Unraveling the Dangers: The Trap of Velocity of Capital

You may have heard the term Velocity of Capital used in the context of being smart.

Truthfully I think people like to say Velocity in a business context because it sounds like they know what they're doing. Without thinking about it deeply, they mimic the term to make themselves sound credible.

So why am I so apposed to this term?

Because in my opinion it turns investing into trading. It switches the long term mindset with a short term mindset.

The theory is that you a large chunk of your value creation in the first two years of ownership with your renovation. Then after you sell the asset and repeat. When you think of it that way, it makes sense. Have your money get the highest returns possible. But what risks come from this potential upside?

Risks:

1. Short term floating rate debt.

   1. Agency loans won't loan you capex renovations. Products like floating rate bridge loans will. These products are usually 2-3 year terms.

   2. As we see in 2025, bridge loans hurt a loat of people as we're going into the third year of historic interest rate rises.

2. Fees

   1. Each transaction has new fees. Acquisition fees, loan fees, closing costs, brokers, etc.

   2. With high fees comes an incentive to do deals just to do the deal for fees and hope it works out.

3. Lag time

   1. Your money sits on the sidelines when you look for another deal to invest in. When you do find one, it could take months to close the deal.

   2. This could easily result in 6 months where your money isn't working for you after each sale. If the holds are 2 years each deal, that's 1/5th of the time where your money isn't working for you. Really that's like reducing the perceived high return by 1/5th. A 20% IRR would be a 16% IRR.

Conclusion:

Are there benefits to the velocity of capital? Yes. But it does come with risk and a different mindset.

I have invested into a deal as a limited partner which ended up being a quick sale. It was a 2.23 equity multiple in under 2 years, 61.7% IRR to LPs. I would probably do other deals like this. However, I would like well over half my capital invested into deals with long term loans.

Say for instance you were a velocity of capital style investor 3 years ago. If you put all your money into these deals, you'd probably be in trouble with interest rates doubling. I can handle stress, but when your life savings is on the line for 3 years, it would be a struggle for anybody.

Formula from Warren Buffett's book 'The Snowball:"

If there's a 10% chance of you losing and you do it 50 times, there's a 99.5% likelihood of it happening.

The danger is if you invest everything into a 10% risk deal over and over. In my mind, short term loan deals get dangerously close to this risk percentage.

I asked several mathematicians and got the formula Warren Buffett was referring to. Here it is.

A. 1 - risk % (.1 for a 10% risk in this example)

B. Raise this number x to the y (x to the y button)

• Type in the number of times its performed (50 in this case)

C. The answer is 0.005

• This means that there is a 1/2% chance of this not happening. In other words a 99.5% chance of it happening.