Start A Business AFTER The Collapse
Everybody loves a bargain. Everyone knows the best time to go shopping is when the things you want are on sale. If Walmart was having a 50%-off sale, you couldn’t even get into the store. Unfortunately, most people shop for things that make them poorer, things like new flashy cars, new clothes, and jewelry. But the rich shop for bargains that make them richer. They wait for stock market crashes to buy the best stocks at bargain prices. They’re poised for crashes so they can buy real estate at bargain prices. They buy gold and silver, and businesses, at bargain prices.
That is what happened when the real estate market began to crash in 2007. Millions of people thought they were rich because they had equity in their homes—equity that many people had used as their personal ATMs. And then, suddenly, the market crashed and they were upside down. They’ve owed more on their home than it was worth. Overnight, they were poor. Many lost everything.
The reason why 90 percent of people lost money when the real estate and stock markets began crashing in 2007 is that instead of playing the game of cash flow, they played the game of capital gains. People who play the game of capital gains are often hoping the price of their home will go up or that the stock market will go up. However, someone who invests in cash flow does not really care if the market or the price of a house goes up or down.
Cash flow investors wait for market crashes. Fools run and hide and the real investor comes out of hibernation, looking for bargains.
My rich dad said, “When the ‘money high’ hits, people feel more intelligent, when in fact they are becoming more stupid. They think they own the world and immediately go out and start spending money like King Tut with tombs of gold.”
My tax strategist once said to me, “I have been an advisor to many rich men. Just before they go broke after making a ton of money, they tend to do three things. One, they buy a jet or big boat. Two, they go on a safari. And three, they divorce their wife and marry a much younger woman. When I see that happening, I begin preparing for the crash.” Again, much like reason number one, they buy liabilities or divorce an asset, which then creates a liability. Then they marry a new liability. They now have two or more liabilities.
Phantom Income: Income of the Rich
Describing phantom income is like attempting to describe a ghost in a room. Phantom income is the income of the very rich. It is income that very few people are aware of. Without real financial education, most people are blind to phantom income. But phantom income is how Kim and I survived after the real estate market crash in 2008.
At the suggestion of my rich dad, I started my financial education by taking classes on real estate investing. At the time, I was still flying for the Marine Corps. One night, after a night mission, I returned home to my condo in Waikiki. It was late and I turned on the TV, and caught an infomercial on real estate investing. The promoter promised to teach me how to buy real estate for “no money down.” Since Marine Corps pilots did not make much money, the idea of buying real estate, in Hawaii—some of the most expensive real estate in the world—for no money down interested me. I called the number on the TV screen and made a reservation for the initial “free seminar.”
The instructor at the three-day seminar went far beyond how to find and buy property for nothing down. Like my rich dad, he spoke about phantom cash flow—the invisible income. He taught, “Phantom cash flow is the real income of the rich. Phantom income is the income the poor and middle class cannot see.”
In other words, he was saying phantom cash flow is not ordinary, portfolio, or passive income—income you can see. Phantom cash flow is invisible to people without financial education. Phantom cash flow is an invisible income, a derivative of debt and taxes.
When people put money down, a deposit, on a house, they generally use after-tax dollars. For example, let’s say a $100,000 property requires a 20% down payment. That means the property buyer must come up with $20,000. If the investor is in the 40% income tax bracket, that $20,000 really cost the investor approximately $35,000 in ordinary income or paycheck money. Approximately $15,000 went to the government in taxes.
The question is: What if the investor borrowed the $20,000, rather than used his or her own, after-tax paycheck money? The answer is the investor saved $15,000. The $15,000 is phantom income, money the investor did not have to work for, did not pay taxes on and did not have to save.
Examples of phantom income…
1. Debt is tax-free money.
The phantom income from debt is the time and money you save renting money rather than working to earn it, paying taxes on it, and saving it.
The example used earlier explained how a $20,000 down payment really costs $35,000 in ordinary income. The $15,000 difference is phantom income—money and time saved.
You can get richer faster if you know how to use debt as money.
2. Appreciation is phantom income.
Appreciation occurs when the price of a property goes up. For example, a $100,000 property increases in value to $150,000. The $50,000 is phantom income known as appreciation. The problem is that most people have to sell the property to get their hands on the $50,000. Selling triggers a taxable event, capital gains taxes. Rather than sell a property, Kim, Ken McElroy and I have a different strategy. We pull out our $50,000 in appreciation through debt, rather than sell the property. Homeowners do this all the time—it’s called a home equity loan. The appreciation, the phantom income, comes out as debt and into our pockets tax-free.
The big difference is that the tenants pay the interest expense on the $50,000 on our rental property. In the case of a home equity loan, the homeowners themselves pay the interest on the loan.
More often than not, many homeowners take the $50,000 loan and pay off credit card debt and other higher-interest loans, like school loans. This may reduce a family’s total monthly interest expense, but they are not getting ahead financially.
The professional investor will take the $50,000 and use it as a down payment on more rental properties. Let’s say the professional investor takes the $50,000 from an existing property and acquires two more rental properties. Their financial statement now has three rental properties in the Asset column, instead of just one.
3. Amortization is phantom income.
Amortization is the reduction of your debt. Every time you make a mortgage, car, or credit card payment your loan balance is being amortized or paid off. Mom and pop amortize their debt with after-tax, ordinary income dollars. They use their money. That’s very different than real estate investors’ debt, debt that a tenant amortizes.
The reduction in debt is another source of phantom income for professional investors. I love real estate because my tenants amortize my debt, not me. Remember good debt is your debt that someone else pays for. Every month, Kim and I get richer because every month our tenants are amortizing our debt.
4. Depreciation is phantom income.
Depreciation is also known as wear and tear. The tax department gives you tax write-offs because, in theory, your investment property is going down in value due to wear and tear. Even if your property is appreciating, going up in value, the taxman gives you a tax break for depreciation, as if the property’s going down in value.
Depreciation is a major source of phantom income for professional real estate investors.
Editor, Rich Dad Poor Dad Daily