Real Estate Investing: The Infinite Investment Strategy

In the Introduction to Investing in San Diego real estate, I mentioned the idea of an Infinite Investment Strategy.  The ideal investment is one which costs no money, takes no effort and provides a never-ending, safe return.  If you find such an investment, please let me know.  In the mean time, investing in distressed real estate can get you pretty close.  Done correctly, your left with only frictional costs, the money value of your time and somerisk.  Sound too good to be true?  It’s not.  It’s simply built on the #1 requirement for all successful investing: have better knowledge, quicker timing or more money than the competition.  In other words: Know the Arbitrage.

So, how does it work?  In a simplified manner, once repairs are finished and a cash out loan has been secured based on a 75% Loan-To-Value, it would look like this

It looks nice on paper, but there is a glaring roadblock ahead: the First and Second Laws of Thermodynamics.  The first law says you can’t get something for nothing and the second law says that in every exchange there is a loss.  It looks like we’ve created a perpetual motion machine with no losses - in direct contradiction of the first and second laws of thermodynamics.  Quick, someone notify MIT!

All kidding aside, those two laws apply in real estate the same as they do in every other aspect of the universe.  You cannot create something from nothing.  In this case, you’ve created something from the value of your knowledge, time, and or financial ability to improve the investment property.  Even with that, there are losses we haven’t calculated: real estate commissions, lending costs, lost use of funds and so on.  The point here is not a complete course on accounting (nor even a course on quantum mechanics) but rather to open your eyes to the idea that you can buy investment properties in such a way that, when all is said and done, you have no money at risk.

These investments are not lying around waiting for the average investor to be sure; but they are out there.  I have done them.  It is the ultimate real estate arbitrage.  The parameters are easy to search.  You are looking for a neighborhood where the fundamental values are roughly 75% of the utilitarian values.  Within that neighborhood, you’re looking for a distressed property whose repair costs, when added to the purchase price, will be equal to or less than the fundamental value.  Voila!  You have an investment paying for itself with none of your money at risk.  The cost to you has been time, knowledge, market risk and whatever frictional costs you incurred.

The concept of frictional costs is an important one.  Commissions are not cheap in real estate; this is one of the points argued most pointedly by those who stand by the stock market as a better investment than real estate.  No argument from me – the costs in real estate can be a great deal higher.  But, you can acquire a real estate license for relatively little cost and effort as the laws are currently structured.  Which means you will be paying yourselfthe commissions and effectively removing them from the ledger.  (You are still spending your time though.  Just because it doesn’t cost you money doesn’t mean you can ignore it altogether.  But for purposes of this model, your frictional costs were reduced.)

As good as the Infinite Investment Strategy sounds on paper, there are a couple of final issues I want to mention.  First, don’t belittle the market risk as one of the costs I mentioned.  The example I gave above can be done.  But, you only have to be wrong once to put a real dent in your ability to keep going.  As a matter of fact, the more of these deals you find the more likely you are to form a little contempt for the market risk: this greatlyincreases your likelihood of being wrong on the next one.  Treat every investment you review the way you treated your first one: cautiously and with a whole lot of respect.  Otherwise, you may drop your entire investment nest egg in a property and be unable to get it back out.  That’s the end of the Infinite Investment Strategy.  Speaking of “drop,” that is the subject of the next article.  Given a specific amount of money to begin with, there is a Drop Amount you should know and understand.  This will give you the freedom to modify the Infinite Investment Strategy into the much more common Limited Investment Strategy.

Filed under: BUYERS, INVESTORS, LENDERS, REALTORS