Opinions on debt in a rental properties
Alexandria , VA · Member since 2018 · 7 posts · 4 votes
If you can pay off the mortgage on your first rental property should you? And is it a viable strategy to then use a HELOC on the (now paid off) rental to buy a second? I ask this because my wife and I dislike debt but love rental properties.
Equity in a property is only earning the equilivant of the prevailing mortgage interest rates. If it were earning it's true opportunity value (10%) your property would be negative cash flow. Dead equity reduces TRUE cash flow from the property since it is your own cash that is generating the bulk of income not the investment property itself. If the property were sold and the cash placed in a income fund you would likely generate a much higher return.
Paying off a rental is poor use of cash and is dead equity. Based on todays interest rates it is a dismal return.
Disliking debt and investing in rental properties for maximum returns are in opposition. Cash must be cast out to earn it's keep. Pull it out with a HELOC or refinance.
Or don't...everyone has their own approach to cash utilisation.
Most of my portfolio is paid off, but for specific reasons and only the higher rate or commercial loans. I still had a fully funded emergency and opportunity fund on the side as well. I keep the long term low rate one's that don't bother me for my financials every year.
I did not rush to accelerate my first rental, especially if it had long-term low fixed rate residential financing on it. I and most everyone can beat a 4ish% return in their sleep. A lot of wealth building advocates recommend getting up to 5 rentals before paying them off early.
I have found buying opportunities come in waves. When looking for 2 rentals in 2003, I ended up with 12. When hoping for 2 in subsequent years, I was dry for 5. Keep an opportunity fund if you are still thinking of expanding.
Congrats though on having this as an option, David. Would love to hear more details about the loan rate and balance and how you came to save enough to pay it off!
In a rising market with low interest rates, then in the short term you are "missing out" on opportunities by not leveraging to the hilt. However, all of those people who are doing the same will be the ones giving their properties back to the bank in a downturn.
I don't think there is any such thing as "dead equity". Your equity is only realized when you sell. If you get in front of your skis by leveraging yourself based on the value of that equity, how is that any different than the equity being "dead" in your property? Both are phantoms that can only be realized when you sell.
Equity is based on the theoretical sales price of your property. Like anything else theoretical, it isn't real. I have a couple properties that I bought cheap for cash, and have now massively appreciated. They have approximately $200-250k in equity each based on being sold at today's market prices.
I could lever these properties and take out $500k in cash. But then I have to REINVEST at today's high market prices! I don't want to do that. So instead, I bank my $3000 a month and wait for the market to take a turn. I'll be the guy standing at the courthouse steps with a bag of cash when something bad happens.
The answer to your questions, @David Richmond depends on several factors. What are your goals/plan for RE investing? Are you just starting out or in the maintaining phase? How willing are you to take risks, and what do you consider a risky investment? How important to you is a feeling of financial security, and what circumstances make you feel insecure?
The answers to these questions are behind every reply you will get to your post, and your own answers will help you to find what is right for you.
Hubby and I currently own 12 SFRs and our personal home completely debt-free. At this point in our lives, and considering our goals and investment plan, it is the best answer. However, change just one factor and things could be very different.
If I only had one or two properties my concern would be scaling up. One or two single family rentals will not make you wealthy.
I sincerely appreciate the detailed replies. Extremely educational for a beginner. Perhaps a few more details will help further. my wife finally completed her 15+ years of medical training and is a trauma surgeon making Really big girl money. But since we have been used to living on just my salary, we now have the ability to pay off her 300k in student loans and thr 300k left on our 500k rental propriety in three years. We dislike debt by nature because we both grew up eating government cheese in families where money was always super tight, so our first instinct is to slay the debt.
That’s said, I would love to have 3-4 rental properties to suplement retirement income or just have a cash flow to allow less/different work, but don’t necessary want a rental empire given the time/other work interests. Were both right around 40 so don’t have forever to play around, but sounds like from the advice an alternate move might be to just be trefi the rental to increase cash flow and use some of the recent increased doc salary to buy a second rental.
Again I really appreciate the insightful advice.
I sincerely appreciate the detailed replies. Extremely educational for a beginner. Perhaps a few more details will help further. my wife finally completed her 15+ years of medical training and is a trauma surgeon making Really big girl money. But since we have been used to living on just my salary, we now have the ability to pay off her 300k in student loans and thr 300k left on our 500k rental propriety in three years. We dislike debt by nature because we both grew up eating government cheese in families where money was always super tight, so our first instinct is to slay the debt.
That’s said, I would love to have 3-4 rental properties to suplement retirement income or just have a cash flow to allow less/different work, but don’t necessary want a rental empire given the time/other work interests. Were both right around 40 so don’t have forever to play around, but sounds like from the advice an alternate move might be to just be trefi the rental to increase cash flow and use some of the recent increased doc salary to buy a second rental.
Again I really appreciate the insightful advice.
Congrats to you & your wife-- especially your wife. I admire the work she dedicated to her passion and calling.. (I also wish my JD/MBA wife was making really big girl money!) :-)
Again, Student loans are bad debt. FOCUS on that, absolutely. Then, focus on... whatever the heck other debt you may have-- I think that living debt-free in your OWN home, is probably also advisable.... depending on what your tax adviser says about your situation and the interest deduction.
HOWEVER, Leveraging assets, in the line of business, is a way to diversify both your cash pile and your cash flow. Let's work it out:
Average investment properties in your area are... $300K. You have $300K to invest.
would you rather have 1 income stream bringing in $1500 a month, or 2 income streams bringing in $3K a month, with a mere 50% each leveraged... ok, That's a good visual, but don't answer yet.
Now remember that the interest is a business expense...
yeah, there it is. Again CONSULT your (attorneys, consultants, Accountants, etc.) first. But if your goal is to AMASS real estate (as opposed to just buying Mom a place to live for a while, that you'll rent out later after the horrible inevitable happens) then you should use leverage until you don't need it any more.
That said, one person above said something very intelligent about maybe not buying this very second based on the Market and the prevailing values... @Hal Thompson Yeah-- I might agree.
why do you love rental properties @David Richmond?
@Jay Helms after traditional tax deferred places to stash cash rental properties seem like a diversified place to build wealth and supplement income, plus I like that similar to investing you can create a strategy that’ fits your risk tolerance, time horizon and available time. In our case we are fairly cautious, busy professionals with limited time (plus four kids) and although we have had a good cash flowing experience with our first rental for 6 years, I am struggling with developing a growth (next rental purchase) strategy that fits us. Our end goal is 3-4 rentals, but I need a conservative/not over leveraged growth strategy. I admire the many members on here that have aggressively grown large portfolios, but I would personally never be comfortable with that much leverage.
Cash parked in a rental has a extremely low ROI, probably in the 2-4% range at best, and in your situation you would be wiser to park your surplus cash in a REIT, income fund or syndication. Your returns would be higher than in paying off a rental, would be a far more passive investment and likely safer.
There are far better places for investors of your type to find suitable vehicles.
You do not seem like a good fit for investing in income properties based on your personal situations.
Sounds like you have a solid foundation & vision for your goals @David Richmond. Leverage is one thing, asset protection is another. Some legal advice I recently received incorporated leverage as a form of asset protection.
By that I mean, hypothetical situation, I'm sued because my tenant's son was injured on my property doing something stupid. I'm not at fault but it is the world we live in. I have an umbrella policy or the property is titled into a LLC. If the property is owned "free and clear" this gives the plaintiff attorney options and encouragement to pursue the suit and a bigger payout.
Luckily I haven't had to experience this yet, but makes sense on the surface. Would love your input on the idea.
@Jay Helms that is an interesting point and one we have been focused on previously from the oposite direction: getting sued through my wife's medical practice, since most docs in her line of work almost always have one open law suit against them. All is well and good provided the hospital backs you, but if your at fault.... To protect against both directions our strategy has been to use umbrella ensruance and move the property(s) into an LLC and or land trust.
Sounds like you have a solid foundation & vision for your goals @David Richmond. Leverage is one thing, asset protection is another. Some legal advice I recently received incorporated leverage as a form of asset protection.
By that I mean, hypothetical situation, I'm sued because my tenant's son was injured on my property doing something stupid. I'm not at fault but it is the world we live in. I have an umbrella policy or the property is titled into a LLC. If the property is owned "free and clear" this gives the plaintiff attorney options and encouragement to pursue the suit and a bigger payout.
Luckily I haven't had to experience this yet, but makes sense on the surface. Would love your input on the idea.
I am drafting 2 deeds of trust now to self-encumber 2 of our free and clears. My mgt corp (which has a very generic name) will be the mortgagee.
An idea to appear leveraged if gold diggers come a snooping.