To pay off rental properties or not...that is the question!

26 Replies

I am developing my business plan for buying and holding. I was talking out some ideas with another investor, and she said you should never pay off your properties, and never pay all cash.
It seems to me that if you don't have a mortgage to pay that your profit would would be a lot greater. And you would be less likely to over leverage yourself.
Am I missing something? What are the pros and cons?
Am I missing something?

It depends on your opportunity cost of your money to you, risk tolerance to your cash flows, how well you can manage your cash flow with reserves, asset protection concerns with exposed equity in your properties if any if they were paid free and clear, and overall tax profile with respect to income, deductions, available depreciation to shield your income and what you need to show to keep the ability to obtain financing going forward or not. You can be more aggressive with your deductions if you don't plan on needing financing going forward. However, there are certain financial ratios that banks will want to see depending on how sophisticated you plan to get in order to show your a prudent steward of your own finances.

We did pay off a rental and regretted doing so a few years later.  Turns out you cannot pull cash out of a paid off rental if you already have 4 mortgages on other properties, well, not with conventional financing, anyway.  The loans we could get had higher rates, higher fees and shorter terms, so not worth doing.  Had I known how hard it was to get money out of a paid-for rental, I would not have done it, I would have simply refinanced as the rate was about 6%.  I'm not paying a dime extra on my other mortgages now, simply saving the cash flow for the next down payment, as those rates are so low I'm happy keeping them for the life of the loan.

This has been covered here in detail several times. Of course the answer depends on your goals and where you are at. Like Lynn, I did and regret it. Its a trade off between growth and cash flow/debt. Pros to loans is ability to have more cash to do more deals and grow, make money off spread, increased COC. Pros to cash purchase- less debt, more CF, less liability. There is a reason people say cash is king= flexibility.

Thank you for your opinions, and help. My plan wasn't to aggressively pay down or seek cash only deals, but I figured if I had a combination of paid off and mortgaged properties (over the long term...15-20 years) I'd have the benefit of both. 

This other individual was just so adamant that you never payoff properties I was confused...especially cause she didn't really have a legit reason why, just a definitive never, cause it's a stupid thing to do. And that just didn't sit we'll with me

Something to consider is the real cost of financing anything. Let say you get a loan for 100k @ 5%. Over 30 years you will pay back 180k add associated cost etc..What you are really agreeing to do is pay 180k over 30 years not 100k today. Seems reasonable. Now try 300k you will pay 240k for the right to borrow that amount at 5% 30 years. Now I left out tax deduction on interest which is big but so is the upto 25k deductable for landlording just one property. For sure most finance but I will bet most cash payers sleep better at night.

thanks, 

Matt

Because current loans are so cheap, IMO it better to get as much as you can.  I plan to grow until I have the a gross amount that I am good with and then start to snowball paying them off.

@Brandon Luke  My plan is the same as @Pete T.  

I don't like getting up in the morning to pay interest to a bank.  It's just the way I live life and it's worked well.  

It's very typical most people have different things they were taught when they were young or grew to learn but at the end of the day the resounding answers I hear generally emotionally related such as:

- I'm glad I have no mortgage to pay in the morning

- I am debt free and it feels great

- mortgages are a headache 

- or you can save 80k of interest over the life of your loan if you don't borrow and instead purchase with cash and yes that is true but if your earning 15% or a 10% net positive return on borrowed funds did you know your opportunity cost is 6.6 million wealthier? Many neglect to look at things globally and if we factor in tax incentives and other returns it could be even higher. The pundits will tell you it's impossible to earn 15% annually continually on all  the earnings and that may be possible however even at a lower return like 9-12% the earnings  will still be exponentially higher than the cost.

So at the end of the day  you can pick whether you'd like to use finance to plan  your investing strategy or emotionally make decisions.

Updated almost 4 years ago

* I meant that it may not be possible to earn 15% continually on all returns but even if we were to revise that number down to something reasonable like 9-12% the result is still much higher than the rate at which we are borrowing at. Payments these days

Most people don't realize how great life is when you aren't paying interest to someone else.  I will finance all my properties until I hit my gross amount.  Then I will kill the payments, because life is wonderful when you don't owe people money.  You have to live it, to understand it. 

Originally posted by @Bryan Neal:

Most people don't realize how great life is when you aren't paying interest to someone else.  I will finance all my properties until I hit my gross amount.  Then I will kill the payments, because life is wonderful when you don't owe people money.  You have to live it, to understand it. 

Bryan, Bryan, Bryan, don't you know you're making decisions emotionally instead of logically? Apparently that makes you irrational.  ;-)

Of course, some of us believe that being leveraged to the hilt is foolhardy . . .

@Sylvia B.   Exactly!!!!

My refrigerator died on Friday.  I didn't even care.  We just paid cash for another one.  My wife and I never even thought "how will we pay for a new French door stainless steel fridge."  That's an emotional decision that we just smile at :)   If I was levereged like a real American I would be figuring monthly payments on a new refrigerator instead...

Thank you so much for all your help and advice. 

@Brandon Luke  

It depends on you.  If you are just starting out and plan a long career of real estate acquisitions and you don't have a sugar daddy, then financing of one sort or partnership, joint ventures are the way to go.

If you are winding down, selling off property, preparing for carefree retirement, then maybe all cash is the way to go.

First of all @Brandon Luke do or would you have the ability to pay off or pay cash for a property?

Secondly, do you want 1 or 10 or 100 rentals? You will need to stay leveraged for more property. Maybe you like a super simple and frugal lifestyle w/o debt then that works for you. Maybe you aren't happy unless you are shooting for the moon.  Figure out your goals and the rest will fall into place.

You could regret paying off a cheap mortgage if/when rates rise. If you have a 5% mortgage and can buy CD's at 8%, no effort or risk, then that would be nice IMO.

I think it makes sense to use leverage to your advantage early on, especially now with rates so low. Then once you reach your desired level of monthly income start paying those suckers off. I didn't have one cent of debt until last year when I bought my first property at 28. Owing $130k to someone else is definitely not something I would do in an ideal situation but I would have had to save for another 5 years at least to pay for the property in cash; I wasn't willing to do that. Just make sure you don't overleverage and have 6 months of reserves to cover each mortgage and you will sleep fine.

Today you would pay 5% or less on a conforming mortgage. Ca you makeore than 5% investing in other ways, then take the cheap loan, if not or you have piles of cash, borrow at these cheap rates ?ill take all the 5% money I can get)

Hey @Brandon Luke, I think this is a case by case and a market by market issue, if you decide based on your lifestyle that paying off your "investment property" mortgage is the right thing for you and you can afford it then good for you.

For me the cash on cash return opportunity that would be lost by not leveraging money would put me on medication :-) After all isn't the tenant paying the mortgage and allowing you to leverage your money? I would also consider the opportunity cost as related to interest and inflation. If you park your money into your properties, how will your future purchasing power be affected especially if your property doesn't appreciate?...and will your rents be able to offset that?

In the long run is it going to cost me more to payoff  the mortgage or leverage my money? Where is my money less at risk? How liquid do I want or need to be? How many units do I want to have?

In the end, It all comes down to ones personal and business goals. Whatever you decide, in the words of  Kevin O'Leary (Mr. Wonderful) - "Don't murder your money!"

Here is an article that speaks to this issue ->

7 Reasons Not To Pay Off Your Mortgage Before You Retire

Stories abound of investors who pyramidded their profits into "empires" only to lose every single unit (or at least MANY units) to foreclosure.

It's hard to lose a SFR with no mortgage on it.

Great info all. Thanks for sharing

Originally posted by @Mark Whittlesey:

Stories abound of investors who pyramidded their profits into "empires" only to lose every single unit (or at least MANY units) to foreclosure.

It's hard to lose a SFR with no mortgage on it.

 Could be many arguments for and against acquiring many properties with leverage and losing or not losing them all problem is most people dont purchase the properties based on sound financial principles. I work with investors all the time on financing and its very common place, but the ones that have been very successful have developed systems and unique processes and have stuck to it over, and over, and over again. 

I guess it's all risk dependent.  Do you want to wake up every morning thinking about 15 loans you have to stay good on?  Or wake up every morning thinking I want to go fishing? Leverage is essential.  Eliminating leverage is just as essential to financial peace. 

Originally posted by @Bryan Neal:

I guess it's all risk dependent.  Do you want to wake up every morning thinking about 15 loans you have to stay good on?  Or wake up every morning thinking I want to go fishing? Leverage is essential.  Eliminating leverage is just as essential to financial peace. 

It all depends on the investors emotional relationship with leverage if leverage makes you stressed and the pain of leverage exceeds financial gain then sure you'll try to reduce leverage even if it makes financial sense to keep debt or add more.

Nowadays with the advent of the internet, systems, full service property management companies, and technology bills/payments can be taken care near seamlessly with little of your intervention. If you buy right and planned/structured the systems correctly the returns from all sources should exceed expenses. I am sure there are many outliers out there like if you bought in a D- area and building and or other.

Right now I am in the process of buying a million dollars worth of property. I figure that will mean me owning five or six properties in the price range where I am buying. The next step is to have a million dollars in equity. After I have bought a million dollars worth of cash flowing rental property, I will use the rental income and income from my job to pay them off. The end result of course being to become a millionaire in net worth. 

The next step is to make a million a year in income from real estate. 

Some people hug interest to grow their net worth.  After hugging interest, the smart people smash it like a disease and hug their net worth.  Why?  Because they wake up and go fishing.  They don't wake up and balance finances to make sure payments are made on time.  Anyway, everyone has their own philosophy on investing.  I respect all the angles and appreciate the advantages involved.  All I know is the sky could fall tomorrow and I won't lose sleep, because my "leverage" doesn't exceed my current wealth.  I could crush my leverage tomorrow and my wife and I wouldn't even notice...

Leverage is essential to growth in real estate.  I understand and respect that.  Leverage is also the death of a real estate investor if not contained.  I understand and respect that.  

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