How do you like having paid off rentals?
Most Popular Reply
Real Estate Broker · Bay Area · Member since 2018 · 1k+ posts · 3k+ votes
7yPaid off rentals are great it gives you holding power. Regardless of economic conditions, you will be able to survive it. I am taking one variable out of the risk of investing by having it paid in cash.
I understand both sides of leveraging and owning houses outright. In the beginning, an investor needs equity and leveraging is the best way to attain it. Towards the middle (10yrs) of the investment career that need may not be as great and they want more cash flow. That is when an investor wants their units paid off and netting them more money per deal.
At some point, you have to evaluate your portfolio for risk and time. Do I want to own 30 houses netting me $200 a unit or do I want to own 7 houses cash that pays me the same? What has more risk 30 houses with loans or 7 houses paid off? How much time will I have saved owning 7 vs 30?
Having your money sit in your house is NOT DEAD EQUITY. I understand why someone would say that but if my house pays me every month it is not dead. It is being utilized as the exact tool that I planned. It's like saying someone who invests in treasury bonds is dead equity. But no one ever says that.
In the end, it depends on the investor and how they run their business and what's most important
153 Replies
- Real Estate Broker · Houston, TX · Member since 2017 · 64 posts · 27 votes7y
@Tj M.
Spend 100000 on 5 properties putting 20000 down on each
100000 property - 80000 debt - 20000 equity - rents 1000 /mo - 6% loan to bank 360 mo - 479.64 PI - 150 taxes - 100 insurance = 729.64 exp resulting in 270.36 mo cash flow x 12 = 3244.32 income year / 20000 down - 16.22 rate of return on your 20k investment and you have 80000 left to go do 4 more investments of 20000 each so 3244.32 x 5 (houses total) = 16221.60 total income a year on 100000 investment plus you get depreciation and appreciation on 5 properties
Spend 100000 on 1 property putting 100000 down (no debt)
100000 invested in 100000 property no debt - 1000 rents - 150 taxes -100 insurance = 750 month cash flow x 12 = 9000 income year / 100000 investment in your no debt ( no leverage) investment = 9% return on your investment annually
In each example you spent 100000 - you can’t tell me that dead equity in a property makes more money than smart leveraged property - this example did not account for the deductibility of mortgage interest which could be another bonus
Also let’s assume there is 5 % appreciation in one year
In example one, that’s an extra 5000 equity you gain, in example 2, it’s 25000
The last way to make money in real estate is called equity capture - let’s say you were able to negotiate the property on purchase for 5000 less than market value - you “capture” that equity - this could also be an increased value because you slightly repaired the property - if you did this on 5 properties instead of one, it’s another 25000 in equity capture
I could have this debate all day - equity sitting in a house is only making you money in one of the 5 ways to make money in real estate - appreciation
Here are the 5 ways to make money in real estate ...
Appreciation
Cash flow
Equity capture
Tax advantages - 1031 exchange & depreciation
Principle pay down - by tenant
- Flipper/Rehabber · Minneapolis, MN · Member since 2016 · 1k+ posts · 1k+ votes7y
@Jon Lanclos so how does that formula work in a market downturn? I will tell you, increased ROI in a market upturn = increased negative ROI in a market downturn.
We all know that leverage can increase ROI but many who believe in this fail to recognize how the inverse relationship works. The market doesn't always go up, it can go down and has in the past.
Smart leverage and risk tolerance matter a lot, someone wanting to retire early will have different goals than someone who already has their nest egg built and doesn't want to lose it.
- Real Estate Agent · Greater Boston, MA · Member since 2016 · 14 posts · 7 votes7y
@Tj M. Love paid off rentals!
- Rental Property Investor · Toano, VA · Member since 2018 · 91 posts · 22 votes7y
@Tj M.
It is definitely your preference. I love going to bed at night knowing that I don't have to worry about paying a mortgage and receive free and clear cash every month from the renter. I was able to purchase the next home in cash because you were able to save cash quicker for your next purchase. I also like to deal with a portfolio that is manageable. My goal is to retire comfortably and not have to worry about who I owe.
But others may have their preference to have as little skin in the game as possible.
- All Over, USA · Member since 2017 · 689 posts · 756 votes7y
Originally posted by @Joe Villeneuve:
Originally posted by @John Woodrich:
Originally posted by @Joe Villeneuve:
Maybe you should have read all the posts.Can already tell you are a type B person in my example by looking at the post below mine and "dead equity".
This is a common question here and the same people always dig their heals in. One side of the table may get caught with their pants down if we get another recession, the other side is making sure they don't get caught. I was fortunate to start investing in 2007 so picked up property on the back end. I have also worked with many individuals who weren't as fortunate, many realtors sold on the game of monopoly.
There is no correct approach to this, it depends on the individual's needs and goals. So that makes you wrong :)
Question: If the market turns down, and the property values decrease, and we are talking about a rental property with positive cash flow, how is the investor negatively impacted?
Positive cash flow on thin numbers, (yes, even your $400+/month) can easily evaporate when the market turns. In this case, the one with paid off dead equity is in a LOT better shape.
- 7yJoe VilleneuvePro MemberPlymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes
Originally posted by @Aaron Hunt:
Originally posted by @Joe Villeneuve:
Originally posted by @John Woodrich:
Originally posted by @Joe Villeneuve:
Maybe you should have read all the posts.Can already tell you are a type B person in my example by looking at the post below mine and "dead equity".
This is a common question here and the same people always dig their heals in. One side of the table may get caught with their pants down if we get another recession, the other side is making sure they don't get caught. I was fortunate to start investing in 2007 so picked up property on the back end. I have also worked with many individuals who weren't as fortunate, many realtors sold on the game of monopoly.
There is no correct approach to this, it depends on the individual's needs and goals. So that makes you wrong :)
Question: If the market turns down, and the property values decrease, and we are talking about a rental property with positive cash flow, how is the investor negatively impacted?
Positive cash flow on thin numbers, (yes, even your $400+/month) can easily evaporate when the market turns. In this case, the one with paid off dead equity is in a LOT better shape.
To each his/her own. I prefer to look at two things. My ability to analyze, and my cash. If I only put the down payment into deal, I only have the down payment to lose. If I have high enough CF, I cover vacancies and slow rent. Also, through my experience, and that of many others, when the economy turns down, there are more renters than less. This allows me to let the market recover and my rental too. If my rental value goes below my balance owed, it doesn't impact me...I just wait it out...collecting my rent along the way.
Nobody has any control over future events, such as property values. Equity can be here today, and gone tomorrow. I remember distinctly not long ago when many REI (and others) hit that date when they wanted to retire, depending on the equity/value of their investments to carry them through. The market crashed so bad, many had to work part time as greeters in Home Depots, and other stores...or where ever they could find a job that would hire a retirement age person.
The REI that survived, were the ones with cash flow. Some of the cash flow went down, some went up, but the vast majority were still positive...and none that survived it originally bought with thin numbers. They all started high enough to be able to cushion any reduction that might have happened to their rents...if at all.
The retirees that suffered were the ones that banked on their equity, and the ability to tap into it. It didn't matter if they owed nothing on all of their properties, the values all went down to less than what they needed to retire on.
Like I said from the start, "to each his/her own", but I prefer to own cash flow (but I still like the equity that builds up in them...thanks to my tenants).
- Investor · Boston, MA · Member since 2015 · 1k+ posts · 3k+ votes7y
Originally posted by @Joe Villeneuve:
Originally posted by @Bill F.:
Originally posted by @Joe Villeneuve:
Originally posted by @John Woodrich:
Originally posted by @Joe Villeneuve:
Originally posted by @John Woodrich:
Originally posted by @Joe Villeneuve:
Originally posted by @John Woodrich:
Original Cost = $100,000
New Value = $85,000 (represents a 15% drop)Formula: New Value - Original Cost = Net Gain/Loss
100% Buy ==> $85k - $100k = - $15k (as in lost $15k of their money)
20% Down==> $85k - $20k = +$65kSo in this example Joe you are assuming the person who has a loan doesn't have to pay the loan???????? By my calculation, they both lost $15,000! The cash buyer owns a $85k house, the non-cash buyer owns a $85k house with a $80k mortgage.
No, what I'm saying as that the money to pay the mortgage is coming from the rent...not the REI's bank account.
And that doesn't matter... The tenant can pay the bank $85k and payoff your mortgage, or that same $85k can go in the investor's pocket as additional cash flow each month. Doesn't affect the gain/loss you mentioned above.
But it "does".
What's the ROI of each investment?
Full Cash: -15% (85k-100k)/100k
Levered: -75% (85k-20k-80k)/20k
This is a clear demonstration of the downside of leverage. Small changes in the underlying asset value magnify the impacts on returns, both for good and ill.
Who pays the mortgage (it's not the tenant, the transitive property doesn't apply to accounting) is of no consequence.
Explain your formulas
Not my formulas, I'm not nearly clever enough to derive them myself, but I'd be happy to point you to my sources Joe.
ROI = (Gain from Investment (GI) - Cost of Investment(CI)) / Cost of Investment
Full Cash: GI=$85k (sale proceeds) CI= $100k:
($85k-$100k)/$100k=$-15k/$100k=-15%
Levered: GI=($85k(sale proceeds)-$80k(outstanding debt)) CI=$20k
[($85k-80k)-$20k]/$20k= ($5k-$20k)/$20k=-$15k/$20k=-75%
n.b Transaction costs are ignored for simplicity and ROI is not the best measure to use when evaluating the sale of a rental since it 1. assumes the home was bought and sold in the one year and 2. it is not an accurate measure of total return since it does not take into account cash flow from operations.
- 7yJoe VilleneuvePro MemberPlymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes
Originally posted by @Bill F.:
Originally posted by @Joe Villeneuve:
Originally posted by @Bill F.:
Originally posted by @Joe Villeneuve:
Originally posted by @John Woodrich:
Originally posted by @Joe Villeneuve:
Originally posted by @John Woodrich:
Originally posted by @Joe Villeneuve:
Originally posted by @John Woodrich:
Original Cost = $100,000
New Value = $85,000 (represents a 15% drop)Formula: New Value - Original Cost = Net Gain/Loss
100% Buy ==> $85k - $100k = - $15k (as in lost $15k of their money)
20% Down==> $85k - $20k = +$65kSo in this example Joe you are assuming the person who has a loan doesn't have to pay the loan???????? By my calculation, they both lost $15,000! The cash buyer owns a $85k house, the non-cash buyer owns a $85k house with a $80k mortgage.
No, what I'm saying as that the money to pay the mortgage is coming from the rent...not the REI's bank account.
And that doesn't matter... The tenant can pay the bank $85k and payoff your mortgage, or that same $85k can go in the investor's pocket as additional cash flow each month. Doesn't affect the gain/loss you mentioned above.
But it "does".
What's the ROI of each investment?
Full Cash: -15% (85k-100k)/100k
Levered: -75% (85k-20k-80k)/20k
This is a clear demonstration of the downside of leverage. Small changes in the underlying asset value magnify the impacts on returns, both for good and ill.
Who pays the mortgage (it's not the tenant, the transitive property doesn't apply to accounting) is of no consequence.
Explain your formulas
Not my formulas, I'm not nearly clever enough to derive them myself, but I'd be happy to point you to my sources Joe.
ROI = (Gain from Investment (GI) - Cost of Investment(CI)) / Cost of Investment
Full Cash: GI=$85k (sale proceeds) CI= $100k:
($85k-$100k)/$100k=$-15k/$100k=-15%
Levered: GI=($85k(sale proceeds)-$80k(outstanding debt)) CI=$20k
[($85k-80k)-$20k]/$20k= ($5k-$20k)/$20k=-$15k/$20k=-75%
n.b Transaction costs are ignored for simplicity and ROI is not the best measure to use when evaluating the sale of a rental since it 1. assumes the home was bought and sold in the one year and 2. it is not an accurate measure of total return since it does not take into account cash flow from operations.
Question: Why are you selling the rental?
Follow up: Why would you sell it, assuming it is cash flowing, when it's at a loss?
- All Over, USA · Member since 2017 · 689 posts · 756 votes7y
Originally posted by @Joe Villeneuve:
Originally posted by @Aaron Hunt:
Originally posted by @Joe Villeneuve:
Originally posted by @John Woodrich:
Originally posted by @Joe Villeneuve:
Maybe you should have read all the posts.Can already tell you are a type B person in my example by looking at the post below mine and "dead equity".
This is a common question here and the same people always dig their heals in. One side of the table may get caught with their pants down if we get another recession, the other side is making sure they don't get caught. I was fortunate to start investing in 2007 so picked up property on the back end. I have also worked with many individuals who weren't as fortunate, many realtors sold on the game of monopoly.
There is no correct approach to this, it depends on the individual's needs and goals. So that makes you wrong :)
Question: If the market turns down, and the property values decrease, and we are talking about a rental property with positive cash flow, how is the investor negatively impacted?
Positive cash flow on thin numbers, (yes, even your $400+/month) can easily evaporate when the market turns. In this case, the one with paid off dead equity is in a LOT better shape.
To each his/her own. I prefer to look at two things. My ability to analyze, and my cash. If I only put the down payment into deal, I only have the down payment to lose. If I have high enough CF, I cover vacancies and slow rent. Also, through my experience, and that of many others, when the economy turns down, there are more renters than less. This allows me to let the market recover and my rental too. If my rental value goes below my balance owed, it doesn't impact me...I just wait it out...collecting my rent along the way.
Nobody has any control over future events, such as property values. Equity can be here today, and gone tomorrow. I remember distinctly not long ago when many REI (and others) hit that date when they wanted to retire, depending on the equity/value of their investments to carry them through. The market crashed so bad, many had to work part time as greeters in Home Depots, and other stores...or where ever they could find a job that would hire a retirement age person.
The REI that survived, were the ones with cash flow. Some of the cash flow went down, some went up, but the vast majority were still positive...and none that survived it originally bought with thin numbers. They all started high enough to be able to cushion any reduction that might have happened to their rents...if at all.
The retirees that suffered were the ones that banked on their equity, and the ability to tap into it. It didn't matter if they owed nothing on all of their properties, the values all went down to less than what they needed to retire on.
Like I said from the start, "to each his/her own", but I prefer to own cash flow (but I still like the equity that builds up in them...thanks to my tenants).
I’m not disagreeing with cash flow and leverage early on, but I have seen two ends of the spectrum and man, does the grass look greener holding a lot of equity when older, than holding a lot of debt.
- All Over, USA · Member since 2017 · 689 posts · 756 votes7y
Originally posted by @Jon Lanclos:
@Tj M.
Spend 100000 on 5 properties putting 20000 down on each
100000 property - 80000 debt - 20000 equity - rents 1000 /mo - 6% loan to bank 360 mo - 479.64 PI - 150 taxes - 100 insurance = 729.64 exp resulting in 270.36 mo cash flow x 12 = 3244.32 income year / 20000 down - 16.22 rate of return on your 20k investment and you have 80000 left to go do 4 more investments of 20000 each so 3244.32 x 5 (houses total) = 16221.60 total income a year on 100000 investment plus you get depreciation and appreciation on 5 properties
Spend 100000 on 1 property putting 100000 down (no debt)
100000 invested in 100000 property no debt - 1000 rents - 150 taxes -100 insurance = 750 month cash flow x 12 = 9000 income year / 100000 investment in your no debt ( no leverage) investment = 9% return on your investment annually
In each example you spent 100000 - you can’t tell me that dead equity in a property makes more money than smart leveraged property - this example did not account for the deductibility of mortgage interest which could be another bonus
Also let’s assume there is 5 % appreciation in one year
In example one, that’s an extra 5000 equity you gain, in example 2, it’s 25000
The last way to make money in real estate is called equity capture - let’s say you were able to negotiate the property on purchase for 5000 less than market value - you “capture” that equity - this could also be an increased value because you slightly repaired the property - if you did this on 5 properties instead of one, it’s another 25000 in equity capture
I could have this debate all day - equity sitting in a house is only making you money in one of the 5 ways to make money in real estate - appreciation
Here are the 5 ways to make money in real estate ...
Appreciation
Cash flow
Equity capture
Tax advantages - 1031 exchange & depreciation
Principle pay down - by tenant
That example also left out 5X the CapEx and 5X the turnover costs. Again, I agree, if someone has TIME on their side leverage makes most sense.
- 7yJoe VilleneuvePro MemberPlymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes
Originally posted by @Aaron Hunt:
Originally posted by @Joe Villeneuve:
Originally posted by @Aaron Hunt:
Originally posted by @Joe Villeneuve:
Originally posted by @John Woodrich:
Originally posted by @Joe Villeneuve:
Maybe you should have read all the posts.Can already tell you are a type B person in my example by looking at the post below mine and "dead equity".
This is a common question here and the same people always dig their heals in. One side of the table may get caught with their pants down if we get another recession, the other side is making sure they don't get caught. I was fortunate to start investing in 2007 so picked up property on the back end. I have also worked with many individuals who weren't as fortunate, many realtors sold on the game of monopoly.
There is no correct approach to this, it depends on the individual's needs and goals. So that makes you wrong :)
Question: If the market turns down, and the property values decrease, and we are talking about a rental property with positive cash flow, how is the investor negatively impacted?
Positive cash flow on thin numbers, (yes, even your $400+/month) can easily evaporate when the market turns. In this case, the one with paid off dead equity is in a LOT better shape.
To each his/her own. I prefer to look at two things. My ability to analyze, and my cash. If I only put the down payment into deal, I only have the down payment to lose. If I have high enough CF, I cover vacancies and slow rent. Also, through my experience, and that of many others, when the economy turns down, there are more renters than less. This allows me to let the market recover and my rental too. If my rental value goes below my balance owed, it doesn't impact me...I just wait it out...collecting my rent along the way.
Nobody has any control over future events, such as property values. Equity can be here today, and gone tomorrow. I remember distinctly not long ago when many REI (and others) hit that date when they wanted to retire, depending on the equity/value of their investments to carry them through. The market crashed so bad, many had to work part time as greeters in Home Depots, and other stores...or where ever they could find a job that would hire a retirement age person.
The REI that survived, were the ones with cash flow. Some of the cash flow went down, some went up, but the vast majority were still positive...and none that survived it originally bought with thin numbers. They all started high enough to be able to cushion any reduction that might have happened to their rents...if at all.
The retirees that suffered were the ones that banked on their equity, and the ability to tap into it. It didn't matter if they owed nothing on all of their properties, the values all went down to less than what they needed to retire on.
Like I said from the start, "to each his/her own", but I prefer to own cash flow (but I still like the equity that builds up in them...thanks to my tenants).
I’m not disagreeing with cash flow and leverage early on, but I have seen two ends of the spectrum and man, does the grass look greener holding a lot of equity when older, than holding a lot of debt.
Agreed. I just prefer to let my tenants provide me with my equity.
I know, 30 years is a long time if you're starting after the age of 30...I know that. That doesn't mean you can't use both cash flow and equity to get to the same place you want to be...just a different, more expandable path.
- 7yJay HinrichsBusiness MemberReal Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
Originally posted by @John Woodrich:
@Jon Lanclos so how does that formula work in a market downturn? I will tell you, increased ROI in a market upturn = increased negative ROI in a market downturn.
We all know that leverage can increase ROI but many who believe in this fail to recognize how the inverse relationship works. The market doesn't always go up, it can go down and has in the past.
Smart leverage and risk tolerance matter a lot, someone wanting to retire early will have different goals than someone who already has their nest egg built and doesn't want to lose it.
plus in those examples pretty tough these days to find 100k props that rent at 1k that are not management intensive and if its Texas tax's will be greater than 150 a month.. and then you have cap ex turn over etc etc.. what most landlords ONLY learn once they are in the deals is that houses dont run on proforma.. some may do quite well some can be alligators. Like in Texas a good hail storm foundation issues and or for anyone a bad tenant.. in my mind with only 20% into properties your running an under capitalized business unless you have a few hundred grand liquid to back it up..
- Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes7y
Originally posted by @Joe Villeneuve:
Originally posted by @Joe Splitrock:
Originally posted by @Joe Villeneuve:
Originally posted by @Joe Splitrock:
Originally posted by @Joe Villeneuve:
You're not paying any interest. The only thing you paid was the down payment. If you have positive cash flow, your tenant is making the payments for you.
Sure you are paying interest. Tenant pays you, you pay the bank interest. The exact dollar amount is itemized on your tax returns. My point is if you paid off your loan, you avoid that interest. Avoiding interest is the same as making interest. If you chose to put your cash into mortgage pay down, you avoid interest. Tenant still pays you, but now you don't give it to the bank. You pocket the difference.
I didn't say it was the best use of money, just that it is not dead.
Follow the money from the sources...not just from a spot on the path it takes.
The source of the funds paying the mortgage is the tenant.
The source of the funds paying the DP is the REI.
When the REI adds money from their bank account, to avoid paying interest on the loan, the tenant is no longer making all the payments.
If on a 100k buy, the REI pays all 100k, the total interest saved is around (5.5% int) $83k...over a 30 year period. The money used to acquire that 100% equity was paid for by the REI, thus it is the exact same money that was originally in the bank...just in a different location. The CF would be around $10,000/year without the mortgage payment...or $300k over that 30 year period.
If a different REI only paid the DP of $20k, an let the tenant "pay off" the house over that same 30 year period, the REI gained the spread (cash flow) off or the rent. In this case, it would be $5k/year, or $150k over that same 30 year period.
Total up the costs/incomes"
REI buys = $400k
Tenant buys: $430k...+...the compounded returns from taking the $80k not spent on this property, and investing it, and reinvesting it (including profits) for that same 30 year period, at a conservative rate of 5% per year =~ $450k...and still growing. For a total of $880k ...and still growing.I am trying to follow what you are saying, but I get lost at how you total up the comparison. I am assuming on REI buys that the $400K is the $300K cash flow plus $100K property value. I don't follow on the tenant buys example how you get the $430K. Cash flow is $150K and property is $100K so you have $250K.
I do follow what you say after that about investing the $80K compounding at 5%. Valid point that the loan is a fixed 5.5% rate and not compounding. Versus investing $80K over 30 years compounding, you are making interest on interest. Although my math shows 5% annual return compounding to be more like $350K over 30 years. Maybe I am punching something wrong.
Of course the other thing to consider is that in the "REI buys" situation, the extra $5K cash flow each month could be reinvested so that needs to be figured in.
Tenant REI only comes up with $20k out of pocket, the DP, so theat REI only pays $20k...the rest is coming from the rent (tenant). That also means that instead of using the full $100k at the start (like the other REI), the "tenant" REI gets to keep that $80k...plus the $20k from the DP (now equity) = $430k
...and you're correct about the $350k...(can I blame spell checker...LOL) typo. Which would make the total return = $780k.
I'm not reinvesting either of the CF's, but the extra $5k CF that the 100% buyer gets, reinvested and compounded over that same 30 year period gets them an added $21k. I didn't reinvest either REI's cash flow because I assumed they would keep that as income...or why bother?
I think you are double counting either the payments or the original equity in your "Tenant REI" example. Can you give me detail on how the $430 is calculated? For simplicity, let's assume the property is worth $100K at the end of 30 years. Here is what I come up with at the end of 30 years:
REI buys ($100K paid):
$100K (property value)
$300K (cash flow $10K per year for 30 years)
$200K (interest only from reinvesting the $5K spread every year at 5% , the $150K is lumped into the cash flow number above. You have to include this if you are assuming the $80K was invested in example 2)
$600K (total cash at the end of 30 years)
Tenant buys ($20K paid):
$100K (property value)
$150K (cash flow $5K per year for 30 years)
$350K (principal plus interest from investing the $80K at 5% - so the number includes the original $80K)
$600K (total cash at the end of 30 years)
These are not precise numbers, but essentially you end up with similar outcome, because you are reinvesting the "initial cash difference of $80K" or the "added yearly cash flow of $5K" at the same interest rate.
Where you would see a major difference is if the $80K was used to buy four more properties financed at $100K each. I agree that leverage can give you a much larger return on your money, but only if the money is invested in a higher yield investment.
Tenant buys five properties ($100K total paid):
$500K (property value)
$750K (cash flow $5K per year for 30 years)
$1,250K (total cash at the end of 30 years)
- Yuma, AZ · Member since 2015 · 140 posts · 137 votes7y
@Tj M. I have a mix of paid off I always get my base pay and now have leveraged properties alao. If things go wrong I can still have a income and wait it out.
- 7yJoe VilleneuvePro MemberPlymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes
OK. Let's keep this simple, and use all the money as we get it comparing the two options. The assumptions are as follows:
A - All flipping money will be reinvested
B - Flipping returns to be 5%/year
C - All cash flow to be invested into flips
D - Flips start when both options accumulate $50k in cash flow
E - Both start with $100k and all money is in play at the start
F - REI Buy(RB) = 100%; Tenant Buy (TB) = 20%...TB can buy 5 properties
G - Cash flow with loan = $5k/year; Loan pmts = $5k/yr; CF no Loan = $10k/yr
H - Properties appreciate at an average of 2%/year; @ 30 yr mark = $190k/ea"Ladies and Gentlemen,...start your engines".
RB:
1 - 5 years at $10k/yr to equal $50k to start flipping
2 - Year 10 (5 years of compound flipping) inc. $10k CF at terms above = $125k
3 - Year 30 (20 more years) = $637k
4 - 1 paid off property w/appreciation = $190k
5 - TOTAL = $737 + $190k = $927k TOTAL
TB:1 - 2 years at $25k/yr (5 properties @ $5k/ea) to equal $50k to start flipping
2 - Year 10 (8 years of compound flipping) inc. $5k CF at terms above = $280k
3 - Year 30 (28 more years) = $1.66M (remember the CF component is for 5 properties)
4 - 5 paid off properties w/appreciation = $595
5 - TOTAL = $1.66M + $595k = $2.26M TOTAL - Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes7y
Originally posted by @Joe Villeneuve:
OK. Let's keep this simple, and use all the money as we get it comparing the two options. The assumptions are as follows:
A - All flipping money will be reinvested
B - Flipping returns to be 5%/year
C - All cash flow to be invested into flips
D - Flips start when both options accumulate $50k in cash flow
E - Both start with $100k and all money is in play at the start
F - REI Buy(RB) = 100%; Tenant Buy (TB) = 20%...TB can buy 5 properties
G - Cash flow with loan = $5k/year; Loan pmts = $5k/yr; CF no Loan = $10k/yr
H - Properties appreciate at an average of 2%/year; @ 30 yr mark = $190k/ea"Ladies and Gentlemen,...start your engines".
RB:
1 - 5 years at $10k/yr to equal $50k to start flipping
2 - Year 10 (5 years of compound flipping) inc. $10k CF at terms above = $125k
3 - Year 30 (20 more years) = $637k
4 - 1 paid off property w/appreciation = $190k
5 - TOTAL = $737 + $190k = $927k TOTAL
TB:1 - 2 years at $25k/yr (5 properties @ $5k/ea) to equal $50k to start flipping
2 - Year 10 (8 years of compound flipping) inc. $5k CF at terms above = $280k
3 - Year 30 (28 more years) = $1.66M (remember the CF component is for 5 properties)
4 - 5 paid off properties w/appreciation = $595
5 - TOTAL = $1.66M + $595k = $2.26M TOTALLike I said in my last response, no doubt if you use leverage to buy 5 properties versus all cash for one, that the returns will outpace a conservative 5% investment. But look back at my last post. If you compare paying all cash versus putting 20% down and the remainder into a 5% conservative investment. It works out very similar to paying all cash and putting the "extra" cash flow into the same 5% conservative investment. That is because because "avoiding interest" is giving you a return via increased cash flow. I know some call it "buying cash flow" but the return is greater then the cash invested.
Look at the math from the original example. The extra $80K returns and additional $5K per year over 30 years, so $150K. Pull out the cash ($150-80=$70K) and you see a $70K gain which is essentially loan interest avoidance. But that is only part of the story, because you have $5K every year to invest elsewhere. That money reinvested also has a return.
My only point is that cash in an investment property is not dead. It has a return rate, although lower than if the same funds were leveraged into more real estate.
- 7yJoe VilleneuvePro MemberPlymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes
There's no return until the cash flow is equal to the cash paid in. If you paid just the DP, you only need $20k (4 years...and you have $80k left in cash to invest with) from CF to break even and start profiting. IF you pay full price, you need $100k (10 years).
- 7yJay HinrichsBusiness MemberReal Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
Originally posted by @Joe Villeneuve:
Originally posted by @Bill F.:
Originally posted by @Joe Villeneuve:
Originally posted by @John Woodrich:
Originally posted by @Joe Villeneuve:
Originally posted by @John Woodrich:
Originally posted by @Joe Villeneuve:
Originally posted by @John Woodrich:
Original Cost = $100,000
New Value = $85,000 (represents a 15% drop)Formula: New Value - Original Cost = Net Gain/Loss
100% Buy ==> $85k - $100k = - $15k (as in lost $15k of their money)
20% Down==> $85k - $20k = +$65kSo in this example Joe you are assuming the person who has a loan doesn't have to pay the loan???????? By my calculation, they both lost $15,000! The cash buyer owns a $85k house, the non-cash buyer owns a $85k house with a $80k mortgage.
No, what I'm saying as that the money to pay the mortgage is coming from the rent...not the REI's bank account.
And that doesn't matter... The tenant can pay the bank $85k and payoff your mortgage, or that same $85k can go in the investor's pocket as additional cash flow each month. Doesn't affect the gain/loss you mentioned above.
But it "does".
What's the ROI of each investment?
Full Cash: -15% (85k-100k)/100k
Levered: -75% (85k-20k-80k)/20k
This is a clear demonstration of the downside of leverage. Small changes in the underlying asset value magnify the impacts on returns, both for good and ill.
Who pays the mortgage (it's not the tenant, the transitive property doesn't apply to accounting) is of no consequence.
Explain your formulas
Joe I think were the formulas will not hold is thinking that cash flow rentals will appreciate at a constant 2% a year.. at least as it relates to mid west rust belt.. if there is no owner occ to push pricing. the values will only follow Rental rates.. and I find rental rates in these areas to be quite stable.. and on the higher priced areas I think the run up on rent rates is about done for now.. and we could actually see some softening.
- Investor · Boston, MA · Member since 2015 · 1k+ posts · 3k+ votes7y
Originally posted by @Joe Villeneuve:
Originally posted by @Bill F.:
Originally posted by @Joe Villeneuve:
Originally posted by @Bill F.:
Originally posted by @Joe Villeneuve:
Originally posted by @John Woodrich:
Originally posted by @Joe Villeneuve:
Originally posted by @John Woodrich:
Originally posted by @Joe Villeneuve:
Originally posted by @John Woodrich:
Original Cost = $100,000
New Value = $85,000 (represents a 15% drop)Formula: New Value - Original Cost = Net Gain/Loss
100% Buy ==> $85k - $100k = - $15k (as in lost $15k of their money)
20% Down==> $85k - $20k = +$65kSo in this example Joe you are assuming the person who has a loan doesn't have to pay the loan???????? By my calculation, they both lost $15,000! The cash buyer owns a $85k house, the non-cash buyer owns a $85k house with a $80k mortgage.
No, what I'm saying as that the money to pay the mortgage is coming from the rent...not the REI's bank account.
And that doesn't matter... The tenant can pay the bank $85k and payoff your mortgage, or that same $85k can go in the investor's pocket as additional cash flow each month. Doesn't affect the gain/loss you mentioned above.
But it "does".
What's the ROI of each investment?
Full Cash: -15% (85k-100k)/100k
Levered: -75% (85k-20k-80k)/20k
This is a clear demonstration of the downside of leverage. Small changes in the underlying asset value magnify the impacts on returns, both for good and ill.
Who pays the mortgage (it's not the tenant, the transitive property doesn't apply to accounting) is of no consequence.
Explain your formulas
Not my formulas, I'm not nearly clever enough to derive them myself, but I'd be happy to point you to my sources Joe.
ROI = (Gain from Investment (GI) - Cost of Investment(CI)) / Cost of Investment
Full Cash: GI=$85k (sale proceeds) CI= $100k:
($85k-$100k)/$100k=$-15k/$100k=-15%
Levered: GI=($85k(sale proceeds)-$80k(outstanding debt)) CI=$20k
[($85k-80k)-$20k]/$20k= ($5k-$20k)/$20k=-$15k/$20k=-75%
n.b Transaction costs are ignored for simplicity and ROI is not the best measure to use when evaluating the sale of a rental since it 1. assumes the home was bought and sold in the one year and 2. it is not an accurate measure of total return since it does not take into account cash flow from operations.
Question: Why are you selling the rental?
Follow up: Why would you sell it, assuming it is cash flowing, when it's at a loss?
I posted the ROI calculation to counter this absurd formula:
Who said I was selling? I never did. You don't evaluate the performance of each of your properties every few years? At a minimum to get a sense of the true returns compared to your initial purchase assumptions so you become better as an investor but also to ensure you aren't watering your weeds and picking your flowers?
Hypothetical reasons to sell at a loss:
-you have a loan that is going to balloon and you will need to bring cash to refi, but the property isn't performing as expected and since it suffered a 15% loss in value will need a 17.6% increase to get back to even. ie pick a weed, don't water it.
-you have another opportunity that, even with the loss from the first deal, will produce above average returns. ie pick a weed and water a flower.
I get that you have your system of investing that works for you and I respect it because you have refined it to suit your goals. However, do you not allow for the possibility that other people could have other methods that work for them and, while diametrically opposite of your methods, can still help them meet their goals?
- Rental Property Investor · San Diego, CA · Member since 2018 · 7 posts · 1 vote7y
At the end of the day, I think it boils down to your investment objective. If you are looking to grow your portfolio, you should use leverage. However, during retirement, your objective might change more to asset protection and perseverance, you can definitely have those rentals paid off. Also, I think that money is important. But make sure that you are happy while you are investing as well! It won't do you any good, if you are wealthy, and still have trouble sleeping at night wondering whether you have over-levered or not.
- Rental Property Investor · Atlanta, GA · Member since 2016 · 325 posts · 253 votes7y
@Tj M.i love paid off rentals, my cash flow jumped from $300 -$400 average to $1300-$1400 per unit, of course you now have to pay insurance and property tax on your own as there is no escrow. I see it this way, you have 10 units bringing in $3500 a month vs. 10 units bringing in $12k-$15k a month. More cash allows you for more cash deals. Also, tremendous peace of mind if it ever takes longer to fill vacancies, also it allows you to maintain your properties better because you are not on a shoe string budget anymore. Better properties attract better quality and high paying tenants. Less headache and lower maintenance cost.
- Rental Property Investor · Brentwood, TN · Member since 2016 · 6 posts · 1 vote7y
Ok, all these responses have been terrific learning! I would love to hear advice on our personal situation: We only started investing during the downturn few years ago (in 2012) and were able to acquire 2 duplexes and 2 single family homes in what is now a great area of the city. Good cashflow, 3.9% interest, and properties are worth 3X more now. But that's nothing to retire on. Then 2 years ago I got more education, and got a little more aggressive, (motivated by fear, because I just turned 60 and husband is 55), and I looked in a nice, slowly up and coming town 30 minutes outside the city and bought 4 duplexes, and 4 single family homes (so far). I'm excited about real estate, it's been the best thing we have ever done. But we are a little tight, and in debt having used a HELOC on our home to do some rehab. We DO have decent equity in the first properties. Not sure how to proceed. Take equity out and pay off the heloc and credit cards? Or buy another house, as there are still good deals in my area and not a lot of investors are there yet. Or sit tight and pay stuff down and wait for the correction? What would YOU do?
- Member since 2018 · 4 posts · 1 vote7y
@Gary L Wallman outstanding reply with one paid off for every 4!! Never thought of this. Thank you!!
- Rental Property Investor · Sacramento, CA · Member since 2015 · 1k+ posts · 893 votes7y
I buy a fair amount of deals at really deep off market discounts for my own portfolio and sometimes it's tricky to get financing at the time of purchase so I'll just purchase cash, fill tenants.. etc.. but I've found myself owning 38 units right now without debt and it's kinda nice. Money's tied up, sure, but it's much less money than the market value and I have no mortgage payment. If there was a use for the money I would IMMEDIATELY go and get financing from the bank... that's kind of the approach I would recommend:
Look at what you can do with your cash and/or equity position and make sure it's being maximized. Don't pass on great deals just because you don't want to put debt on a rental (as long as that rental will continue to perform well with that debt). Always think of the highest net gain your money can earn you!
- none · Member since 2017 · 49 posts · 24 votes7y
Originally posted by @Tj M.:
I know people have different opinions on paying off rentals but for those who have how do you like it? Did it allow you to buy more properties faster,did you pay for the next property with cash or did you end up taking loans out on them later down the road? If you had to do it over again would you pay them off?
Looking forward to the reply’s.
Tj
I think there is a point many are missing and it's called "The Cost of Doing Business". As an investor into a business (which buy and holds are) you have to find your sweet spot. Factors to consider=Your Objective of investing, Your Risk Tolerances, and Your Resources. For me I have found a my sweet spot and with just a few properties with 50% equity I get great tax benefits, can cover my cost of living or as I'm choosing to do for the next 5 years... direct that money to down payments for more properties that fit my investment requirements. After this period I'll make a decision based on the economy and re-assessing my goals to either pay off properties completely or to take a few years of cash flow and invest in diversifying my portfolio to other monthly income streams. I would not be able to achieve my objective or manage my risk tolerance to make my timeline given what resources I had available had I not found my acceptable cost of doing business/investing.
Best of Luck to you.
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