There are two wealth accelerating tools that I employ in my real estate investing. The first is leverage or the use of fixed bank financing to purchase a property which I will write about in my next post. The second wealth accelerating tool is velocity of money. In its simplest terms, velocity of money is how quickly a dollar invested returns to its owner to be reinvested.
With stock and mutual fund investing, the most popular strategy is the buy and hold strategy. I too like to buy and hold for the long-term. However, I prefer to buy and hold real estate over paper assets. Over time, the principal gets paid down by the renters and the value of the property rises through net operating income (NOI) increases. As such, a large amount of equity can build up. Allowing that equity to sit there idly and not work for you is the definition of a lazy asset.
How can I access this growing equity? The most obvious answer is to sell the property. This is what you do with stocks and mutual funds. If you want to access your money, you have to sell and pay a tax on the gain. However, I don’t want to cannibalize my quality performing property, I just want to access the equity so I can go out and buy a second quality performing property. To do this, I use a refinance to harvest the equity tax-free.
Equity harvesting is a powerful wealth building tool that illustrates the concept of velocity of money as it pertains to real estate. It is important to remember that if you are going to harvest equity, use it to buy assets and not liabilities. It is easy to misuse this concept and buy yourself a boat, a sports car, or a myriad of other liabilities that will make you poorer and not richer.
On the other hand, if you harvest your equity through a refinance, combine it with the incremental cash-flow that you have been receiving, and buy another performing asset your one property becomes two. Continue to drive NOI and pay down the mortgage and in another four to five years, you can refinance your two properties and buy another two. Now your initial one property has turned into four cash flowing properties.
This has a wealth accelerating effect that will expand your nest egg rather than just allowing your equity to grow and sit lazily doing nothing. I recently compared the returns of a stock held for 10 years compounding at 10% annually with an apartment building held for 10 years employing periodic refinances to buy more properties without any new infusion of capital. Obviously 10% is generous for stock as the real historic return for the S&P 500 is more like 6.5%. Additionally, I would not be interested in a property that only returns 10% a year. Utilizing leverage, I routinely target properties that give an overall return in the 15% – 20% annual overall return range. However, to approximate an apples-to-apples comparison I assumed a 10% annual return for each. At the end of 10 years utilizing the concept of velocity of money, my real estate investment returned me almost three times as much as my stock investment.
Many of us have been practicing for ten years now and longer. How much closer to financial freedom and early retirement would you be if your current nest egg was worth three times as much as it is now? The concept of velocity of money and its wealth accelerating effects are powerful. The uncertainty of today’s medical climate with its decreasing reimbursement and increasing regulations makes it even more important that every health care professional learn as much as they can about accelerating their wealth as safely as possible.
P.S. Velocity of money through equity harvesting has a wealth accelerating effect like no other that allows you to grow your nest egg and make money in real estate.
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