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Should You Buy More Rental Properties Or Pay Down the Ones You Have?

by Paula Pant on March 19, 2014 · 29 comments

  
Buy More Rental Properties

Many rental property owners are debating between two choices:

Should they focus on paying down the handful of properties that they already own? Or should they buy more properties?

In this article, we’ll discuss two questions that you should ask yourself in order to arrive at the answer.

Two Caveats

I’d like to give two caveats before discussing this problem.

First, the term “handful” (when used to describe the number of houses that you own) relates to your personal experience and debt tolerance. Some people think a “handful” of properties is one or two units; other people think it’s 15 or 20 units.

Almost every investor will start to seriously contemplate this question once they’ve accumulated a number of properties – though that number differs wildly. And that’s totally okay. Personal finance is personal.

Secondly, this article focuses on what an investor should do as opposed to what an investor can do. I’m not going to focus on whether or not an investor CAN buy more properties (i.e. qualifying for loans). I’m going to focus on how to make the decision as to whether or not you WANT to buy more.

The “buy more or pay down?” question relates to your debt tolerance and the goals that you set for your life. Let’s look at these two factors.

Debt Tolerance

Risk tolerance—and its corollary, debt tolerance—lays on a spectrum. On one end of the spectrum, you’ll find people who aren’t even reading Bigger Pockets because they would never foray into real estate investing in the first place. They are comfortable keeping their money in bonds, cash, and bank CDs.

On the other side of the spectrum, you’ll find people who enthusiastically use margins to leverage their penny-stock purchases and who take out massive loans to fund all types of businesses.

These are extreme examples. The majority of us lay somewhere in the middle.

On Bigger Pockets, you’ll find investors who represent every side of this issue. Some investors believe you should never put your own money into an investment, while others only buy properties with cash.

“Debt tolerance” may be a more accurate description of this question than “risk tolerance.”

Why? Some investors think that using their own cash is riskier than using other people’s (lenders) money. But other investors, who are exclusively cash buyers, disagree. The rest of us lay somewhere in the middle.

So if you’re deciding whether to pay down your properties or accumulate more, the first question you should ask yourself is: What’s my debt tolerance? How close am I to “maxing out” my comfort level?

Goal Setting

The second issue is a question of your life goals. What are your goals for your real estate business? How well do your investments align with these goals?

We don’t create profit in a vacuum. We do it for a higher purpose. What is your purpose? Is your goal to have a lot of money when you’re in your 60’s, or is it to have decent cash flow when you’re in your 30’s?

Related: Not Another Goal Setting Post! Really? Really! (With a Twist…)

Two Examples

Joe is 30. He owns four single-family homes as rental properties. Each house collects a gross rental income of $2,000 per month. After paying the mortgage, repairs, management, vacancies, and all other expenses, Joe collects $800 a month in passive cash. His goal is to have his rental properties provide him with a nice fat retirement when he is in his 60’s.

Based on this goal, he chooses not to pay down his houses. Instead he makes the minimum mortgage payments on his properties, and he focuses on accumulating even more houses. This will allow him to enjoy a heftier cash flow when he’s in his 60’s.

Jill is also 30 years old. She also owns four single-family homes as rental properties, each of which have a gross rent of $2,000 per month and a current passive cash flow of $200 each ($800 total). In other words, her current situation is identical to Joe’s.

However, her goal is to enjoy passive income and financial freedom when she is in her 30’s. This will allow her to spend her youth focusing on other endeavors, such as moving to Europe, launching a different business, joining the Peace Corps or raising a family. Rather than focusing on accumulating more properties, she focuses on paying down the rentals that she owns.

When all four houses are paid-in-full, she’ll gross $8,000 per month. Assuming that roughly half of her gross income will get spent on non-mortgage related operating expenses, she will collect $4,000 per month in passive income. And if she aggressively pays those houses down, she can enjoy that money in her 30’s.

Related: I Paid Off My First Rental Property! (Here’s How… and Why)

The Best Option

Which of these two options is correct? The best course of action depends on your personal goals. Joe wants to have more money in his 60’s; Jill wants to have immediate cash flow in her 30’s. Both of these are valid options, and they underscore how your decisions need to align with your life goals.

We don’t make profits in a vacuum; we make them to support the lifestyle that we want to enjoy.

Should you buy more rental properties or focus on paying down the ones that you own? That’s not the question you should be asking yourself. The real questions are: What do I want out of life? And how much debt am I willing to accept in order to reach those goals?

Once you answer those two questions, the “buy-more versus pay-down?” question will be easier to solve.

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{ 29 comments… read them below or add one }

Perry Rosenbloom March 19, 2014 at 6:25 am

Wow. 8,000 gross for 800 profit per month? Man, I’d avoid REI like the plague with those margins :)

Seriously though, nice article and analysis

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Shay March 23, 2014 at 12:07 pm

10% ROI in passive, repeat PASSIVE, income is a great margin! Plus, you’ll notice in both analogies that this margin is only temporary. With Jill, she is quickly able to boost it to 50% ROI after paying down quickly. And Joe could probably have the same 50% margin at 60 but the difference is he is sacrificing current profits for the opportunity to expand his portfolio let’s say 3x and be able to collect $12,000/month passive at 60 rather than $4,000 for the rest of his life. If your head is stuck at the small, TEMPORARY, margin (which is still better than most any other passive margins, ie. bank CD’s, money market funds, etc…) then you definitely shouldn’t take up real estate investing.

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Shay March 23, 2014 at 12:47 pm

And I just made a fool of myself. Sorry, it was early when I woke up and read this comment to get the sarcasm….

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Sharon Vornholt March 19, 2014 at 6:45 am

Excellent post Paula.

Both of those examples will allow the particular folks to reach their goals. The one thing I would like to ad, is that you can also have it both ways to some degree if you start investing young. You could take a decade while you are young and use the cash flow to travel.

Then come back and add more properties and aggressively pay them down. You might do that by wholesaling some properties for the next decade. If you accumulate 20 properties, you might have a goal to retire with 10 paid off properties which would be very attainable. You could sell the 10 least desirable and keep the best 10. If you were getting $1000 rent from each one every month that would be a nice little sum of money.

I guess for each person the question would be what are your goals both short term and long term.

Sharon

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Zach March 19, 2014 at 6:58 am

There is no right or wrong. It’s just as you say, what are you comfortable doing? If you take a more in depth look the minimum payment and buy more option, it could be very lucrative.

If you started buying rentals at age 30 and only paid the minimum mortgage payment but also continued to purchase more rentals. Both cash flow and equity would steadily rise. If you can buy 1 financed property a year that produced minimum $200 positive cash flow per month, by the time you reach age 60 theoretically you will have a cash flow of $6,000 per month and, collectively, a ton of equity. But real estate appreciates and rent rates rise to keep up with the market. Now what if every 5 years you could refinance 5 of those homes and raise rents across the board? You don’t only have a comfortable passive income and an influx of cash every 5 years, you have a serious business you could sell at retirement time as well.

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Mark Ferguson March 19, 2014 at 7:42 am

Nice article Paula! Everything is different for each individual and they must decide for hen selves what is best. I pay down one house at a time while buying more houses, which seems weird to many. To me it the biggest issue is getting loans after ten mortgages, not down payments or immediate cash flow. Most people have a much different situation.

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Jason March 19, 2014 at 7:46 am

I agree with all the other posters here. There are many options. My wife and I are mulling this decision right now. We settled on the combination of both. Any amount of rental income, that fills our bucket above our cash reserves, will pay down our mortgages. The money we have saved from our w-2’s will go towards new properties with mortgages. This helps keep our debt coverage ratio in check. Although I admit, the idea of putting the excess cashflow into notes is very intriguing.

We enjoy your philosophy of living life rather than be a cubicle slave for 30 years.

Jason

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Sharon Tzib March 19, 2014 at 7:57 am

Without knowing the principal and interest rate, it’s hard to say for sure, but I would suspect that the first home would not be paid off until sometime in her early 40’s, with the rest following thereafter. But I get your point.

I would much rather pay off homes closer to retirement, assuming those homes are on the newer side in a stable area with a good tenant base. Last thing I want to be dealing with in retirement is a bunch of deferred maintenance, vacancies, and declining rents. Then I could enjoy my retirement in peace.

During my prime earning years, I’m fine having mortgages. As you say, to each their own :)

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Ryan Ebanks March 19, 2014 at 9:34 am

Paula, It is always difficult to explore the full range of a discussion in a post but the principle is very clear. The challenge for most is that we want to simultaneously ‘have our cake and eat it’. The future is never sure but there are limitations in the present. Other factors such as socialization and culture play a role in the decision – at least from an emotional perspective. The key as you mention is the have goals.

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Robert Watkins March 19, 2014 at 9:43 am

Excellent Post. Very well said. I like the way you think and make others think about their own needs.
Greatly appreciate your time and effort of thought.

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Dawn Anastasi March 19, 2014 at 10:22 am

It’s definitely not an all or nothing approach. Example: I currently have 10 rental properties. 5 of those properties have mortgages, and 5 do not. I plan on keeping some without mortgages for higher cash flow, and letting the tenants effectively pay my mortgages on the other properties. I still do plan on buying more properties.

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Jonna Weber March 19, 2014 at 11:33 am

Good points, Paula. The biggest key is that not one size fits all – it is OK for people to have varying opinions and approaches on this. There is more than one way to win this game in the long run!

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James Pratt March 19, 2014 at 12:19 pm

Paula, good post. I completely agree with Mark. It mainly depends ones age and when they want to retire. By taking care of the properties so there is no major repairs to do and having a cash flow twice your working income, you’re good to go.

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Michael March 20, 2014 at 1:12 pm

That’s a simple but great article. I have been asking myself the exact same question and was trying to approach is mathematically. But you are right, the real question is do I want more cash flow years from now (then buy more) or do I want more cash flow as soon as possible.
That just clarified everything for me.
thanks again for a great article that helped me.
:-)

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Sara Cunningham March 21, 2014 at 1:32 am

We are presently doing a combination. When we first started we just bought houses and paid on the loans. Since we are now getting closer to retirement about 10 years from now we have changed our strategy. We are using all our cash flow to make large payments on the loans and most of them will be paid off 2 years from now. We are still buying houses and using the banks money to do that plus buying a couple of houses for cash as we go along. I think your goals and your age are a big factor in how you choose to play the game.

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Stephanie March 22, 2014 at 8:06 pm

I facing this exact question, so this article is right on time. Thank you.

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Ray March 23, 2014 at 5:44 am

1st of thanks for posting this scenario. I been thinking about this same topic. But I’m confuse how in the case of Jill who is in her 30’s get to enjoy the passive income paying off her mortgage early in her 30’s. I guess paying off the mortgage early makes you young forever. We’re do I sign up.

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Abel Vazquez March 23, 2014 at 11:39 am

Awesome article Paula. When you put things in perspective the way you just did it really makes you think and rethink your goals. The reason I say that is because it is very as an investor the goal is always to have more but looking at it like the way you just mention it really makes you wonder if your current goals are really ailing with your priorities now and in the future. Thank you Paula.

Abel

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Pete March 23, 2014 at 7:16 pm

Paula, great article, but if you had the money to pay down thoser mortgages that fast, you also have to calculate how many house you could have got in that time. I think the single house illustrates that best. If it takes seven years to pay off house number one, leaving you with nothing that whole time or you buy a dozen houses along that time, all providing equity build up and cf, who is in a better position?

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Neil Rainford March 24, 2014 at 10:07 pm

Paula,
Nice article. Another factor one has to consider is the amount of time one wants to spend managing properties, or managing property managers, both at 30 and at 60. With children, a rewarding non-rei profession, and hobbies, there are only so many properties one can effectively manage. Keeping that in mind, as well as the fact that you can’t take it with you, leads many to a pay down strategy for maximum cashflow out of the smallest number of properties that meet basic cashflow requirements at some future date. I appreciate the discussion.

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John March 26, 2014 at 4:53 pm

Investors close to retirement might want to pay down rentals too. The cash flow will be met with lower taxes.

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Shaun March 27, 2014 at 11:49 am

Great points about individual goals and desires.
So many people get caught up with what THEY want that they feel that is the only right answer.

People can yack on forever about how many houses Jill could have bought and the ROI with that and how much more income she could have 10-20 years later if she kept leveraging her cash… Blah blah blah yada yada yada.
Point is Jill doesn’t care as much about having a lot more income in 10+ years, she wants to have enough cash flow to fund the lifestyle she wants RIGHT NOW.

There will rarely be a “right” answer in terms of a real estate strategy like this. Everything is very dependent on personal circumstances and your goals and desires. The fact that so many people with such divergent strategies can be so successful that they have a passion for their way of doing it kind of proves that there are lots of viable options.

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Blake March 30, 2014 at 1:30 pm

I am facing this exact decision right now. I have the ability to pay off my smallest loan in one lump sum and have a nice additional cash flow which I can use for a mix of travel and investment. On the other hand, I could use this sum as a downpayment for my next property and continue building my portfolio. The Issue that I have run into, which is not discussed on your article, is that the current market conditions in my area are not great for investors. Over the past year, investors have driven up prices and diminished cap rates. This is greatly affecting my decision. If I could achieve substantial cash flow on my next property I would almost certainly buy another. But if I cannot find that opportunity I will most likely resort to paying off a mortgage. The additional cash flow from one less mortgage may also position me to be ready when market conditions once again favor investors.

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Sharon Tzib March 30, 2014 at 1:37 pm

Blake, if you can’t find cash flowing deals in your own backyard, then it’s time to start looking for a market where you can. Don’t stop investing simply for the privilege of driving by your rentals :) I do speak from experience, as I abandoned my Calif market for Indiana years ago, and I’ve never regretted it.

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Blake March 30, 2014 at 4:38 pm

Sharon,

I am actually referring to a market that is 2.5 hours from my own backyard. I already have several properties in my backyard (Tucson) and a couple in Phoenix. For diversification, I have been investing in Phoenix. But as I said the market is not as appealing as it once was for the type of housing that I am buying. The issue that I have with branching out, say, to the Midwest, is the considerable time it would take to set up a team there that I would trust to handle those investments for me. It would not be practical for me to travel there to search for investments, much less manage a renovation. In addition, Tucson and Phoenix are markets that I know and understand, as I have been studying them for years. Any suggestions for removing these hurdles?

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Sharon Tzib March 30, 2014 at 5:24 pm

Hey Blake! Well the Midwest is one area you can look at, but there’s lots of others as well (Ali Boone just wrote a great blog on this). I guess it depends on your niche and your strategy. I am a buy and hold, cash flow investor, so I don’t have major renovations to worry about.

Since this was an article about buying more properties or paying them down, I assumed you were buy and hold too, not a flipper. Having said that, even if you do buy under-market properties, reno them, and then rent, it is possible to do so remotely. I see people on the BP forums every day doing just that, and actually, that’s exactly what I did (altho the renovations were mostly cosmetic).

Setting up a team is actually not that time consuming at all. What I recommend is you start with one team member first, and generally they can refer you to others, who will refer you to others, and so on (it kind of starts snowballing). I started with a realtor. However, back in ’07, I didn’t have BP. If I had, I would have just gone on the forums and asked for referrals.

I will say, however, that I would not recommend investing in a different area without visiting it first. It is a personal non-negotiable investing rule of mine, and if you see me on the forums, you’ll see me mention that. But you only need to go once. After you do, your realtor will have a really good idea of what you want, and you will have a really good idea of what you don’t want. Frankly, it’s the best money you will ever spend, and is generally tax deductible. Before you get on a plane tho, do some heavy duty online investigating first, of course. If it’s just physically impossible for you to travel somewhere for a weekend, then I guess you’ll have to stick to your own backyard.

Good luck, Blake!

Zach March 31, 2014 at 10:44 am

Sharon great reply back to Blake. I had made it a rule for myself to not acquire rentals more than an hour from home but your comment has allowed me to reconsider. Especially with the suggestion to use biggerpockets as a referral resource.

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Sharon Tzib March 31, 2014 at 1:38 pm

You’re welcome, Zach. If you can cash flow WITH a property manager built in, there’s no reason why you can’t expand your horizons. Good luck!

Ken Huston II April 22, 2014 at 12:36 pm

So, what if the first guy kicks the bucket at 58? Just saying!

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