rather have steady cash flow from a business and real estate, or use options to protect my positions in volatile markets. But that is just my opinion.

One of the benefits from playing both CASHFLOW 101 and 202 multiple times is that you too can begin to see the four different levels of investments and find out how you too can learn to invest for greater returns, steady income, and with far less risk. Of course, to invest in the four levels will require that you commit to studying for a number of years to gain your education and experience. If you are not willing to invest in your education, then investing in mutual funds or picking stocks is much safer than the four other levels of investments.

When you look at my CASHFLOW board game, you notice that there are two tracks. The small circular track is fondly called the rat race, which is where 90 percent of all investors are. The larger outer track is called the fast track. Kim and I invest in primarily investments from the fast track. They are not invest-ments for the average investor. If you talk to most financial advisors they will say that the investments that Kim and I invest in are far too risky and should not be invested in. I agree. They are too risky for the average investor. Yet they are not risky if you educate yourself and gain experience on the B and I side of the quadrant. If you do gain the education and experience on the B and I side of the quadrant, you may find that these investments are the safest, highest yielding, most exciting investments in the world . . . but you must do your part.

Over the years, Kim and I have lost money in businesses and in these other types of investments. We have had businesses not succeed and we have invested in private investment partnerships that failed. In the last five years, we have lost approximately $125,000 in such ventures. We have also made tens of millions of dollars during that same period of time. So our ed ucation and experience continue.

The point in sharing descriptions of our investments is not to brag but to encourage and inspire some of you to begin your journey to greatly improve your financial education and find your way to financial freedom. While we agree that these investments are too risky for most people, with the proper education and experience we have found these pathways to actually be the safest and most secure. We have also found that it is not the investment that is necessarily risky but in most cases it is the investor that is risky.

If you do not have the money to invest in these investments, then I often recommend you keep your daytime job and start a part-time business. Read the book Protecting Your #1 Asset: Creating Fortunes from Your Ideas by Michael Lechter. The greatest fortunes have been created through building businesses. If you do not have the money to start a business or lack the experience, then join a network marketing company with a great educational plan to teach you and give you the opportunity to gain the money to invest with. When people say to me, “I don't have the money,” I often reply with, “Then start a part-time business.” Some do, but most would rather still say, “I don't have the money.”