Rental properties: owning free & clear vs. mortgage
Edmond, OK · Member since 2015 · 7 posts · 3 votes
Most of the posts so far have been heavy on the disadvantages of owning outright, so I will stick with the advantages. For reference, I own 11 properties, no mortgages.
1. Closings are easier, cheaper, faster, and more under your control if you buy with cash. No bank paperwork or approvals. Inspections and appraisals are at your discretion.
2. Carrying costs during rehab and vacancies are much lower, therefore less worrisome.
3. Insurance coverage is under your control, not the bank's.
4. Peace of mind. This is the biggest. If a renter is late it's annoying, but you don't have to wonder how you're going to come up with the money for your mortgage payment. Long term or multiple vacancies don't put you at risk of losing your investments.
But you have to realize that everyone's situation is different. Just look at the location of each person on this thread. Some rural, some urban, and 8 different states. Some are at the beginning of their careers and others are almost ready to retire. Some need to get into RE with as little as possible invested while others need a place to park cash. The size of the investment is also a factor. Are you buying a house for $50,000 or $500,000? All of these factors and more will affect the responses to your question.
The main advantage of having a loan on real estate is leverage. By using other people's money you are able to invest in more properties than you can afford to hold free and clear. If done intelligently, this will also help spread out your risk across multiple properties. By using this leverage you can also increase your return on investment and have your tenants effectively paying your mortgage.
Sometimes due to the cost of real estate in some areas it makes it impractical to purchase a property free and clear.
@Chris Pace very insightful question.
@Kevin D. answered it quite eloquently.
But let me throw in some food for thought.
This whole grab more and more assets logic has always troubled me. Landlords buy more but don't optimize what they own. I understand you need more rentals to reach your financial freedom goal, but you can do so a lot sooner and with least risk exposure if you generate more income from fewer rentals.
So consider the middle ground. Consider buying one leveraged rental that produces the cash flow equivalent of four traditionally operated rentals.
This will give you low maintenance risk, fewer tenant issues, and cash flow towards your financial freedom goal.
It's important to stop underwriting after you purchase a rental. It is very possible to take in more income than just rents. Keep your mind open to monetizing all of your rentals assets - not just the inside of the structure.
Best to you.
@Chris Pace there are a lot of threads on here about this topic. For me, I may not even own one rental and at most 2 if I paid cash for them. I currently own about 30. Even after 20 years with my real estate company I doubt I have put $30K of my own cash into the business. By leveraging I just get the down payment and let others pay the property off. Rental margins are very tight here. I actually have 2 rental properties I add money to make the tax and insurance payments for, and maintenance comes out of my pocket as well. They are nicer properties that will be less headaches then most when they are paid off. I consider them B properties so they do not produce the cash flow of C properties. Buy a place for $60K you can rent it for about $600 per month, buy one for a $100K and you can rent it for $750 per month. For now they do slightly better than break even because I have consistently stripped equity to expand. If I quit buying I should have them all paid off in a little over 10 years. My strategy in the past has been if I can buy it and it makes mortgage payment, taxes, insurance, and a little more for repairs I buy it. If I have a $100K in loans I make $100K when it is paid off and get a little equity. If I have $5 million in loans then when it gets paid off I have $5 million plus equity from appreciation. Leverage turns what would be 3 houses paid off into 50 houses paid off.
I love what @Al Williamson is saying, but I can assure you there is not a house or multi unit for sale in town that will produce $400 cash flow per month. Barring buying a house from an incompetent person I won't be landing those deals. To make matters worse I see a market that is slowing down and is likely to have a few reversals in value. My cash flow should weather the storm, but I have stopped buying and will watch my market closely. Leverage can be very bad if your market is declining.
I'm a big fan of leveraging vs. owning outright. If I only bought with cash, I'd own 2 homes right now. I currently have 6. I've got about $80k of my own money in my rentals, and they are all worth around $370k right now, grossing $5,000 a month, netting about $2,200 a month.
There is literally NO WAY I would be putting up those numbers if I bought with cash.
Most of the posts so far have been heavy on the disadvantages of owning outright, so I will stick with the advantages. For reference, I own 11 properties, no mortgages.
1. Closings are easier, cheaper, faster, and more under your control if you buy with cash. No bank paperwork or approvals. Inspections and appraisals are at your discretion.
2. Carrying costs during rehab and vacancies are much lower, therefore less worrisome.
3. Insurance coverage is under your control, not the bank's.
4. Peace of mind. This is the biggest. If a renter is late it's annoying, but you don't have to wonder how you're going to come up with the money for your mortgage payment. Long term or multiple vacancies don't put you at risk of losing your investments.
But you have to realize that everyone's situation is different. Just look at the location of each person on this thread. Some rural, some urban, and 8 different states. Some are at the beginning of their careers and others are almost ready to retire. Some need to get into RE with as little as possible invested while others need a place to park cash. The size of the investment is also a factor. Are you buying a house for $50,000 or $500,000? All of these factors and more will affect the responses to your question.
You can make that argument that unless you are leveraging there is no real reason to buy cash flowing properties. The reason is this.
A "good" cap rate is considered 10 percent, with a lot of markets only offering 8 or 9 or even lower. That means on a cash investment it's returning 10 percent, that's good right? Well yes it is. However, when you compare other investments that don't have the hassles of land lording such as REITS, or mutual funds, that can give you darn close to that return. It makes buy/hold, cash purchases not look as good, consider the risk involving in land lording. However, when you drop leverage in to the equation, your returns can be juiced to over 20 percent, plus equity pay down on the mortgage, plus any appreciation.
Then it get's real interesting. Where you can literally start by investing 15-30k of your own money, and get the snowball rolling, and keep leveraging, and leveraging, not with your own money, but cash flow from previous rentals.
This is how many start one day buying one property and 5 years later, they have 30.
It's risky yes, but it's what makes buy/hold exciting, without the leverage, it's much less of a good investment.
I'm with Sylvia. I own 16 properties and have paid cash for every one one of them. Took out a small Home Equity Loan (50K) and used it to buy about 8 of these over time (we started in 2007 and I bought my last house in 2014) and paid it back slowly just so I could take the interest off taxes (you get to a point with no mortgages where you might be LOOKING for tax breaks at tax time).
Peace of mind (I sleep better at night if I've got an empty house and no mortgage to worry about), quick, cheaper closings, choosing my insurance company, not feeling the push to rent to the first yahoo who comes along to get someone in there.
I'm not a risk taker; I admit it. Sixteen houses is my limit (my partner wanted me to stop at 10). I've never paid over 50K for any of these houses and rents range from a low of $625 to a high of $1150 with most in the $750-$850 range.
Gail
The big difference is risk. If you have 10 properties with loans, over the course of a year, you get a turd tenant who doesn't pay rent and you have to evict and you lose 3 months rent. 2 go vacant and take a month to turn over with average make ready costs and another one needs a new hvac system. Can you afford all that and make the mortgage payments? If you have 10 free and clear. You don't have to sweat how to pay for all that stuff and pay mortgages.