Landlording & Rental Properties

An Investor Analyzes: When Does it Make Sense to Pay Off Your Properties?

Expertise: Business Management, Mortgages & Creative Financing, Landlording & Rental Properties, Real Estate Investing Basics, Personal Finance, Real Estate Deal Analysis & Advice, Commercial Real Estate, Personal Development, Real Estate News & Commentary
228 Articles Written
pay-off-properties

If asked when it makes sense to pay off my properties, my answer during most of my investing career would have been never.

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I do understand that people have different investing strategies, levels of risk tolerance, and goals — especially at different stages in their lifetime. For me, up until recently, my strategy has been one of leverage and reserves.

Leverage, Cash Flow, and Reserves

If you own $3 million in real estate and have $2 million in debt against your portfolio, with $2 million in accessible reserves in another more liquid investment, then what's the difference if the real estate was paid off or not?

For me, I would have lost hundreds of thousands of dollars if I hadn't tapped into the equity I had built in my portfolio. At one point, I had acquired 11 lines of credit on my SFRs and apartments, which I was able to borrow against at 3-5%. Then, I lent that money out to fellow rehabbers at 15-18%.

People say you want your money working as hard as you do, but I wanted my equity working that hard, too.

Related: Want to Secure Your Family’s Financial Future? Before You Pay Off Your Properties, Consider THIS.

From an asset protection and accounting point of view, it may make more sense to keep the real estate leveraged with debt (especially if any of your properties are in your own name) and to keep pulling the cash out of the real estate (in other words, sweeping the account). Then you could put the cash into safer, more liquid buckets, such as retirement vehicles, insurance contracts, or even other asset classes. For example, notes, private lending, and tax liens could all be a viable investing alternatives. You can also write off the mortgage interest while your tenants continue to pay on the debt on your behalf.

Two Deals Instead of One

Often, I encounter real estate investors who want to use their money or their lines of credit to finance their acquisitions and rehabs. For a period of time, that’s what I did too — at least, until I had a better comfort level and more experience under my belt.

Today, instead of using my own money for real estate deals, I use other people's money (OPM). Then, I use my money for other things like hard money deals and notes. For example, I can even borrow money out of insurance contracts to invest in note deals that pay a higher yield than the loan rate. Now, if you think about it, I'm doing two investment deals at once instead of one. Anytime I can use someone else's capital to build wealth in a safe way, I will.

As for cash flow, I’ve always valued it more than equity. Over the years, I’ve seen equity rise and fall and even go away, but cash flow is the saving grace when this occurs.

When it comes to paying things off, I just figured my life insurance could take care of that if it’s something my heirs decide to do after I’m gone. That was my viewpoint up until now, but sometimes things change.

Financing Constantly Changing

For many people, paying down their properties can psychologically feel good, bringing peace of mind.

As I’m approaching retirement, I’m starting to reconsider some of my strategy. Would it be so bad to have some properties paid off in retirement? Maybe my heirs really don’t want my properties, and some now live out of state. It’s not like they want to help me take care of them.

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Related: Do You Pay off the Rental Properties You Have or Purchase New Ones?

Much of the change in my viewpoint is due to financing. Banks just don't want to let me refinance too much unless I go commercial, and some of the terms are pretty crappy, with me taking on way too much risk. Some of my properties have higher rates from before the downturn, and things like property taxes and flood insurance have been starting to skyrocket. Township rental licenses and inspections, along with everyday maintenance, have been taking a real bite out of the amount of cash flow I get.

So, if you have money on the sidelines, maybe it’s time to work on paying some mortgages off.

Did I really just say that?

[Editor’s Note: We are republishing this article to help out our newer members.]

What would you do if you were me, continue to re- leverage or start to consolidate and pay things down?

Be sure to leave a comment below!

Since 2007, Dave Van Horn has served as president and CEO of PPR Note Co., a $150MM+ company managing funds that buy, sell, and hold residential mortgages nat...
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    Steve Vaughan Rental Property Investor from East Wenatchee, WA
    Replied over 3 years ago
    I’ve enjoyed your article and all the comments, Dave. Lots of folks out there crushing it – so huge congrats to all! Not all debt is the same. I am perfectly comfortable leaving long-term fixed rate mortgages in the 3s and 4s alone without accelerating. They aren’t bothering me and a child could beat a 3-5% passive return in their sleep. Commercial debt, however, is a different animal and I am paying off or refinancing all of mine with l/t fixed private money aggressively. Commercial lenders bother you every year to submit your tax returns and PFS. Then every 5 years they basically make you re-qualify at a new adjustable rate. Some aren’t just callable, but expire every 5 years. They make you originate the loan again with a full $3500 appraisal and full underwriting. Rate risk and PITA. No thanks! On top of all this, commercial lenders make (me) you sign personally and give commercial guarantees and rights to rents of every business you own. At lower LTVs. When they are triple covered, I’m not. I am at a much higher risk as a borrower and they need to go bye-bye. Something to consider besides life stage or return maximization – commercial or residential debt. Cheers!
    Dave Van Horn Fund Manager from Berwyn, PA
    Replied over 3 years ago
    Hi Steve, Thanks for sharing! I agree with you completely. I don’t have any personal commercial loans – I’ve gotten rid of mine too. The only way I invest in commercial RE is through private equity as an investor or I’m using commercial financing for more than 100 units with a non-recourse loan. Best, Dave
    Kris Patel Investor from Arroyo Grande, California
    Replied over 3 years ago
    For good rated NNN property, get non-recourse fix rate loan for up to 25 yrs.
    Eric Jones Rental Property Investor from Rochester, NY
    Replied over 3 years ago
    Hi Dave, great article. First of all, this is a great problem to have! I have some family members in a very similar position so it’s something I’ve thought about – lots of properties with no real desire for more property, but plenty of cash, untapped equity, and monthly cashflow. If it were me, and I already had exposure to notes and private lending, I’d consider diversifying by looking outside of real estate at muni bonds in my state of residence for double tax free income before paying off mortgages (assuming you have low interest rate mortgages). For example, if I can pay off a 5% mortgage or invest in a 5% muni bond, I’d choose the muni bond since my pre-tax equivalent return would be 5%/(1-tax rate). So if I assume a 35% tax rate, the muni bond has a pre-tax yield of 7.7%, which easily beats out the 5% mortgage. Now if I had a steady supply of good note deals and/or lending deals maybe I’d choose those over muni bonds, but as my wealth builds I may see some value in diversifying into other asset classes.
    Dave Van Horn Fund Manager from Berwyn, PA
    Replied over 3 years ago
    Hi Eric, I agree. I’m the same way in that I prefer to invest the money at a higher rate and have it more liquid, rather than paying down all my debt. Best, Dave
    Kim
    Replied over 3 years ago
    Aloha Dave, I never thought that I would get old when I was younger. And then, one day, I looked in the mirror at my grey hair and ugly body and realized, OMG, I am old now! It wasn’t pretty but once I accepted the reality of it, I began to slow down my investing. You are wiser than I ever was because you are realizing that time is moving on for you and when you are older, you will be prepared. Your article about paying off mortgages or using leverage was excellent, as well as all the comments your readers made. For peace of mind, I would love to pay off mortgages and get higher cash flow, but mortgages come with their own kind of peace of mind – some protection from dirt bag law suit predators, and automatic payment of insurance and property taxes. However, Jeff Brown’s (one of the smartest people, imo) model of living mortgage free in the sunset years with higher cash flow is very appealing. I recently re-financed 2 properties in Hawaii at 50% LTV, with a 30 year (yikes) at 3.5%. Beautiful rate but I still pay almost $3000/month on each. I live in one and rent the other. I could possibly pay off one, or half of both. It would be a waste of equity. And I still would be paying a rather high monthly mortgage. I recently bought a condo/hotel unit with cash, and get about $900/month net cash flow from it. Potentially, I could use the 2 Hawaii properties’ equity and get 4 more condo/hotel units, but the equity would be financed and incur monthly payments, resulting in far less net cash flow than the single unit. I think at this point in my life, I have a lot of thinking to do. What do I need to live a life of simple luxury, and how do I use what I already have to get there? Mahalo for your thought provoking article!
    Kris Patel Investor from Arroyo Grande, California
    Replied over 3 years ago
    Where condo unit and cost? Return COC, thanks
    Kim
    Replied over 3 years ago
    Aloha Dave, I never thought that I would get old when I was younger. And then, one day, I looked in the mirror at my grey hair and ugly body and realized, OMG, I am old now! It wasn’t pretty but once I accepted the reality of it, I began to slow down my investing. You are wiser than I ever was because you are realizing that time is moving on for you and when you are older, you will be prepared. Your article about paying off mortgages or using leverage was excellent, as well as all the comments your readers made. For peace of mind, I would love to pay off mortgages and get higher cash flow, but mortgages come with their own kind of peace of mind – some protection from dirt bag law suit predators, and automatic payment of insurance and property taxes. However, Jeff Brown’s (one of the smartest people, imo) model of living mortgage free in the sunset years with higher cash flow is very appealing. I recently re-financed 2 properties in Hawaii at 50% LTV, with a 30 year (yikes) at 3.5%. Beautiful rate but I still pay almost $3000/month on each. I live in one and rent the other. I could possibly pay off one, or half of both. It would be a waste of equity. And I still would be paying a rather high monthly mortgage. I recently bought a condo/hotel unit with cash, and get about $900/month net cash flow from it. Potentially, I could use the 2 Hawaii properties’ equity and get 4 more condo/hotel units, but the equity would be financed and incur monthly payments, resulting in far less net cash flow than the single unit. I think at this point in my life, I have a lot of thinking to do. What do I need to live a life of simple luxury, and how do I use what I already have to get there? Mahalo for your thought provoking article!