When faced with a new investment opportunity, most investors are focused on ROI – how much of a return they can expect on their capital. The thinking is linear. If I put in $1,000, how much can I expect to make on that $1,000?
Investors who think out of the box don’t think of investments in linear terms. In other words, when they make an investment, they’re not thinking about the end of their investment; they’re thinking about how to leverage their capital to generate returns in perpetuity. How do they do this?
Smart investors are less concerned about the return ON capital than they are on a return OF capital and how quickly they can receive that return. Like chess players, they’re thinking about their next move. They’re focused on a return of their capital because they’re thinking about the next investment to which they can deploy that capital. The sooner they can do it, the better because they can leverage the second property to acquire the third property.
Essentially, they’re not focused on generating a single stream of income but on multiple streams of income. They leverage the speed at which an asset can return its capital so they can allocate that capital to additional assets to generate exponential growth. They leverage the velocity of capital.
Here’s how you can leverage the velocity of capital:
Suppose you buy a commercial property for $2m with value-add opportunities. You put $400k of your capital down and finance the rest. You put another $200k of your cash into renovations, putting your total capital commitment at $600k. For simplicity, let’s assume a cap rate of 7.5%. The expected average annual return on that rate would be $150,000, which means it would take four years to earn a return on your original capital of $600,000.
Now, you could wait patiently to accumulate enough cash flow from operations to earn a return on your capital to put into another similar investment with $600,000, or you could do something else. You could accelerate the timeline by leveraging the value-add in the property.
After renovations and implementing management efficiencies that improve rental rates and reduce vacancies, the property’s value has increased to $2.75m. What if you refinanced your original $1.6m mortgage to a $2.2m mortgage and cashed out the difference of $600k? You now have a return of your entire cash investment of $600k much quicker, and you still own the property. You can deploy that $600k to acquire another property, and you don’t have to wait four years in this refinance scenario.
The velocity of money allows you to enjoy the benefits of rental income, appreciation, and tax benefits of the first property while being free to reinvest your $600k into another property. Instead of a straight line of returns, you create multiple lines branching off from the original line to create exponential growth and wealth.
As you can see, value-add deals are ideal for accelerating the velocity of money. Experienced and skilled operators can acquire and renovate a property, improve it, add to it and implement operational and management efficiencies to add value to the property quickly, then refinance to extract the equity to deploy to another cash-flowing property.
By increasing the property value, an investor can refinance at a higher amount to receive a quicker return of capital than if they did nothing.
Savvy high-net-worth investors understand the velocity of money and leverage that velocity to accelerate wealth-building accumulation and maintenance by creating multiple streams of income that build upon themselves.
You may be asking how you can leverage the velocity of money in a passive investment scenario. It’s clear how you can do it in a direct investment scenario like in the example, but what about in a private investment fund or private equity scenario?
Fortunately, many private real estate funds implement strategies that include a cash-out refinance to return investor capital while allowing investors to stay in the fund to continue reaping the benefits of the property. It’s like investing directly without the headaches.
In our example, an operator/sponsor raises the down payment and renovation cost of $600,000 from investors and finances the remaining $1.6m. After adding value, the operator can refinance the loan and return all investors’ capital while allowing them to stay in the fund. With a return on their capital, the investors are free to deploy their capital to another fund.
The key to financial independence is acceleration and growth. Nobody wants to wait until they’re 75 to start experiencing life.
Thinking outside the box and considering investments in non-linear terms is the key to accelerating wealth creation.
Creating multiple streams of passive income quickly is key to achieving financial freedom sooner than later, and leveraging the velocity of money is how you can get there.