Paying off properties vs buying more
Member since 2008 · 155 posts · 2 votes
What is your goal, and why? Apparently where I am at, property appreciates very slowly. My thinking is buy one at a time until they are 100% mine, then go to the next one, as opposed to buying 10 now and having to take on all of them at once, and worrying about multiple vacancies. At a cashflow of $800 a month on a 100k house, it would take 4 properties that are not paid off with a cashflow of 200 a month to be the same. Am I missing something?
Leverage, the double-edged sword. Here's a scenario to lok at. Buy 10 properties, 10% down and sit on them, or buy cash and keep buying until you get to 10.
Why buy 10 properties with loans:
Any appreciation is multipled by 10 meaning you can make a killing if properties go up in value at all.
Rent increases are also multiplied by 10. In fast rent rising areas, it can make sense to leverage hard.
More depreciation write-offs from day one.
More properties means less chance of all properties going vacant at once making it easier to plan for it.
It's sexier owning all those properties up front (I guess) :)
Why buy for cash more slowly:
Properties that go down in value will not put you in a situation where you cannot sell and/or have negative networth.
You'll have cashflow from day 1. This makes it SO much easier to do things correctly when things break and people leave.
You won't have to pay loan fees on the way in and quite likely will be able to negotiate an all-cash discount.
You can later sell on a simple note for a premium. Cash allows flexibility.
Your properties will show up as large assets as far as lenders are concerned for future business. Having properties heavily mortgaged scares lenders away (rightfully so)
So basically, buying with loans allows you to increase you networth much quicker if properties are appreciating in equity (forced or not) or cashflow. If you are buying in an area with no appreciation nor rent increases, then why are you buying? You'd better be purchasing a lot of equity coming in the door or your cash may be better off in a CD somewhere.
I look at it this way. The more homes I buy, the less risk I have due to vacancies. I would rather have 4 homes and 1 vacancy, then one home and 1 vacancy. Your rented units will carry your mortgage payments on your vacancies as long as you have cash flow.
1 vacancy per 4 homes would be better than 1 to 1, but what about 2 vacancies in 4 homes? 3? 4? And what if this were out of 10? If you have to pay $1000 each, that means that you would have to come up with 3-4k for the month, see what I mean?
My question would be, what are you doing wrong that causes you to have 3 to 4 vacancies at the same time out of 4 units total. I have a different outlook on this business then some around here do. Could be because I am still knew to it, but I believe you are running a business and it's not any different then any other business, which means your renters are your customers and you need to treat them as customers.
Are you not responding to their requests fast enough? Are you not making them feel safe and secure in your homes? Did you not screen them properly and had to evict 3 tenants all at the same time? Maybe the competition for renters in your area is extremely tough and you need to offer something a little different then your competitors. Is it possible to have all or most of your units vacant at one time, I guess it is. But that shouldn't happen very often and you should have that money put aside just in case that happens.
I have rentals in a town where according to the city, 70 percent of the homes are rentals units. I cannot buy a home and get it rehabbed fast enough for perspective tenants. I have only been in the business a little over a year and word of mouth has gotten out among these people, that I am the guy that provides nice, safe homes and is responsive to a tenants request. If something breaks, I fix it right away, that's it. I am not the typical slum lord that operates in my town and there is a huge demand for it.
Not sure if I even answered your question, so my answer would be, I can't expand by waiting to pay off one house at a time. I have to leverage and by doing so, I believe I am decreasing my risk.
TC answered exactly the same way I would have.
I am also thinking that you are letting the "What If" disease run around in your head to much. People that say "What If" all the time will never get a chance to say "It Worked!".
-Michael
Just do the math and see how long it takes to acquire 10 properties paying them off one at a time. Even without taking a dime out of the business you will still take a lifetime to have 10 properties. Math can answer most questions we have.
ABC...Always be Closing! The whole reason why I got into REI was to leverage purchases and buy as many properties I could get my hands on.
Paying down properties defeats that strategy. I might as well not be in real estate and put that cash into a mutual fund.
very interesting point of view, people! thank you. the one that really got me to thinking was about the mutual funds. I have mutual funds - only about 8500 worth, but in the past 7 years I would have done better keeping the money under my mattress.
for me, it isn't about building an empire (yet). I have my empire i am already attempting to build :) REI - by way of buy and hold - is a means for me to acheive financial independence and reduce stress caused by worry due to lack of income. Talk to any business owner, we are probably all like that to an extent.
My motivating factor in paying off first is to minimize my exposure of going under. As mentioned before, if 2 of 5 properties are vacant for a while, then I'm hurting. On the other hand, I think if I can pay off 2, then I could justify buying 2 or 3 at a time after that, since my rents from my paid off houses should cover the others. Perhaps I need to just build a large cash reserve before doing so. I think that I can do this quicker by paying my house off fast, and then save so I am not paying so much on interest.
Jason,
As you mentioned, all you need is a reserve account for the "rainy days" By paying off an investment, you are losing the power of leverage, exposing yourself to lawsuites due to your high equity position, and losing the second most important thing in RE - write-offs (via the tax deduction on the interest paid).
My suggestion is to use leverage, buy smart, have a reserve, manage properly, and repeat the process over & over.
I'm just about to write my first contract on an investment property-so take this with a grain of newbie salt-but my plan right now is to do a combination of what you are debating. I plan on leveraging up to 5-6 multifamilies (primarily 2 & 4 families) as fast as possible and then focusing on paying off loans. If you use your 1 @ $800 or 4 @ $200 example-think of the beginning when you are only making $200 on that property while you still have a mortgage. That's going to take a long time to pay down. Now if you leverage up to 4 @ $800 in the beginning, you're now going to be paying one of the loans off much faster and then things will really be smoking after the first loan is gone.
My dad used to tell me buy a house and pay it off before you buy another. My former employer would say work your full-time job and with your spare time buy as much residential re as you can - disregard price, disregard interest rate, and have no fear. Only focus on supply/demand in your area and if after realistic expenses that property generates a positive cash flow. Have a small cushion for emergencies. R.E. is cyclical - follow the cycle. Well I didn't follow dad's safe way. He has 2 homes - I have 1 and 54 rental units. Nothing is "paid off". Dad doesn't understand my logic and I've given up trying to show him.
If your property area is in a "high" rental area (many working class folk) there will always be demand. I don't like vacancies but I don't fear them. Vacancies will never come in droves in "rent reasonable" areas and they will never last for more than 1-3 months even in a bad cycle. People always need a place to live. Reduce your rent a little, offer an incentive, offer your other tenants a "referral" incentive to bring their friends, post flyers in the supermarkets, introduce yourself to your local Housing Authorities, contact homelessness prevention,make repairs promptly and treat your tenants with respect and courtesy. When you make yourself "known" as a good landlord tenants spread the word very fast.
So I am confused. Having 10 paid off rental is NOT better than having 10 rentals with payments?
10 paid off rentals is certainly better than 10 rentals with payments.
That's not really the choice, though. More like 2 paid off rentals or 10 with payments.
Like C Burris said, do the math. Lets say you can buy $75,000 houses that will rent for $1200/month. And that you have about $80,000 in cash. You could either buy one for cash or five with 20% down payments plus closing costs. Lets assume 50% of rent for expenses, vacancy, capital improvements, etc.
One house
Investment $77,000 (w/ closing costs)
Rent $1,200
Expenses $600
NOI $600/month
Payments $0
Cash flow $600/month
Cash flow $7,200/year
Cash on cash return 9.35%
Five houses with payments
Investment $85,000 (20% down plus closing costs on each one)
Rent $6000/month
Expenses $3000/month
NOI $3000/month
Payments $2500/month
Cash flow $500/month
Cash flow $6000/year
Cash on cash return 7.06%
Hmmm. Looks better to own just the one. Though, not actually very much different.
Fast forward 30 years, and lets have a second look. Assume inflation has driven up the value of the houses, the rent and expenses by 3% per year. This is a really bad assumption, and very unlikely to actually play out, but any other set of assumptions, including no changes is at least as bad. Values rounded.
Value of each house $182,000
Rent $2900
Expenses $1450
Annual cash flow from one house: $17,400
Since all the houses are paid off at this point, the holder of one house has equity of $182,000 and annual cash flow of $17,400. The holder of five houses has equity of $910,000 and annual cash flow of $87,000.
A related question, which I just don't have the time to answer right now is the cumulative cash flow for the two scenarios.
And, there are other considerations here. After 27.5 years, there is no depreciation deduction. That makes the tax situation less favorable after 27.5 years. So, realistically, you may do things like 1031 exchanges to move from these specific houses to others as time goes by.
ok, I see. Makes more sence now. So ifa person had 10 rentals, would it make sence to use some of the profit from all 10 rentals to pay down one house at a time? Once 1 is totally paid off I can see this moving along quite a bi faster depending on the mortgage price. Is it common to do this or just pay down each from its own rental income.