If you didn’t have a penny of your own money invested in a property, but you earned $250 per month on it, what’s your return on investment? Well, you can’t divide by zero, so some investors consider that an “infinite return” on that $0 investment. Reality gets a little more complicated, however.
Due to the power of leverage, investors can sometimes pull their initial investment back out of a property, leaving them with nothing invested in it. They can then reinvest their original principal over and over again, building up a portfolio of assets by recycling the same money.
Intrigued? Here’s how it works — and a few dangers and downsides before you bet the farm.
There’s a strategy in real estate investing called the BRRRR method that stands for buy, renovate, rent, refinance, repeat. You buy a fixer-upper with a hard money loan, rehab it, then refinance it for a long-term mortgage to keep it as a rental property.
The trick: by renovating it, you force equity in the property, and you can refinance it based on the new after-repair value. That means you can potentially pull your original down payment and closing costs back out of the property.
Say you tie up $50,000 in a BRRRR deal, and within four months you refinance it to pull that $50,000 back out. You then do it again, and then a third time within the same year. With each property you buy, you build your rental portfolio and add another source of cash flow. New properties likely won’t cash flow well given the high leverage, but over time they’ll do better as rents rise yet your mortgage stays fixed, and of course, each property is likely to appreciate for you with every year that goes by.
In theory, you could take the same $50,000 and buy an “infinite” number of properties. In reality, you’re limited by the pace of property renovations. But you could realistically buy three new properties a year with the same down payment and closing costs, ad infinitum.
The BRRRR method takes a lot of work on your part. I should know — I used to do it.
Not everyone wants a side business buying and renovating properties. For that matter, not everyone wants to be a landlord. I hated it, and eventually, I got rid of all my rental properties.
If only there were a way to pursue this “infinite returns” strategy on passive real estate syndications.
It turns out that there is. Some syndicators refinance their properties rather than sell after they renovate and stabilize a property. They return some or even all of their investors’ capital.
You, as a passive investor, could therefore get your money back while keeping your ownership interest in the property. You keep collecting cash flow, the property keeps appreciating, and you keep scoring tax benefits. But you got your initial investment back, and you were able to reinvest it elsewhere to keep earning ever-higher returns on it.
Granted, it takes longer to renovate and stabilize a 100-unit apartment complex than a single-family home. Think several years instead of several months. More on that shortly.
In our passive real estate investing club, we sometimes invest in syndications aiming for “infinite returns.” We can then keep reinvesting the same money again and again, each time adding another cash-flowing investment to our portfolios.
Imagine you invest $10,000 in a real estate syndication, and after three years the sponsor refinances and returns all of your investment capital. You keep earning $800 per year in cash flow after the refinance.
You take that $10,000 and invest it in another syndication, also paying $800 per year in the first three years (8% cash-on-cash return). You’re effectively earning 16% on your $10,000, plus the annual appreciation on the two properties. Then the second property refinances and returns all of your capital, and you reinvest it again.
There’s no theoretical limit to how much you could earn on that $10,000. You can keep stacking on properties and returns. But you are limited practically by time — in this example, you’re able to recycle your money once every three years.
If you instead followed the BRRRR strategy, you could recycle your money far faster. But you’d have to put in many hours of labor for each deal. That starts to raise some of the downsides and risks involved in investing for infinite returns.
“The BRRRR method requires a massive amount of time and labor,” notes Alexandra Alvarado of the American Apartment Owners Association. “Finding good deals takes work, as does hiring and managing contractors, pulling permits, hassling with inspectors, refinancing with a permanent lender, and a dozen other tasks.”
So yes, you may not have any money left invested in the deal after you refinance. But you potentially have hundreds of hours of your time invested, and your time has a very real value and cost.
Or you could invest passively in syndications like I do. Just expect a much slower velocity of money, which reduces just how “infinite” your returns could be in the real world.
Then there’s the risk of over-leverage. Borrow too much money, and your BRRRR rental might not cash flow — it might cost you money every month instead of earning it for you. That risk is generally less pronounced with refinanced syndications, but it doesn’t disappear entirely.
“Beware of any sponsor overpromising on the prospect of infinite returns,” cautions Chad Ackerman of Left Field Investors. “Sure, it’s possible they could refinance and return 100% of your capital, and then continue collecting decent cash flow. Or market conditions could turn against them and leave them with a smaller refinance, or higher post-refinance interest rates eating up all of the cash flow. You just can’t know for certain exactly when (or even if) you’ll get your money back, so don’t assume it’ll happen exactly when or how the sponsor says.”
I love the investment strategy behind infinite returns. But I still know that they’re not really infinite and that there’s no free lunch.
You can earn extremely high returns by recycling the same capital into multiple properties. Think of it as the ultimate compound returns.
Just make sure you understand the risks and downsides, and if you follow the BRRRR strategy, watch out for negative cash flow putting you in a pickle.
About the Author:
Brian Davis is a real estate investor, personal finance writer, and co-founder of SparkRental with over two decades in the real estate and finance industries. He owns fractional shares in over 2,000 units and regularly contributes as a real estate and personal finance expert for Inman, BiggerPockets, R.E.tipster, and more.
Disclaimer:
The views and opinions expressed in this blog post are provided for informational purposes only and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action.