How important is equity build-up?

Question

I have a rental property that produces $100 of positive cashflow. If I apply an extra $100 to my principal payment each month I will payoff the mortgage in 25 years instead of 30. What is more important? Paying off my mortgage or leverage the equity to purhase additional property or both?

Thanks for your help!

Eric Pirozok

Thanks for your help!

Eric Pirozok

Jon Holdman · Answer

I'm not a lawyer, and you may want a lawyer to get good contracts.

Write your lease purely as a lease.  Put the option part out of mind, and just write a pure lease as if the tenant was ONLY leasing the property.  Then, write the option agreement to include anything you want the optionee to take care of.

Since it is commercial, what you're doing seems pretty typical for a NNN (triple net) lease.  I was thinking you were talking about a residential property.

Jon

Eric Pirozok · Answer

Yup...it is a lease with a seperate option...and yes...it is a free standing commercial property...can you teach/explain me about placing the clauses into the option instead of the lease?

Michael Shadow · Answer

I want to have fixed rate mortgages for as long as possible because rents are always going up and the value of the dollar is always going down.  Because of this mortgages are paid back with cheaper dollars.

-Michael

Eric Pirozok · Answer

Property purchased 35% below market value with my own HELOC.

LEASE AGREEMENT:

TAXES. Tenant shall pay to Landlord along with rent, any sales or use tax payable to any governmental authority.  In the event the real estate taxes attributable to the premises are raised for any future year under this agreement, Tenant shall pay each month an amount of such increase proportional to Tenant's portion of the premises in addition to the rent payment...

MAINTENANCE & REPAIR. The Land lord shall keep the foundation, outer walls and roof of the premises in good repair, except that Landlord shall not be liable for any repairs occasioned by the acts of Tenant. Tenant shall be responsible for maintenance and repair to the inside of the premises including heating and cooling systems, electrical, plumbing, hardware, doors, windows, screens and painting. All such repairs shall be made with materials and workmanship equivalent to the original. Tenant shall be responsible for extermination service to premises...

INSURANCE. Tenant shall keep in effect for the term of this lease a policy of liability insurance covering Tenant and Landlord against any liability arising out of any injury on or about the premises...

OPTION AGREEMENT:

CONTRACT FOR OPTION. The initial payment of $10,000 is a partial payment for the right to be granted a purchase option.

Eric Pirozok

Jon Holdman · Answer

You said rental in your original post, but that sounds like a lease option.

You sure that will hold up?  I think I'd lean toward putting some of those clauses into the option agreement rather than the lease.  Pretty unusual to have a lease that puts that much maintenance, taxes, and insurance onto the tenant.  Maybe not for commercial, but for residential.

Jon

Jon Holdman · Answer

A rent payment of $100 over the mortgage (assume mean PITI) is NOT positive cash flow.  You have numerous other expenses, including property management, advertising, maintenance, legal fees, utilities, vacancies, tenant screening, and who knows what else.  If you rental is only getting you $100 over your PITI payment, you better be socking that (and more) away each month to cover the big expenses (like a month of vacancy or an eviction) that WILL eventually occur.  You're losing several hundred a month, and just haven't noticed.

Oh, I just did the math, and $1100 is just the P&I on $150,000 at the terms you cite.  Add in taxes and insurance, and you're definitely in the hole.  At expense = 25% of rent (like bank's seem to think), you're in the hole about $225/month.  If expenses are 50% of rent, you're in the hole about $550/month.

Jon

Eric Pirozok · Answer

Check this out:

Loan Amount: $150,000 
Annual Interest Rate: 8% 
Loan Period in Years: 30 
Scheduled Monthly Payment: $1,100.65 
Scheduled Number of Payments: 360 
Total Interest Expense: $246,232.87

Rent Schedule for the next 13 years ($100 over mortgage payment plus 5% annual increase): 
1 $1,200.65 
2 $1,260.68 
3 $1,323.71 
4 $1,389.90 
5 $1,459.39 
6 $1,532.36 
7 $1,608.98 
8 $1,689.43 
9 $1,773.90 
10 $1,862.60 
11 $1,955.73 
12 $2,053.51 
13 $2,156.19

If I apply every extra dollar to principal I will pay off the mortgage in 13 years or 156 payments and pay only $105,127.30 in interest expense...this is a savings of $141,105.57 in interest expense.

Someone needs to verify the following...this is equivalent to an investment that returns an approximate yield of 12%. Stated another way...if I invest every extra dollar that investment would have to yield approximately 12% to achieve the same/similar results of paying off my mortgage in 13 years:

Yr. Xtra $/mo. Balance at 12% 
1 $100 $1,268.25 
2 $160.03 $3,450.05 
3 $223.07 $6,693.10 
4 $289.25 $11,164.71 
5 $358.75 $17,054.28 
6 $431.72 $24,576.04 
7 $508.33 $33,972.12 
8 $588.78 $45,516.03 
9 $673.26 $59,516.52 
10 $761.95 $76,321.94 
11 $855.08 $96,325.13 
12 $952.87 $119,968.88 
13 $1,055.54 $147,752.07

Eric Pirozok

Michael Shadow · Answer

I guess it depends on what your goals are and your timeline.  My goal is to keep leveraged for 10 years then start paying everything down.  My plan is for the first 10 years maximum growth then in the next 10 pay everything off that way we can spend the next 10-20 baby sitting our grandkids on airplanes as we take them all over the world. :-)