I’ve been reading Rich Dad’s Increase Your Financial IQ: Get Smarter with Your Money, by Robert Kiyosaki and while I like the general gist of the book (especially the first half), he rubs me wrong way in several places. One of these is in his use of math to support his opinions on real estate.
Much of the second half of the book focuses on real estate as a means to grow wealth, but he does make an important distinction between speculating for growth or flipping a house, and buying property as an investment. In other words, he espouses buying real estate for the purpose of renting it out and creating a cash flow, not hoping for the market to rise and create capital gains. I’m not really interested in becoming a renter, but his approach makes a lot of sense to me, especially with the current economy, housing market and demographic changes.
Where I have problems is when he gets into things like OPM (Other People’s Money). Here is one of his examples:
- He buys a rental property for $100,000 in cash.
- He is able to rent this property for an annual income of $10,000.
- He has made a 10% return on his investment.
So far, so good. He’s using very simple math and ignoring taxes, repairs, etc.. but that’s fine – he states that in the example. His problem is in his comparison to the same scenario but using OPM. Here’s his example using OPM (i.e. money from the bank – a mortgage):
- He buys a rental property for $100,000.
- He puts $50,000 down and the bank loans him the other $50,000 at 6% interest.
- He is able to rent this property for an annual income of $10,000.
- He has made a 20% return on his investment.
The problem is that he has not made a 20% return on his investment – unless he is a deadbeat and doesn’t pay his mortgage! While it is true that $10,000 in profit would be a 20% return on $50,000 invested he is ignoring the mortgage payment entirely!
Using the Mortgage loan payment calculator at BankRate.com, I plugged in a $50,000 mortgage over 30 years (I’m being generous in giving him a low monthly payment) at 6% (his figure in the book) I determined the monthly mortgage payment to be :
$299.78
This works out to be $3,597.36 annually, which makes his actually profit in the OPM example $6,402.64 not $10,000. That means his return on investment (ROI) in that example is 12.8% not 20%.
Granted, 12.8% is better than 10% but it’s a far cry from 20%!
This makes me wonder about the rest of his examples and stories. What if the mortgage were larger or the rent less? Someone reading this book may think it’s a slam dunk only to find that his property and mortgage alter the numbers to a point where he’s not profitable. Kiyosaki neglects to mention that part of the financial equation altogether.
Still, the book is quite motivating and offers much food for thought and for that alone it is worth the read in my opinion.
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