The ‘velocity of money’ is a well-known concept among economists and investors. It is a broad principle that explains how money circulates within a given financial ecosystem. The velocity of money can be applied to global or national economies as easily as small businesses.
To real estate investors, the concept is more finely tuned. The velocity of money describes how quickly an investor recoups his initial investment and turns it around to put into a new opportunity. The greater the velocity, the greater the potential for compounding returns over long periods of time.
Generating Revenue or Turning a Profit
The end goal of high velocity in real estate investing is either generating revenue or turning a profit. In terms of the former, consider a client who obtained a hard money loan from Salt Lake City’s Actium Partners some years ago to purchase a multi-unit apartment property. His main priority was to obtain the property and rent all the units in order to generate revenue.
Had he decided to renovate the property and sell it, his goal would have been to turn a healthy profit at sale. Either way, he needed the property to pay off quickly in order to recoup his initial investment. The money could then be put into obtaining a new property.
The velocity of money dictates that real estate investors purchase, renovate, and then either sell or rent acquired properties as quickly as possible. Speed offers the opportunity to redeploy funds in new deals rather than tying up capital for extended periods of time.
Velocity Applied to Hard Money
Actium Partners explains that hard money loans are short term loans of 6-12 months, on average. They are built to enhance the velocity of money concept. But where does that leave an investor? That depends on the investor’s goals.
Ideally an investor looking to hold a property for an extended amount of time wants to at least get his initial down payment out of it as quickly as possible. So let’s assume an investor gets a 12-month hard money loan to acquire a new property. He ultimately arranges conventional financing to cover the hard money loan. He will get at least a portion of his down payment back when the initial loan is repaid. That amount can go into a new property.
Another investor who simply wants to renovate and sell gets his initial money out a lot quicker. And yet he needs to get the property to sale before the hard money loan matures. If he cannot manage to do it, he needs another exit strategy. That only slows down the velocity of money.
Benefits of Keeping Velocity High
It goes without saying that maintaining a high velocity of one’s money makes real estate investing more profitable. But why is that, exactly? A high velocity of money:
- Maximizes returns through rapid recycling of available capital into a constant parade of new deals.
- Provides a competitive edge by giving investors more flexibility and adaptability when pursuing lucrative deals.
- Affords more opportunities to compound returns by constantly investing in new returns that grow the investor’s principal.
- Shifts the focus from return on investment to return of investment, which is to say the speed at which an investor’s principle is returned.
The velocity of money may be a challenging concept to understand outside the economics of investing. Nonetheless, it is an important concept for driving investments forward. The faster investment funds can be turned over, the faster investors can grow their portfolios and subsequent returns. Needless to say, investors love high velocity.
