chicago, IL · Member since 2011 · 4 posts · 0 votes
My goals are to own enough real estate property that can produce 100k a year after all expenses and after having paid the ALL OFF. This will facilitate early retirement.
I am in mid 20's, and have 160k salary. I am paying a loan for my 1st rental property (3-unit house). The rent income pretty much pays for the property with little money coming from me everynow and then to pay any difference.
I have 100k cash and I want to keep buying more rental properties to reach my goal. I am currently looking at a 200k property (3-unit house).
I wonder if its wiser to
A) just finish paying off my 1st property and then getting a 2nd later
B) use that money to make a big downpayement for a 2nd property
c) get (2) 200K rental properties and put down 50k as a downpayment for each.
d)buy a single-family house CASH paid in full.And probably make $1000 month in rent and then use this INCOME to either help pay off my 1st prop mortage or to buy a third property later.
Investor · San Ramon, CA · Member since 2011 · 1k+ posts · 569 votes
14y
Originally posted by Venkat Raghavan:
Simply put... if you pay off the mtg, you have a
*Stuck in Equity doing nothing
*You don't get tax breaks on interest
*You are not LEVERING UP.
* Missing the boat big time - you are getting cheap money from banks...borrow as much as possible and lock it for as long as possible.
* Equity saves you interest and lowers risk.
* Interest tax breaks are a falacy. Give me $1, and I'll save you $0.25 on your taxes. How much are you going to give me?
Fred, the logic for leverage is pretty simply. Because of how cheap money is right now, there's a very wide spread between what you can make on $1 of cash versus what you pay on interest for that same $1.
Lets look at a simplified example. I bought a duplex for $72,000 and it will rent for $1,400 a month. My payment on $54,000 (75% LTV) is $389 a month. If I assume 50% expenses, my projected cash flow is $311 a month. My $18,000 downpayment (yes, I'm ignoring closing costs for simplicity here) generates $3,732 a year, a 21% CoC return.
Now lets say you bought the same place in cash. Without a mortgage, your cash flow would be $700 a month, $8,400 a year but that's only a 12% CoC return.
Lets go a bit further. Lets assume I did have $72,000 in cash. Instead of going above and buying a property in cash, I split that into 3 equally performing properties (couldn't really do 4 because of closing costs, origination fees, etc). Your cash flow was $8,400, mine would be 3 * $3,732 = $11,196, that's 33% higher than yours.
Here's a few more things to think about. While I am making 3 mortgage payments for over $14,000 a year, about 2/3rds of that is principle, equity. I'm really getting another $8,000 to $9,000 a year in "value", you're getting 0.
Also, I'm depreciating (for tax purposes) 3 properties to your 1. That means you are making less cash AND paying more taxes on what you do make.
Lastly, I now have $216,000 of property to your $72,000. If the market goes up 10%, my equity increase is $21,600 to your $7,200.
Put those things together and you can begin to easily see the advantages of leverages given the cheap cost of capital. You will get greater cash flow, you'll pay less in taxes, you'll build wealth faster through equity payments, and you have greater potential for appreciation.
That said, you do have more monthly payments and therefore more risk. Balance that at your discretion.
SFR Investor · Virginia Beach, VA · Member since 2010 · 150 posts · 36 votes
14y
I'm in the same situation where I go back and forth between paying my 30yr mortgages off or buying more properties. Currently, while money is cheap and close to inflation, I'm going to add to my portfolio instead of paying off debt. I recently received a 30yr investment loan at 4.5 on a 10yr old property. As long as I can continue to get these rates I'm going to continue to purchase more going forward. When interest rates rise then I may consider paying off debt.
chicago, IL · Member since 2011 · 4 posts · 0 votes
14y
@Jeff i am leaning more towards doing that as well. however something keeps reminding me that if i do that, over the life time of the loan i would have paid 100k plus in interests, while if I tried to pay it off asap i could save a whole bunch of that money and put it towards another house.
So if i buy a 2nd and 3rd, etc , house and use loans for them and pay them over 30 year periods, it would be 100k worth of interests (im estimating here but the point stands) for each of those houses............
@Bienes Raices, thanks I looked over them but it does not have answers to what Im looking for like my comment above....
Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes
14y
Fred but what you might not be considering is you have a great OPPORTUNITY NOW in this buying cycle to acquire many undervalued properties.
Your income is awesome for your age.Remember to live way below your means and invest the rest.That job you plan on having can change in a heartbeat and the next job you find might not pay close to that.I have seen great companies pay out a bunch where they do not have longevity and the person with the job has to hop from company to company to make close to the same money.
If you have properties paid off you have TRAPPED EQUITY that is doing nothing for you.
Especially with today's interest rates.
With the kind of money you have I would go with multifamily.Leverage yourself up into larger deals instead of having little properties all over creation.
What are the rents for your current property you own?? If your area is really high priced you might want to look at states like Georgia and others where rents received compared to price paid and value add to increase sales price down the road is better.
As long as you buy correctly in the beginning I do not see anything wrong with leverage.
My mother-in-law has 150k equity sitting in a paid off house.I could turn that into much more for her but she is scared of the risk.The money sits there doing nothing for her.
Mobile Home Investor · Spanaway, WA · Member since 2008 · 1k+ posts · 578 votes
14y
In order not to get over extended, we have decided to pay down some of the debt for one of our properties. By adding $6000/month to the payment for just 3 years reduces the payoff time from 30 years to 21.25 years and also reduces the amount we have to pay back by about one million dollars. This makes sense to us due to the position we are currently in. At the same time we also consider smaller properties and notes on other properties. If we can get a good price we are still interested. Guess we are trying to do both methods at the same time. We want to pick up additional income streams at very low prices while also paying down existing debts.
Investor · Pawleys Island, SC · Member since 2008 · 1k+ posts · 837 votes
14y
Originally posted by Fred Damali:
@Jeff i am leaning more towards doing that as well. however something keeps reminding me that if i do that, over the life time of the loan i would have paid 100k plus in interests, while if I tried to pay it off asap i could save a whole bunch of that money and put it towards another house.
Fred,
If the property is generating a positive cash flow, then YOU are not really paying all that interest. Your tenants are buying the property for you but you still get all the tax benefits.
While you are young, and as long as money is cheap, keep buying more property to build your future income stream. When money gets tight again, then use some of your excess cash flow to pay down your loan balances.
Investor · Reston, VA · Member since 2011 · 683 posts · 191 votes
14y
When I was in my 20's, I went out on many limbs. Rates are great now and so are prices and rents. It wasn't that way in the 80's. I think that this is a unique opportunity.
That said; I am in my early 50's and have 20+ rentals. That is about all I want. I do throw extra money to principal (only to the highest interest rate properties). It's a tough call whether to pull out cheap money or pay-off property. I'm no Donald Trump and have a much lower portfolio/drive than most here.
If I were young (and healthy), I'd go all out right now. I'd get as much of this cheap money as I could and lever it to the max (provided I had adequate reserves).
Due to my circumstances, I feel more comfortable having paid off rentals and others that are well on their way. This is more of a hobby/sideline to me.
Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
14y
This is really just a math problem. Given a price, rent, and possible financing terms, you can compute how much income you will produce. Generally, I've found that leverage can produce a higher ROI, and therefore a higher income for a given amount of invested capital. Today's very low rates make leverage even more attractive than a even a few years back.
I'm not entirely clear on your price and rents. Hopefully you're not paying $200K for properties that rent for $1000. Those are not good deals, even though they will produce income if the debt service is small enough. Let me use an example of a $100K house that rent for $1300. With 100% financing at 5% for 30 years, the payment on this would be $537. After expenses, capital and vacancy, you would have NOI of $650. Less the P&I payment and you have $113 a month in cash flow.
Now, 100% financing is not available. The calculation above is just to evaluate the property. So, two realistic scenarios are 25% down and paying cash. With 25% down at 5% for 30 years, you get cash flow of $247 a month, which is a 10.6% ROI on an investment of $28,000 (25% plus $3,000 in costs.) You would need to have about $1 million invested, about 34 houses,to get to your $100K goal (pre-tax).
If you pay cash, you would get the full $650 each month. On an investment of $103K for a house, that's a 7.6% ROI. You would need to invest about $1.3 million. You would only need 13 houses.
Now, that assumes you're paying for a property manager to run the properties. That's a significant costs, about 15% of the gross rents from a combination of monthly charges (typically 10% of collected rents) and charges to fill a vacancy (typically half to a full month's rent.) If you choose to manage them yourself, you can keep more of the gross rents. You are, however, signing up for a job. If you use this approach, and put 25% down, you could get to your $100K goal with an investment of about $525K and 19 houses. If you pay cash, you would be looking at about a $1 million investment and 10 houses.
I don't really buy into the "trapped equity" argument. Nobody ever says you have "trapped equity" when you own a stock or a bond. You've made an investment and that investment (hopefully) earns you some return. Its just a matter of doing the math and evaluating your goals and risk tolerance. You can see above that the leveraged real estate at today's low rates produce higher ROI. If rates are 9% (what I was paying in 1987 on the first house I bought, which was a great rate compared to 15% rates a few years prior), the ROI is almost the same between leveraged and paying cash. In either case you would need to invest about a million bucks. With cash, though, you only need 10 houses vs. 35 with leverage. If rates are any higher (assuming same $100K/$1300 deals), you definitely want to pay cash.
Leverage has a double edge, too. That is if rents and value fall, you could end up losing a large percentage of your value. After the costs of buying and selling, it only takes about a 12-15% drop in values to completely eat up your 25% down payment.
And, those 30 year, 5%, 25% down loans aren't going to be available when you're looking at property 30. Or even property 11. And probably not even for property number 5.
Note that this applies only to income producing investment properties. For your residence, I strongly believe in paying it off. A residence isn't an investment. Its a doo-dad, just like a car.
Investor · Reston, VA · Member since 2011 · 683 posts · 191 votes
14y
Nice analysis Jon.
Fred, given your circumstances, I'd go with option 3. If I read your post correctly, you want to get enough property/rent to produce enough income DOWN THE ROAD to retire early.
When I was around 30 I would sit at my desk and add up net rental income - after the mortgages were paid. I would assume that rents would keep pace with inflation. The mortgages, at that time, were not paid-off but were being paid off by my tenants. I would project income flow. It seems that this is what you are doing. Leverage is your friend now. I, like you, did not need cash-flow. I cared about achieving free and clear properties by a certain age.
I think lending will looosen up. This is reminicent of the S&L crisis (granted, much worse) when being an "investor" was a four letter word. There are many lenders that will go to ten mortgages now as long as you have the reserves - which you appear to have. At one point we were limited to owner financing.
I'd go with the lowest down-payment and the most properties if I were you. Be smart going in. Buy at prices where you can get out tomorrow if a crisis occurs. You are young and ambitious - best of luck!
Austin, TX · Member since 2011 · 3 posts · 5 votes
14y
It's an important point that Jon makes that using leverage gives you a higher ROI. From your comments about paying interest, it sounds like you don't exactly see the point of it. Interest is the cost of leverage. You can buy four $100K properties for $25K each, but you pay interest to be able to do that. And there's nothing wrong with that. You benefit and the lender benefits.
I think you definitely want to use leverage. Financing multiple properties over the years should help you reach your goal faster. However, I think you do need to think about cash flow. Sure, you could finance 5 properties with the minimum down for 30 years, but if you don't have a positive cash flow, you're not going to be retiring very early. You don't want your tenants to just pay the mortgage -- you want your tenants to pay MORE than the mortgage, so you can pay the properties off in much less than 30 years. (Unless you can maybe finance at 10 or 15 years and the rent is enough for you to break even.)
I think it would be fine to put down 50K on a 200K property, but you should make sure you can cash flow on it. So you've gotta find a good deal, negotiate well, and manage smartly.
Real Estate Investor · the villages, FL · Member since 2008 · 5k+ posts · 3k+ votes
14y
Very easy choice, imo, depending on ONE thing. Is your income stream from job pretty much guaranteed to continue? If so, go for the gusto for aall the reasons mentioned.
1. You're young
2. You have good income
3. Rates are really low
4. Prices are still depressed
5. With your income, the extra depreciation will help you some day
6. Buy all you feel safe with your reserve.
7. Cash flow is irrelevant during estate building-as long as your income is secure and you're able to save a good %
8.All these properties will be F&C by time you're 55-without adding increases in rent to pay off properties quicker.
9.Neighborhood banks will love you and make blanket loans
10. I don't care whether your personal residence is F&C or not-as long as you have SOMETHING F&C and safe from all litigation
Rich
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
14y
Originally posted by Rich Weese:
7. Cash flow is irrelevant during estate building-as long as your income is secure and you're able to save a good %
A-freaking-men Rich! Wow...there it is in black and white!
The choice between buying more and paying some off really depends on tens of factors. This is an asset allocation question and largely depends on:
1. Your income and how reliable it is going forward
2. Your goals
3. Your time horizon
4. How the rest of your overall portfolio looks
5. Your risk tolerance
Nobody is going to be able to counsel you on this via a message board unless you give out a lot of facts that should not be disclosed publicly.
In general, more leverage equals more risk. More leverage also equals more assets equals more tax shields, more inflation hedging, more loan amortization, etc. Note that it also equals LESS ability to borrow from traditional lenders going forward because you are already sufficiently leveraged. In finance texts there is actually a theoretically optimal leverage ratio. This is hard to figure out in real estate...especially when you can buy more houses subject-to with really cheap debt.
I would say err on the side of slightly leveraging more than you would in a normal economy because:
1. Debt is super, duper cheap right now
2. Inflation will likely erode the real cost of the debt in the coming years
3. Your time horizon appears to be quite long
My two cents...worth at least as much as you paid for it. :D
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
14y
Ironically someone responded to a post from Lloyd's Investment Blog tonight where I was the original poster asking the same question 4 years ago. Here is a link to it for those that may be interested:
The last comment claims, "This is one of the best post I've ever seen, you can include some more ideas in the same theme." I tend to agree that it is one of the best and most balanced responses to this question I have ever seen. Lloyd is a sharp guy!
Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
14y
I certainly would not consider buying subject-to to be locking in today's low rates. If rates do ramp up, and it seems inevitable that they will, the chances of these loans getting called will ramp up, too. Even if you have to use portfolio financing with 15 year terms, its still a great deal. I have friends getting rates in the low 4's on 15 year NOO portfolio loans.
I fully agree that immediate cash flow may well not matter, if you have other income. However, Fred, in his first post, seems to be saying he does want cash flow from his rentals. I assume that's fairly soon, not 15 or 30 years from now. So, those better cash flow right from the start.
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
14y
A year ago I would have agreed with you Jon, but I think Mark Torak's firm has designed a pretty good system to indemnify investors from the implicit call risk from subject-to-financed purchases. They have lenders willing to pay the loan off in the event rates inch north and a firm willing to defend the case if you close through their title office.
I need to return the guy's call from a few weeks ago to get more details on these "guarantees," but they seem legit. I think they are pretty legit if Phill Grove is pushing them.
Even in the event these promises from Torak's firm aren't good my personal opinion is that people are better off with a bit more leverage even if they need subject-to purchases to get there. This belief of mine is also squared with my belief that interest rates will rise. My reasoning is as follows:
1. The servicers for said loans don't have a financial interest in calling them on behalf of their investors
2. Refinancing properties taken subject-to at a later date on less favorable terms is still superior to waiting to build the equity necessary to do business on the bank's terms while sacrificing much of your personal equity as collateral for a new loan
As is the case with anything this should be done in moderation. I like to sprinkle in a new house in my portfolio every so often and spread some development deals in there too to get more liquid.
Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
14y
Your risk tolerance is higher than mine, Bryan.
Rates were 7% back in 2008. I can certainly see them hitting high single digits at some point in the not-too-distant future. I don't think that's a certainty, but it is a possibility that has to be considered. I remember 15% or higher for owner occupied loans in the early 80's when I moved to Houston. I don't expect to see those rates, but that have existed in my lifetime.
Servicers do what their investors demand. They're being paid to manage the loans.
You may be right about the techniques being used to protect the buyer in these deals. Until someone, or a few someones in various jurisdictions, goes to court we really won't know. My opinion is that if the big lenders decide they want to call these loans, they're getting called.
I don't see anything big happening with rates anytime soon. If I was going to do a subject to deal, I'd hold a year or two then refinance. That eliminates the risk and, if I'm buying right, gets me into a property with less cash outlay than a straight up purchase loan.
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
14y
Originally posted by Jon Holdman:
Servicers do what their investors demand. They're being paid to manage the loans.
Perhaps...if they demand it. For now they do what is in their own financial interest and that is the main reason I don't see the loans getting called anytime soon.
Torak's program may well have holes, but I haven't been provided with all of the specifics.
In any event more leverage equals more risk any way you slice it. It is either the refinance risk of not getting a loan or getting one on less favorable terms IF you are required to later on. I don't think people should finance more properties subject-to than they could safely refinance in the future. Doing so is irresponsible and dangerous financially.
Real Estate Investor · Charlotte, NC · Member since 2011 · 252 posts · 56 votes
14y
I would say do shorter term financing...15-20 year terms and use the cash flow to pay down the debt faster. Buy more leveraged property as you can and eventually use the free and clear property to pay down the remaining debt.
Rental Property Investor · Astoria, NY · Member since 2011 · 16 posts · 11 votes
14y
Fred - I was in a similar position as you a year ago and chose an option similar to your option (c). I think as long as you expect to make some cash flow (after covering all of your expenses, your mortgage, your insurance and any management fees) off of each building that you acquire and keep a cash reserve of, say, $30-$40,000 as a rainy day fund, you'll likely have enough of a cushion to cover any unexpected expenses. What I'm doing is using whatever I save to buy more properties and using the cash flow from my buildings to pay off the mortgages on the buildings that I acquire (paying off one at a time to free up more cash flow).
Investor · Plano, TX · Member since 2011 · 84 posts · 45 votes
14y
Another thing I would ask is what your timeline is and how fast you plan to acquire your nth properties. If you plan on leveraging and plan to do it in a short amount of time IMO I would pace myself to allow time for learning in b/w and start off slow.
I was too eager and in a rush to jump in and made many mistakes along the way, which could have saved me a lot of money if I spent the time reading on BP rather than pick up as many properties b/c I could leverage and had the cash.
All it takes is one eviction or suit to realize how much there is to learn and how vulnerable your assets are.
You may already be versed in all these aspects but I would read up on landlord/tenant laws for your state, how to limit your liability (asset protection, anonymity, etc.), figure a way to streamline the process of managing your properties so you can scale (bookkeepeing, rent collection, how you plan on handling repairs, etc.), etc.
Personally I started off leveraging and acquiring properties in a short amount of time. I soon realized that I had a lot of learning to do so I slowed down or purchased properties F&C to slow myself down. After all, if I had double the number of properties (and double the number of tenants) because I continued leveraging, I think I would be pulling my hair-out or have to quit my full-time job since I didn't have a system/process/experience to handle that number of properties/tenants starting off.
On the other hand if I was experienced and well-oiled like the other posters here, I'd probably leverage and pick up properties like no other.
chicago, IL · Member since 2011 · 4 posts · 0 votes
14y
Sorry for the late response:
Thanks for all your responses. Everybody gave good knowledge and new input that helped clear out a lot of my questions.
Some more information. My current (1st and only prop so far) cost 255k. 3-unit. $2900 monthly rent. With $2100 (15yr loan) monthly mortage payment and maintance/operations it usually evens out. So no cash flow here.
My salary stated is an average of the last 2 years and the next. After that it should be around 90k going forward.
My goal like I said is getting to 100K rental income, the sooner the better :-) I would love to be able to do it before 40. Im 25 now......As far as risk I am really not too much of a risk taker but in this case I am willing to and like someone said I still plenty of time, so I rather make a mistake now so I can learn while Im making a decent salary.
When you guys mention trapped equity you mean as a potential source of a loan that is not used?
Otherwise if a rental property is paid off free and clear and is bringing rental income, I dont see how it would be trapped equity if its providing a stream of income?
This year so far I've paid about 8k interest and I understand its from the rent income but if I paid the debt off that money would come to me not to the bank. BUT I now have a better understanding of how this works. That is basically the price to pay for LEVERAGE which is better than trying to first pay off a house before moving to the next because I get a better ROI, tax shields, I get better interest rates on loans now than what I would get in the future, would get to my goal faster,etc. This is definetly intriguing and I will do a lot more reading on this, but I will be going this route.
@Rich Weese. You made a point "10. I don't care whether your personal residence is F&C or not-as long as you have SOMETHING F&C and safe from all litigation "
So you are suggesting that its a good idea to have at least on F&C property?? Im from Chicago, and I know of some houses in 40k, 50k like @ Steven mentioned.
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
14y
Originally posted by Fred Damali:
When you guys mention trapped equity you mean as a potential source of a loan that is not used?
The "trapped" equity is an unsophisticated way of saying that money is not working optimally. The reason this analysis is unsophisticated is that it assumes there is no cost associated with untrapping the equity. Real estate has VERY large transaction costs, which is very real for freeing the capital. The other factor to consider is that additional debt constrains traditional lending sources to some extent. More leverage equals more risk and thus lenders will demand higher rates or more favorable terms.
One of the counterarguments to this is that you can always purchase properties subject-to and bypass the costs associated with procuring additional debt. This argument is also suspect because subject-to purchases have to be purchased for more and they carry call risk without exotic strategies to design around this problem.
Another thing to consider is that private money or equity fund investors won't account for this added leverage risk the same way a traditional lender would and thus the argument could be made that a more sophisticated investor with these financing options really doesn't incur a higher cost of financing from untrapping equity.
My opinion is that there is always a tradeoff. More leverage and less trapped equity that is working non-optimally carries real tradeoffs because you lose some of your cheapest borrowing sources. Everything ultimately depends your your personal circumstances and what you are trying to accomplish so there really isn't a *right* answer.
Vienna, VA · Member since 2011 · 15 posts · 1 vote
14y
Originally posted by Fred Damali:
My goals are to own enough real estate property that can produce 100k a year after all expenses and after having paid the ALL OFF. This will facilitate early retirement.
I am in mid 20's, and have 160k salary. I am paying a loan for my 1st rental property (3-unit house). The rent income pretty much pays for the property with little money coming from me everynow and then to pay any difference.
I have 100k cash and I want to keep buying more rental properties to reach my goal. I am currently looking at a 200k property (3-unit house).
I wonder if its wiser to
A) just finish paying off my 1st property and then getting a 2nd later
B) use that money to make a big downpayement for a 2nd property
c) get (2) 200K rental properties and put down 50k as a downpayment for each.
d)buy a single-family house CASH paid in full.And probably make $1000 month in rent and then use this INCOME to either help pay off my 1st prop mortage or to buy a third property later.
Simply put... if you pay off the mtg, you have a
*Stuck in Equity doing nothing
*You don't get tax breaks on interest
*You are not LEVERING UP.
* Missing the boat big time - you are getting cheap money from banks...borrow as much as possible and lock it for as long as possible.
