Low ROE - Debating selling to invest in stocks or payoff loan

[Rob White]

I have a rental property making $1250 in monthly cashflow. If I payoff the mortgage of $265k  at 4.375% (home is worth 1.25 million purchased in 2014), my cashflow jumps to $3800 per month. Because my equity is high, my ROE is low, but seems to make a boost on ROE if I payoff the remaining mortgage, which surprised me. Also I do realize I would lose the tax benefits and also the tenant paying down the mortgage monthly etc, if I sell.

I have an unused HELCO on the property for $150k, and dont want to refinance. Because my ROE is so low now at about 1.8% and I can't tap into that locked up equity im debating selling so I can put that locked up equity in the stock market for an average gain of 7%.  I do realize I would lose about 25% of the money in the sale in taxes and depreciation recapture. But seems the growth in the long run of stocks over my low ROE might make it worth while and would have less landlord issues with the property being sold. I also realize I could do a 1031, but I dont see any deals in areas on the mainland US that make sense to me and Cap rates are low there and here in Hawaii.
Im torn between paying off the mortgage for a nice cashflow of $3800 per month (ROE of 3.8%), or selling to put roughly 700,000 k in the market and working the 4% FIRE rule with that money after letting it grow for a bit. If anyone has been in a similar situation, or has some insight, please let me know. Would be greatly appreciated!

[Dave Foster]

@Rob White, Your ROE might be slightly increasing with a payoff because of the loss of the very high monthly mortgage payment for relatively little in debt (your mortgage payoff is based on when you bought the property). However, this also means that your loan amortization is pretty healthy right now as well. And you'll lose that if you pay the loan off. So that is a trade-off that the IRR can help you analyze. My guess is that the IRR is going to show you well over 10%- maybe even 15% on that asset. If that's really what you're making on that asset it wouldn't make financial sense to pay the loan off. Unless there was a secondary reason.

If you were going to sell to reposition into better producing real estate then certainly you'll want to 1031.  Because depreciation recapture will be ugly for you especially.

But with a loan that is still 1.5% lower than anything you'll see in the market in the short term I would think long and hard about selling or paying off the loan.

Why not take the $265K and either

1. put it into a HYSA if security and safety are an issue.  You'll be able to just about break even compared to paying off the mortgage with it.

Or 

2. Put that $265K to work more aggressively with equities however you like. And use both the NOI from the real estate to gradually transfer more and more to the equities side. Since you've got to pay tax on that anyway.

This would give you growth in both real estate and equities, slowly re-allocate your portfolio, and do it without that huge tax bill of a real estate sale.  Or having to 1031 into properties you're not excited about.