An Infinite Return On Investment Is Impossible, Even In Real Estate
Much-maligned real estate guru Robert Kiyosaki (of Rich Dad, Poor Dad fame) is often criticized for misleading aspiring real estate investors by giving advice that is either impractical, illegal, or downright inaccurate. Many of these inaccuracies are harmless, but some cause real damage. One of the ideas often attributed to Kiyosaki by his followers and critics is the idea that if you receive a positive cash flow on a property you acquired for no money down, meaning your revenue is higher than all your combined expenses associated with that property, you’ve just earned an infinite return on your investment. This idea has been subsequently propagated all over the internet by mathematically-challenged individuals. I’m sorry to burst Kiyosaki’s bubble, but an “infinite return” on any investment, including real estate, is a mathematical impossibility.
No Such Thing As An Infinite Return
To the uninitiated, the myth of the infinite return on investment at first seems plausible. After all, if you were able to acquire a profitable asset without investing any of your own money, the profit on that investment would be infinite relative to the magnitude of that investment, right? Wrong.
The utter ridiculousness of the myth of the infinite return on investment becomes obvious when one reflects on the meaning of the word “infinite.” First, think of all the money in the entire universe that exists, has ever existed, or ever will exist. Got a number in your head for how much that might be? There’s no telling how large that number is but one thing is for certain: it’s less than infinity. There is a finite amount of money in the universe. It might be an astronomical number, but its still a finite one. When you say you’ve achieved an infinite return on an investment, what you’re really saying is that you received all the money in the universe and then some. Did you receive all the money in the universe on your last investment? The $20 bill in my wallet right now says you didn’t. Unless you are the only one in the universe with any money, you didn’t earn an infinite return.
Remember Middle School Algebra?
The formula to calculate return on investment is simple: ROI = (gain from investment – cost of investment ) / cost of investment. If you bought a stock for $100 and by the end of the year it was worth $110, your ROI = ($110 – $100) / $100 = 10%. The zero-down-infinite-return proponents will say “well wait a minute, if my investment is $0, that’s an infinite return!” Wrong. Let’s run the numbers using the above example except this time, the “cost of investment” is assumed to be $0.
ROI = ($110 – $0) / $0 = ???
Do you see the problem with the equation above? The more mathematically-inclined among you will immediately note there is a $0 in the denominator. This poses a problem since in math, division by zero is illegal. You simply cannot do it. Ever. For any reason. Thus, the correct thing to say is that in this case, the return on investment is undefined. You can’t calculate what the return is but one thing is for certain: it is not infinite.
Don’t believe me when I say you can’t divide by zero? Just ask the U.S. Navy. In 1997, the U.S. Navy aircraft carrier USS Yorktown’s propulsion system ceased to operate, rendering one of the mightiest ships in the history of the world dead in the water. The reason? An error in the ship’s database caused the on-board computer to attempt to divide by zero, crashing the entire system. The ship had to be towed into harbor. If the U.S. Navy can’t even divide by zero without catastrophic results, you haven’t got a prayer.
But The Return Is Still Huge, Right?
Hopefully by now I’ve managed to convince you an infinite return on investment is possible. “Fair enough,” you might say, “but the financial rewards on the transaction is still huge.” Well, maybe. But probably not.
Zero-down deals are quite rare, and they are never easy. If there really were plenty of zero-down properties out there that would yield positive cash flow right from the very beginning, everybody would be doing it. Obviously, it’s not that easy. In fact, it’s extraordinarily difficult. It takes a lot of time, research, and careful calculation to find these deals and after closing, there’s often a lot of work that needs to be done, since the vast majority of these properties are fixer-uppers. The financial investment required might be zero, but the labor and time investment required is huge. Once you take the value of your time into account (and the associated opportunity cost of not being able to do something else), the picture changes dramatically.
An Example Of The Time Costs Involved In Real Estate Investing
Continuing the example above, let’s assume you are able to buy a $100,000 property with no money down that at the end of the year appreciates 4%. Furthermore, let’s be generous and assume the above property yields $100 per month in positive cash flow after expenses, or $1200 per year. Overall, the property returns $5,200 over the course of the first year, most of it unrealized appreciation.
Let’s assume the investor in question earns $50,000 per year at her day job, which equates to about $25 per hour (assuming two weeks vacation) and let’s furthermore assume it takes approximately 50 hours of work to locate, research, and renovate the property. I believe 50 hours of work is a very reasonable assumption when you take into account the time spent on MLS websites looking at listings, visiting properties, negotiating, dealing with lenders, arranging inspections, attending closing, and a weekend renovating. Nobody who has ever bought a property would balk at the 50 hour figure. All told, 50 hours x $25 per hour equals $1,250. This is the amount of your actual initial investment, not $0. In the end, this works out to a 316% return on investment, which is nice but hardly anywhere close to infinite. Looked at from another perspective, you earned approximately $104/hr on this real estate deal, which is over four times the hourly rate from your day job.
But wait, there’s more! Rental properties don’t manage themselves. Assuming it takes approximately 2 hours per month to manage your new property (24 hours per year), you’ve just added another $600 to your upfront investment, bringing your total to $1,850. In the end, you get a 280% return on investment equating to just over $70/hr. All in all, not a bad return, but it’s certainly nowhere near infinite.