By Dr. James M. Dahle, WCI Founder
I'm a fan of real estate investing. However, one of the things I hate about real estate investing is all of the scammy marketing surrounding it and its “Rah-rah, you can do it!” mentality. It reminds me a little of multi-level marketing that way. That is why we made the No Hype Real Estate Investing course. The only reason you need to be motivated to do something is because it actually takes a lot of hard work to do it! At any rate, a great example of a scammy marketing term is the phrase “Infinite Return.”
Getting an Infinite Return by Refinancing
The phrase “Infinite Return” is generally used in one of two ways. The first is almost completely bunk. Here is the way it works.
You buy a property with a down payment. Let's say it's a $400K property, and you put down $100K. Over a few years it appreciates, and you pay down the mortgage a bit. Now the loan to value is low enough that you can actually refinance it and pull some money out of the property, maybe even an amount of money equivalent to your original investment. It even comes out tax-free, since it is not income nor capital gains. You can then take that money and spend it or use it to buy another property. This can be a pretty savvy move. What it does not do, however, is provide you an infinite return on the property. But that is what those using this term would have you believe. They're saying because you got your original $100K back that the property somehow did not cost you anything and that you should only calculate your return going forward from that point. Which is obviously a bunch of bunk. I mean, let's run the numbers and see what your return is on the property.
A reliable way to calculate a total return is the XIRR function. We'll make up a few numbers for this investment. You put $100K down on a $400K property. 3 years later the property is worth $500K and you have a $275K mortgage. You then pull $100K out of the property. Here is what it looks like in Excel:
Now don't get me wrong, 31% is a very good return. But it is not an infinite return. But what about going forward? Well, let's start from where we are at and look at a few more years.
Right now you have an investment of $125K, $500K in property value minus a $375K mortgage. Let's say a few more years go by. You pay the mortgage down to $350K and the property appreciates to $600K. What's your return? (For simplicity's sake, let's again assume that all income from the property went toward property expenses or that mortgage).
Again, 26% is a very good return. But it is not an infinite return. The only way that could be an infinite return is if you could borrow 100% of the value of the property back out of it. Then it would look like this:
That would be an infinite return. But no lender in their right mind would lend 100% of the true value of a property. Even if they were in first lien position and could foreclose, they're still going to come out way behind by the time all of the costs of foreclosure are paid.
You could do the same thing with a mutual fund, right? Imagine you bought a mutual fund for $100,000 at $50/share. If the share price goes up to $100/share, you now have $200,000. If you sold half of those shares, you would walk away with $100,000 in cash (at least, pre-tax) and $100,000 worth of shares. But you wouldn't then start saying “I'm getting an infinite return on my investment” because that would be stupid. It's like the people who say “I'm now just playing with house money”. No, you're not. It's your money; it stopped being the house's money when you won it from “the house”.
What Does Cash on Cash Return Mean?
So if these “Infinite Return” folks are not talking about total return, what are they talking about? Well, they could be talking about a “cash on cash” return.
Cash on cash return is a bit of an artificial type of return that real estate investors sometimes use, sometimes to try to impress other people (whose money they are trying to obtain). However, it is mostly used because it is far easier to calculate than the more useful total return. How do you calculate it? Let's say an investor puts $100K into a syndicated deal. She is then sent a check at the end of the year for $6,000, her share of the cash flow for that year. You would then say her “cash on cash return” is 6%, $6,000/$100,000. Kind of an interesting number, but it doesn't really say much at all about her total return. In order to know that, you would have to know how much of the mortgage was paid down and how much the property value changed. But it is a number you can rapidly calculate and that does not require the property to be appraised, much less sold, to determine its value.
The funniness comes in when they start calculating her “cash on cash return” for the subsequent years. Let's say the next year she gets $7,000 and the following year $9,000. Now her cash on cash return is up to 7% and 9% because it is based on the original cash she put in, which is related to the original value of the property, not the current value of the property. The property is probably still just paying out 6% of its value as income. That hasn't really changed. It gets really funny after a decade or two. Now maybe it has an annual cash on cash return of 20-30%! What a great investment! No, it's still the same old property earning about the same return it has been earning all along.
So if you want to just look at a cash on cash return, then, sure, you can get an infinite return once you pull that original cash out and only look at the cash on cash return going forward from that point. The cash on cash return is not really the best measure of your overall return, but the real estate gurus NEVER say “Infinite Cash on Cash Return,” they just say “Infinite Return”, leaving the mark unsophisticated potential investor to figure it out.
Getting an Infinite Return by Putting Nothing Down
The second way a real estate investor gets an “infinite return” is by putting nothing down. Since nothing went into the property, if it earns any sort of positive return, that is technically an infinite return. In order to address the fallacies associated with this idea, one must take a deep dive into the “nothing down” philosophy.
As a general rule, a property is not cash-flow positive until there is a loan to value ratio of 0.75-0.67. That is to say, if you do not want to be feeding a property every month by putting money into it, you should plan to put down 25-33% on it. If you put down less, the costs of the property, including a much larger mortgage, are now more than the income the property produces. So now you not only have a negative cash on cash return, but you have an INFINITELY NEGATIVE cash on cash return. That doesn't necessarily say anything about your total return, but it will not be infinite if you put one dime of money into the property at the time of purchase or afterward.
If you want to avoid a down payment AND have a cash flow positive property, you will likely do one of several things (and these are the same “nothing down” techniques taught to you for thousands of dollars at seminars. You can have them today for free. You're welcome.)
- Steal the property. Not legally speaking, but essentially you need to find someone so desperate to sell that you are creating equity when you buy by purchasing the property for 25-33% less than it is actually worth. Don't get me wrong. This is entirely possible. There are a lot of desperate people out there who need to move right now for whatever reason (often because the bank is about to foreclose). These are the people the folks who put those signs along the roads in your town “We Buy Houses for Cash” are looking for. In this situation, you've essentially bought a $150K property for $100K. And you got that $100K from someone else. Maybe an investor or a hard money lender. Doesn't matter. But it wasn't yours. However, the second you buy the property you know what IS yours? That $50K that you created (? stole) by purchasing the house for less than it was worth. So going forward, your total return will not be infinite (because you have $50K in it that can be accessed at any time by selling the property). But your cash on cash return will be infinite.
- Rapidly improve the property. Similarly, if you can rapidly improve a property such that its value is higher, you have essentially created equity out of thin air. An example might be turning a 2 bedroom home with a goofy unfinished basement into a 4 bedroom home just by putting in a couple of cheap walls. Now all of a sudden a home that was worth $200K may be worth $260K. So maybe now you can pull $80K out of it and have an infinite cash on cash return going forward from this point. But your overall total return on the investment is not infinite, because you put something down in the beginning. I'm not saying it isn't a good investment. It is. But its total return is not infinite.
- Get the seller to provide the mortgage. Sometimes a seller is willing to take back a 100% mortgage. What would entice a seller to do so? Usually one of two things—either he gets a higher price on the property or he gets an above market rate mortgage on a property. Or maybe he's just dumb. Or desperate. Either way, you have put nothing into the property. However, the likelihood of that being a cash flow positive property at this point is pretty low. So you're likely to have an infinitely negative cash on cash return and a less than infinite total return.
- Assume the existing mortgage. Sometimes a seller needs out of the house so badly that they'll just give it to you if you take over the mortgage. Now that needs to be okayed by the lender, but this does happen from time to time. However, the same issue applies. Either you “stole” the property for much less than it was worth, or it is unlikely to be cash flow positive.
- Swap personal property. Maybe you can trade your motorcycle for a down payment. Obviously, that motorcycle has value. So while this might be “no cash down”, it is not “nothing down”. When calculating a total return, you would need to include the value of the motorcycle.
- Swap personal services. Maybe you offer to work on another property this person has in exchange for a down payment. However, your time has value and should be included when calculating your return.
- Sweat equity. You put a ton of work into the house, fixing it up such that it becomes cash flow positive despite putting little down. While your cash on cash return may be infinite, your total return is not because your time has value and that should be included in the calculation.
- Get a partner. Sometimes you can take on an investor who provides the down payment if you do the work. Same issue—your time has value so your total return is not infinite, even if your personal cash on cash return is. At any rate, we used to call this thing a job, not an investment.
- Turn your house into a rental. This does not require cash, but it does require the contribution of something valuable—your home equity. Any realistic total return calculation should include that value.
- Combine mortgages. This sounds like “nothing down” but in reality, you're simply taking equity from your other property and using it for a down payment. That would need to be included in a total return calculation.
- Take on the seller's debts. A seller might waive a down payment in exchange for you paying their other debts (in addition to paying a mortgage on this property). However, those cash flows need to be counted when doing a total return calculation. The property is now almost surely cash flow negative and will have an infinitely negative cash on cash return and a less than infinite total return.
As you can see, there are a lot of creative ways to purchase a property without cash. However, most of these do not provide an infinite cash on cash return and none of them provide an infinite total return. When you start hearing people trying to sell you the idea of an “infinite return”, put your hand on your wallet, proceed with caution, and make sure you know what kind of return they're really talking about!
What do you think? Is it fair to say a real estate investment has an “infinite return”? Why or why not? Have you bought a property without cash? How did you do it? Comment below!
I’m still renting, so maybe my ignorance is showing here. What does it mean to pull 100K out of a property in the first example? Are you selling part of the property or are you getting more into debt?
Here’s the timeline as I understand it:
0 Years: 300K debt, 400K property value
3 Years: 275K debt, 500K property value
After Refinance
3 Years: 275K debt (different rate of interest etc), 500K property value
(or)
3 Years: 375K debt (I actually got a bigger loan that I’m on the hook for), 500K property value, 100K in cash!
Getting more into debt. Basically refinancing or taking out a second mortgage or HELOC.
I think this is an important discussion to have. I am a newer investor with 3 doors and working on an additional 2 doors now.
I use cash on cash as my metric of choice for evaluating properties and have talked a lot about that. I think it is a great metric but you have to understand how to use it. It is absolutely not a measure of total return but is a metric of cash flow.
It is also a yearly metric and the yields/money out to pocket need to be totaled year after year to assess actual return.
I do agree with the overall premise that a return can always be calculated. However, I feel steal is a strong word to use for buying under market value. I have purchased plenty of real estate in the scenarios you mentioned and I’m not a thief. If a person would rather sell in days rather than weeks and do so without commissions, buyer’s loan complications, inspections, or repairs they are often willing to sell for under market value. There is considerable work that goes into putting together the structure to close such transactions. The equity gain is compensation for the work done not stolen. As you pointed out in the article, even an investors time should be considered when calculating a return.
Okay, let’s imagine you have a property that is worth $150K. If you got good advice and perhaps a bit of a bridge loan, you can sell it within a few months for $150K. So why would you sell it for $100K? There are only two reasons: # 1 You’re not getting good advice or # 2 You can’t handle the cash flow issue for a few months.
So does the person sweeping in to buy it for $100K tell you that you’re doing it wrong? No. Do they offer to solve your cash flow issue for a few thousand bucks of interest? No. They offer to take the property off your hands. Yes, it’s a capitalistic system but something about it doesn’t feel quite right. It might be a willing seller, but it isn’t an educated, willing seller.
More discussion here: https://johntreed.com/blogs/john-t-reed-s-real-estate-investment-blog/69083331-nothing-down#:~:text=A%20nothing%2Ddown%20deal%20is,loan%2Dto%2Dvalue%20ratio.
Not sure why you imply cash on cash is some sort of artificial, almost engineered type of return used for sales. In my opinion it is the least manipulatable type of return and the only one that you can actually use to make clear life decisions off of.
It’s simple, how much did you receive in cash on an annual basis out of the amount you originally invested? That’s cash in your pocket that you can use to pay bills, support your family, work less as a result of, and frankly just spend. It’s tangible, it’s real. If I invest 100,000 and I expect a 7% cash on cash return, well I should expect 7,000 in cash in my bank account (simple calculation excluding taxes).
The increase in value of the property, the tax savings, the mortgage pay down & resulting increase in equity are all added bonuses that significantly increase returns on paper, but are definitely less tangible than cash.
I also find the cash on cash metric way more concrete and less misleading than advertised returns of market appreciation, for example of an index fund. Financial advertising will always promote 7-10% annualized returns. We all know that’s an average annualized return, so does that mean if you invested $100,000 that you’d reasonably expect to have $7,000 in your pocket at the end of that year from your investment?
No it simply means your portfolio has increased in value, but your bank account value hasn’t changed. So you’d have to cement the return by selling your equities. Want to know how well you did on the investment in this scenario? You’d calculate how much you sold and how much cash was deposited in your bank account up against how much you originally invested (cash on cash). You’d count the rest (market appreciation) as gravy but know that increased value doesn’t matter until you liquidate it.
Nobody lived a good life by having their investments remain as numbers on a computer screen. At some point, it needs to be converted to cash to make a difference. Then you can truly measure how well your investment did. The cash on cash return is key to helping you figure that out.
I agree it’s simple.
I agree it can be a somewhat useful metric at the time of purchase. I find it far less useful after that and basically useless 5+ years in. I also find projections of it to be fairly easily manipulated.
“Cash flow” as a concept is dramatically overrated. For instance, I would LOVE to have less cash flow overall in my life. Truly any income (at least taxable income) above and beyond your actual spending is just wasting money on taxes. I’d prefer to take that return in a more tax-efficient way.
And so you maybe will be able to comment on this concept of ” buy , borrow and die”, When your buy an asset that is expected to appreciate ( like a lot of stocks or real estate), borrow against it to finance your lifestyle, ( and not to get dinged by taxes on capital gains if you would’ve sold your assets). Then pass your assets on to your children on a step up basis after you die.
Depending on the tax bill associated with selling and the interest rate, it can be a great strategy.
I’m biased, of course, because I invest actively in real estate. But I also think Cash on Cash is useful measure to evaluate return from real estate. As you mention above, it’s a simple and convenient calculation. When we take into account loan principal paydown, tax benefits, and appreciation, I consider that the “Real Return.” But I readily admit that those factors are somewhat phantom, because you’d have to sell the property to realize those gains.
I think it’s also important to point out that the return from index funds is also an artificial concept.
If my stock market index fund share increases in value from $100 to $110, you could say I have a 10% return. But to access that money, I have to sell that share, which in most scenarios will be a taxable event. So the actual return will be less than 10%.
I’d agree with Peter that the cash on cash return is a cleaner metric, because it’s real money in your checking account, and in most cases tax free due to depreciation.
As I like to say, “You can’t buy avocado toast with VTSAX.”
1. Cash on cash is a real metric. Nothing ‘artificial’ about it. If so, lets not count dividends from stocks. Not the right word usage there.
2. A 31% return beats the pants out of any stock market return and these are reproducible. However, banks won’t keep lending to you if you will keep putting minimum down and there is a limit. Still, this sort of this is what RE investors do using leverage. Cuts both ways but a fast way to build NW.
2b. While not infinite (thats a marketing word, any investor should realize there is no infinite return….) your post is proving how RE returns are fantastic.
“poroving how RE returns
arefantastic”Fixed that for you.
: )
Hope you are doing well Jim. Post more mountain trip content 🙂 love those. At least I can live vicariously while hanging out in my lame flat state.
” That $50K that you created (? stole) by purchasing the house for less than it was worth.”
Agree with some of the article(and absolutely with the infinite return part).. ..and thats ok with disagreeing. But the word “stole” is a bit too inflammatory.
In business, no one pays the “value” of the item. They pay a lower price, so theres a profit.
There is two adults making their decisions , based on the individual circumstances, at that time
Just like a employer pays an employee , less than they add to the firms profits.
Or like in a recessions the stocks of perfectly good companies may be on “sale”
That’s why the ? was there.
If I see the term Infinite Return on an investment, it’s an automatic delete for me. It’s obviously all marketing.
If you call this concept Infinite Return, then if you lose money in an investment you should call if Infinite Loss.
Maybe my situation is unique, but I have infinite return on 1 of my properties:
– purchased a $70k house with a Doctor’s Loan when I started fellowship. Loan was for 102%. Lived in house for 2 years during Fellowship.
– purchased a second home with my partner (also with a Doctor’s Loan for 100+%) and now live there.
– currently renting out first home – don’t want to share exact details, but rent is > 2 x (mortgage + taxes + insurance)
Maybe my situation is too unique, but since the mortgage is so low on the first house, the bank approved our second house – even without a tenant we could stretch to cover both mortgages).
When you converted it from a residence to a property, what was the loan to value ratio? I suspect it was not 100% after 2 years of mortgage paydown and appreciation.
I didn’t convert the loan type with the bank – my original mortgage is still outstanding with high $60’s remaining. Interest rate was low enough that I didn’t prioritize paying down the mortgage, so I only paid the bare minimum.
As for appreciation, hard to tell right now. Sources like zillow and redfin are giving me estimates of $110-130K, but I don’t trust those sources. That being said, this is in the midwest where property values have spiked in the past year. It is in a safe part of a class C neighborhood and I see potential for appreciation. I’m planning to sell within the next few years to avoid capital gains taxes.
While the rental income and future sale price are nice bonuses, the biggest benefit to me was having such a low housing cost throughout fellowship – allowed me to generously contribute to retirement, make up for past mistakes (credit card debt) and save for a wedding.
Downsides are that I do have added risk due to leverage. And this approach wouldn’t work for people who live in HCOL areas or cannot identify safe areas of class C neighborhoods.
I don’t doubt it worked out well for you. But I wouldn’t call it an infinite return. You had some equity in the property when you converted it to a rental.
I guess, though using a Doctor’s loan on the 2nd house means that the only money that has ever come out of my pocket for either house has been to put a roof directly over my head. If I hadn’t been paying the mortgage for the first 2 years, I would’ve been paying (higher) rent elsewhere.
Certainly agree with that point, but it doesn’t change the fact that you “put some of your home equity” into the rental business, thus reducing your true cash on cash return. I suppose it’s all semantics, but the whole post is semantics.
Amazing post! Real estate has awesome advantages over index mutual funds – it would have to or no one would do it! But it is not magic. I love and respect and have benefitted from owning real estate, but it drives me crazy when people talk about:
1) Infinite returns – that are somehow different than me selling any other appreciated asset and leaving the “gain” invested.
2) Passive income – and then claiming to be a “Real Estate Professional” for tax purposes – meaning RE literally, legally, and morally HAS to be a job – maybe well paying, but NOT passive.
3) High cash on cash returns – without acknowledging the leverage involved. A high cash-on-cash return is terrific and can help you build wealth – but you HAVE to risk bankruptcy to really benefit. You can’t have triple digit Cash on Cash returns without borrowing money.
Anyhow – loved this post!
2. I agree, if you’re putting in 750+ hours a year, it’s not passive income. Of course, once you get outside of simple mutual fund dividends, little is truly passive.
3. If a deal is showing triple digit cash on cash returns I think I’d probably run away from it. Heck if you’re doing double digit cash on cash that first year you’ve got a great deal.
I have $102K of inflation adjusted, truly passive income/year. Only cost me 30 years (including 6 of residency & 1 of fellowship) while doing a job I really loved doing, caring for some amazing people. 😁
Cool. I suppose a military pension is awfully passive isn’t it? Congrats on your success and thanks for your service!
That does sound like a scammy way to claim an “infinite return”.
I have heard infinite return used before to describe the BRRRR method, and while that is functionally infinite if done perfectly, it is limited by your time and it would only get a return of ~217% in the XIRR calculator.
This assumes you buy a house with a hole in the roof for $50k, fix it and get it ready to rent for $25k, then put a renter in it and have it appraised for $100k, cashing out your $75k investment and using the renter to cashflow the property.
Yes, when you do that you are putting $25K in equity (that you created through your hard work and skill) into the deal. There’s a return on that, and it isn’t infinite.
sounds like buck joffrey is going after Dr. Dahle in latest podcast…
Buck’s company sells whole life insurance so no one should be surprised that he doesn’t like me.
You wrote:
“Now the loan to value is low enough that you can actually refinance it and pull some money out of the property, maybe even an amount of money equivalent to your original investment. ”
How does one ‘pull some money out of the property’?
Cash out refinance usually. I guess you could sell off part of it too.
A real infinite return but risky would be the following scenario:
A house needs a 20% down of 15k.
You get a loan from a bank of 15k and use that with a low interest rate.
let’s say you rent the property which is $600/month and you rent it at $1,000.
you make $400.00 in cash flow.
your payments are 250/month on your loan.
The rent pays the mortgage plus pays your loan and you still net $150 in your pocket. That’s a risky but profitable infinite return.
I just think you are way too worked up to know what you are talking about in most cases and self righteous too. Referring to a purchase as stealing based on feelings is absurd. You will never get ahead in life thinking like that.
A home is a vital asset and any good real estate investor is not going to try to teach the seller how to manage their finances better and get the most money out of real estate. You want to be petty over words and haggle over how people get good deals on homes just like everything else and profit. It is the SELLERS responsibility to make sure they do not get ripped off during a deal not the buyers. Come to your senses! I know this is old but hang it up the down payment info you gave about paying over 20% and getting back money slowly from 100 k was the only thing worthwhile to me from this predominantly infinite garbage.
I’m curious how you define “ahead” since you seem sure I’ll never get there. Sure feels like I’m “ahead” so apparently that mindset didn’t hold me back any.