Mortgage vs Owning outright

Buying & Selling Real Estate

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Mortgage vs Owning outright

Lawrence Moore

Heath, TX · Member since 2016 · 39 posts · 12 votes

Just out of curiosity, how many of all your properties do you have a mortgage on and how many do you fully own?

Mainly talking to buy & hold people, but flipping would also be welcomed, and really any type of REI investors.

Thanks!

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Jake Hartnett

Real Estate Agent · Saint Paul, MN · Member since 2014 · 95 posts · 82 votes

10y

@Brandon Ingegneri You could have a very simple business if you just had 10 houses that were all paid off cashflowing $600/month each ($1200/house with 50% expenses). If they were each worth $100,000 you would be getting 7.2% return on equity on your $1,000,000 portfolio, and an annual cashflow of $72,000. Not a bad simple business.

Now if you took that $1,000,000 in equity and spread it across 33 properties with 70% LTV the payment on each one would be about $350, so the cash flow would be $250/house or $99000 annually for a cash on cash return on equity of 9.9%. You are also paying down over $1,150 of principal every year per house, for a total of at least $38,000. So theoretically you can buy another house every year just with the equity build up and increase your net worth by an additional $4150 per year.

The question is, would it be worth it to you to manage 23 more houses for an additional $65,000 per year? Manage 10 paid off houses for $72,000 or manage 33 houses with mortgages for $137,000?

There is no right answer but for me its leverage all the way. Plus, when you own outright you give up the very valuable mortgage interest deduction.

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Larry Turowski
Flipper/Rehabber · Rochester, NY · Member since 2014 · 1k+ posts · 1k+ votes
10y
@Lawrence Moore I have mortgages on all of my rentals. It is called leveraging. You get a much better return on investment that way.
2 Reply
Lawrence Moore
OP
Heath, TX · Member since 2016 · 39 posts · 12 votes
10y
@Larry T. Yes but at what point does that become too much? 10 rentals, 15 rentals, 20? Would it be smart to have 60 rentals all with a mortgage if they're all occupied? I suppose that's another question I should've introduced in the title
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Brandon Ingegneri
Rental Property Investor · Providence, RI · Member since 2015 · 1k+ posts · 594 votes
10y
Personally, I'm one of those people who likes knowing something is paid off. That doesn't mean I'm opposed to lines of credit and what not. However, the other day, I was talking to a pretty squared away friend of mine who isn't in real estate but works managing a hedge fund on Wall Street. He was pretty steadfast that leverage is the key. Can you scale faster with leverage? Yes. But what if you didn't have as many properties but could cash flow more because you had less overhead?
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Chris Christianson
Contractor · Minneapolis, MN · Member since 2013 · 112 posts · 67 votes
10y
I want to own as many doors as I can, that requires leverage. If the numbers work, ie: your making money off each door, and you're taking into account the ramifications of a standard market downturn on the type of property you're buying, LEVERAGE!
Just my two cents, now leverage it and turn it into a dime.
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Jake Hartnett
Real Estate Agent · Saint Paul, MN · Member since 2014 · 95 posts · 82 votes
10y
@Brandon Ingegneri You could have a very simple business if you just had 10 houses that were all paid off cashflowing $600/month each ($1200/house with 50% expenses). If they were each worth $100,000 you would be getting 7.2% return on equity on your $1,000,000 portfolio, and an annual cashflow of $72,000. Not a bad simple business.
Now if you took that $1,000,000 in equity and spread it across 33 properties with 70% LTV the payment on each one would be about $350, so the cash flow would be $250/house or $99000 annually for a cash on cash return on equity of 9.9%. You are also paying down over $1,150 of principal every year per house, for a total of at least $38,000. So theoretically you can buy another house every year just with the equity build up and increase your net worth by an additional $4150 per year.
The question is, would it be worth it to you to manage 23 more houses for an additional $65,000 per year? Manage 10 paid off houses for $72,000 or manage 33 houses with mortgages for $137,000?
There is no right answer but for me its leverage all the way. Plus, when you own outright you give up the very valuable mortgage interest deduction.
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Dan Vleck
Deerwood, MN · Member since 2014 · 184 posts · 122 votes
10y
I have six sfr houses, all with mortgages. My plan is to build my portfolio to 14 houses and then pay them off. P.S. God nay have other plans for me and my portfolio.
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Brandon Ingegneri
Rental Property Investor · Providence, RI · Member since 2015 · 1k+ posts · 594 votes
10y
@Jake Hartnett solid post. It makes absolute sense. You are right though. There are a million ways to skin a cat in real estate. That's what the beauty of it is. You can take 1 deal and work it so many different ways, sometimes none of which are incorrect.
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Samantha Klein
Investor · Monroe, WI · Member since 2015 · 691 posts · 610 votes
10y
Leverage is great but I only plan on having 12 units making 60k a year all paid off. I don't want to manage 20 or 30 properties leveraged just to be making over 100k a year, this is suppose to be semi-passive and I intend on keeping my headaches to a minimum, plus 60k a year goes a long way in the midwest.
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Jay HinrichsBusiness Member
Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
10y
@Jake Hartnett this a great subject and debate... you have two schools.. so I look at two of my past partners... One a CEO of the largest wine maker in the US and the other owner of local garbage companies..
Both got bought out.. CEO took it public got a huge check.. Garbage got bought by Waste management and got a HUMUNGUS check LOL...
CEO is leverage all the way Garbage man owns every thing free and clear ZERO debt on his balance sheet.
During the crash.. Mr. Zero debt was fine no worries.. Mr CEO who had tons of leverage on multiple business and enterprises.. had some scary moments.
Leverage is fine but it can bite you big time.. and to think rentals are immune from having a bad day in a bad economy well that is dangerous thinking.. Many investors hedge funds,, big multi family reits got KILLED in the great recession losing it all.
so be careful with debt.. nothing wrong with some free and clear assets.. or very short term debt that can be shed if things change
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Christos Philippou
Wilmington, DE · Member since 2016 · 116 posts · 59 votes
10y
@Jake Hartnett with some beast math knowledge! Thanks man!
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Joe SplitrockPro Member
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Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes
10y
@Lawrence Moore so many people on BiggerPockets argue leverage and more doors to the point you would think it is the only way to succeed. Yes, the BRRR strategy advocates leveraging yourself as much as possible. I am going to agree that leverage is a great way to grow your portfolio, but at the same time leverage increases risk. Another thing the "more doors" crowd doesn't talk about is that more doors equals more problems. It is more tenants to manage. You want to 10X your doors, then be ready to 10X your problems and expenses. That may be fine for some people. For me personally, I want real estate to be as passive as possible, without paying management fees. That means I am looking for more cash flow with less effort, rather than more doors.
To answer your original question, I have three are fully owned properties and five financed properties with long term low rate mortgages. I like the idea of no debt, but I need to scale to meet my goals so at this time I am using leverage.
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Larry Turowski
Flipper/Rehabber · Rochester, NY · Member since 2014 · 1k+ posts · 1k+ votes
10y
Originally posted by @Lawrence Moore:

@Larry T. Yes but at what point does that become too much? 10 rentals, 15 rentals, 20? Would it be smart to have 60 rentals all with a mortgage if they're all occupied? I suppose that's another question I should've introduced in the title
The question then is about over leveraging. There are a number of things that go into determining this. I'll just say that I don't feel at all that I'm over leveraged.
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Joe SplitrockPro Member
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Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes
10y
Originally posted by @Larry Turowski:

Originally posted by @Lawrence Moore:
@Larry T. Yes but at what point does that become too much? 10 rentals, 15 rentals, 20? Would it be smart to have 60 rentals all with a mortgage if they're all occupied? I suppose that's another question I should've introduced in the title
The question then is about over leveraging. There are a number of things that go into determining this. I'll just say that I don't feel at all that I'm over leveraged.
Do you think anyone thinks they are over-leveraged? I am not saying you are. I am just pointing out that since there is no measure of what over-leveraged is, most anyone will say they are not. If someone is paying their bills, they generally think they are fine.
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Lawrence Moore
OP
Heath, TX · Member since 2016 · 39 posts · 12 votes
10y
@Joe Splitrock I think I found the topic for my next forum post
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Larry Turowski
Flipper/Rehabber · Rochester, NY · Member since 2014 · 1k+ posts · 1k+ votes
10y
Originally posted by @Joe Splitrock:

Do you think anyone thinks they are over-leveraged? I am not saying you are. I am just pointing out that since there is no measure of what over-leveraged is, most anyone will say they are not. If someone is paying their bills, they generally think they are fine.
Good point. I guess you could ask yourself a few questions like: Are my properties in good shape? Would I be able to financial handle a major issue (such as vacancy, a furnace replacement or roof replacement) at half or even all of my properties at the same time? Am I in an area where prices are stable? Would I be able to sustain a major price drop, say 30%? Etc.
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Joe SplitrockPro Member
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Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes
10y
Originally posted by @Larry Turowski:

Originally posted by @Joe Splitrock:
Do you think anyone thinks they are over-leveraged? I am not saying you are. I am just pointing out that since there is no measure of what over-leveraged is, most anyone will say they are not. If someone is paying their bills, they generally think they are fine.
Good point. I guess you could ask yourself a few questions like: Are my properties in good shape? Would I be able to financial handle a major issue (such as vacancy, a furnace replacement or roof replacement) at half or even all of my properties at the same time? Am I in an area where prices are stable? Would I be able to sustain a major price drop, say 30%? Etc.
I was thinking the same thing. You could look at how much reduction in income you could withstand for how long and still cover your monthly bills. Good point on property condition, because better condition means less problems and easier to sell in an emergency. There is probably a breaking point where most people would just walk away and let everything default.
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Dan Cho
Latham, NY · Member since 2016 · 64 posts · 9 votes
10y
So in my opinion real estate is a game where you want to own as many "doors" as possible with as little money down as possible. Its a game of leverage where you are trying to invest the least amount of money and get a return. Lets use an example below: Assumption Buying Price $100,000 Rental Income: $1,000
Scenario 1: Bank Loan 20% Down: $20,000 so with a rental income of $1,000 and $20,000 down our return would be 5%
or
Scenario 2: Seller Financing 5% Down: $5,000 so with rental income of $1,000 and $5,000 down our return would be 20%.
Now these are based on EXTREMELY SIMPLISTIC Assumptions we did not include tax, maintenance, etc. But it gets the point across with a minimum down payment our returns are a difference of 5-20% depending on how much money you put down.
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David Zheng
Investor · Saint Louis, MO · Member since 2016 · 970 posts · 1k+ votes
10y
I'm all about leverage as well. I'm basically in the rental market so if a tenant can pay a mortgage and pay me extra cash, why not. I also find a make a lot more business partners the more properties I hold.
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David Faulkner
Investor · Orange County, CA · Member since 2015 · 2k+ posts · 3k+ votes
10y
I'll give you the typical investor answer ... it depends :)
Seriously, it does. Can't give you a one size fits all answer as honestly sometimes I prefer more leverage (mortgage debt) and sometimes I prefer less. It is a tool like any other, to be used when and how appropriate and with care.
So what is this tool used for? For me it is a really useful tool to manage risk level. All other things equal (which they never are) you can increase risk on an individual property by adding debt and decrease risk by reducing debt. Why would you want to increase risk? Because increasing risk also increases your potential for return. All leverage does is multiply your returns, regardless of if those returns are positive or negative. Higher debt, higher risk, higher potential for reward (and loss). Some may disagree with this and say that they can manage the risk in such a way that more debt equals less risk, but history is full of examples of those that thought they could outsmart the risk and went belly up when a downturn proved otherwise, so I respectfully disagree and state instead that one should assume that there is no free lunch when it comes to debt or anything else.
Some practical examples of using debt to manage risk level ... when I was young, single, and without kids, I was more focused on growing my portfolio and had a larger appetite and capacity to take on risk. So I used more leverage (debt) in my portfolio.
Now that these early risks have paid off and my portfolio has grown larger, not to mention I am now married with children, I have more to lose. My appetite and capacity to take on risk is less. I use less leverage than when I was young, but still some.
As I age further, the time that I will have to make up for any mistakes goes down and I will likely value safety over growth. At some point I will want and/or need to stop working and at that point will need low risk cash flow. At that point I will likely pay off all the mortgages and go free and clear.
All along the way I also adjust my leverage with the RE cycles ... after a crash properties may become over sold and under valued ... when I see this and think there is more upside, I will leverage up to buy more. On the other hand, if the market is super hot then properties may become over valued ... when I see this and think there is more downside, market risk goes up and I counteract by deleveraging.
It is largely a personal choice and some may disagree, but this is my personal philosophy and some practical examples on how I apply this philosophy.
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Andrew SyriosPro Member
Moderator
Residential Real Estate Investor · Kansas City, MO · Member since 2014 · 10k+ posts · 5k+ votes
10y
I got to go with mortgages. You get to take advantage of OPM and leverage. So if there is say 2% apprecaition and you have an 80% LTV loan, you get 10% profit. Now, of course that works two ways, but because real estate is an inefficient market and you can get deals with a lot of built in equity, you can insulate yourself from that risk. If you buy a house for 80% of its value and the market goes down 10%, you still have 10% equity. But if you get a loan and it goes up 10%, you've effectively made 50% on your money. So, I lean strongly toward the leverage side (albeit, it's something you need to do very carefully, of course).
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Gabe C.
Investor · San Francisco, CA · Member since 2016 · 192 posts · 95 votes
10y
Some great answers! For me it's all leverage until I hit a number that I'm uncomfortable covering if I suddenly had a ton of vacancies at once. When I hit that number, I'm going to start paying off a unit. When that's done I can add an additional property, and use the new cash flow to start the domino effect of paying units off faster and faster. Rinse and repeat until I hit my freedom number. If I were younger, I'd probably leverage my brains loose.
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Thomas S.
Member since 2016 · 13k+ posts · 12k+ votes
10y
The biggest misconception those investors have that prefer to pay off their properties is that it increases cash flow, the reality is that paying off a property does not increase cash flow it simply divides the cash flow between two income sources. The cash flow from the property remains exactly the same and the rest is actually generated by the equity at a extremely low rate of return. Investing it anywhere other than in a property would generate a greater return.
The return they receive on the equity is actually only at the prevailing interest rate. They may as well stuff the money under their mattress with todays low interest rates as opposed to burying it in a rental property. It barley qualifies as investing.
Paying down the mortgage on a rental property is nothing more than squirreling away cash for your kids to inherit.
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Ian WalshBusiness Member
Lender · Philadelphia, PA · Member since 2016 · 2k+ posts · 1k+ votes
10y
The answers here will really depend on your investment strategy and monthly cash flow. People looking at high leverage on their properties really need to have very good monthly cash flow . When something goes wrong on a group of highly leveraged properties, that is when the person will have to dig in. Many times I have seen people have to pull from their savings. Low leveraged properties many times allows people to use the actual cash flow from the properties to offset these problems. Lower leverage normally also means less properties to acquire.
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Sean Cole
Investor · Cincinnati, OH · Member since 2012 · 506 posts · 331 votes
10y
Interesting debate. I think that if you're only looking at 1 particular house in a vacuum, leverage certainly generates higher ROI. As others have pointed out, but I'll say differently, the financial calculation of ROI does not allocate any cost of your time, risk, etc. in the equation. This is important as you're examining whether to buy your 10th unit, 20th unit, or whatever your personal breaking point is. As a business owner, I understand that expanding my business would require more work for the same (or less profit) in the short to medium term. From a money value of time (said that way for you finance geeks to chuckle about) perspective, leverage for the sake of additional units isn't always the right answer for everyone.
You can't go bankrupt if you have no debt! You also can't spend ROI but you can spend cash flow.
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Jeremy Brown
Rental Property Investor · Folsom, CA · Member since 2016 · 140 posts · 70 votes
10y
A lot of people are assuming your only option is more rentals. If you can pull out equity and invest it ANYWHERE for a greater return than the interest you pay on the mortgage, you'll be better off. If you can pull out $100k equity at 3.5% and invest in something that pays 7%, you just improved your annual return by $3,500. The other investment doesn't have to be a rental, with all the work it entails. You could even diversify and find something outside real estate.
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