Strategies for Allocating Cash Flow

Eric D. · 2018-10-27T09:53:07-07:00

I am seeking financial advice about what to do with my cash flow which is $1k each for two multi-families -- invest it in the market or pay off the mortgages more quickly? Or something else?Basic info: within the past year, I purchased two multi-family rental properties in north NJ in the $400k-$500k range, putting down 25% and obtaining 30 year mortgages (4.7% and 5.25%). I owe a little over $300k on each.After paying my mortgage/tax/insurance, I cash flow about $1k per month for each.I hear that paying off extra on your mortgage within the first 5 years can really shorten the life of the loan. And it is like making an investment with a guaranteed 5% return in my case.OTH, by paying off the mortgage with the cash flow, I feel like I would be too heavily invested in my properties and should diversify. Further, I feel like over time the home value and rents will increase so that it is not really necessary to allocate money I could use now into the mortgage.What would you do?

Alina Trigub

Rental Property Investor · Glen Rock, NJ · Member since 2015 · 3k+ posts · 2k+ votes

7y

@Eric D. Congrats on buying these two cash-flowing properties! You have a good problem to solve. We can offer you suggestions but it's up to you to decide what works best in your case.

Couple of points to consider:

1) You have 2 loans now with deductible interest correct? If you pay it off, no more deductible interest!

2) You mentioned that if you pay it off now, it is like making 5% guaranteed return. So it comes down to: can you make a higher return right now?

a) you can probably lend money to flippers and make a higher interest. However I don't know if you're on W-2 which will slash your interest by your W-2 tax rate - could be a big hit.

b) you can invest passively in a syndication and generate passive income.

c) buy another property with the money earned from these two properties.

Hope this helps!

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Theo Hicks

Rental Property Investor · Tampa, FL · Member since 2015 · 1k+ posts · 969 votes

7y

The real question is "can you make a return that is greater than 4.7% to 5.25% by investing your cash flow into another deal?"

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Mike R.

Investor · PO, WA · Member since 2015 · 197 posts · 95 votes

7y

i have never understood the idea that you keep a mortgage because you get to write off the interest. You still paid the interest and you do not get to write off the entire amount of the interest. For example, your tax rate times your total interest paid is your "write off".

I also don't think the answer is as simple as "can you get a return higher than the interest rate of the loan". Yes, from a purely return figure stand point, that logic works. However, you haven't addressed the risk side of the equation--what types of risk are you taking by investing with the HOPE of a return higher than the loan rate relative to the risks you are currently taking. Yes, you can invest in a hedge fund or some other investment and earn 7% (gross of fees), but are you taking on risk you don't like. Tell me how the stock market volatility of the last month helped you sleep at night relative to making a known mortgage payment. Tell me how you feel about paying off the mortgage and having the resulting extra cash flow in your checking account. Tell me how that would feel if we are in a recession (likely in 2019 or 2020).

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David O.

Investor · Leawood & Manhattan, KS · Member since 2017 · 41 posts · 56 votes

7y

First thing you ant to do is put some of that cash flow into a savings account for capex and other issues that may come up. You don't want to be dipping into your personal funds to put in a new AC unit or replace a roof.

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Evan KirkpatrickBusiness Member

Accountant · Round Rock, TX · Member since 2018 · 5 posts · 7 votes

7y

My #1 question whenever someone asks me this sort of question is this - what are you trying to achieve by owning real estate?

If you're just looking to invest cash somewhere, paying down mortgages isn't the worst. It's a guaranteed rate of return equal to the interest rate. It's not super liquid, but for a risk-free investment it's not that bad. Also, under 2018 tax rules, if you're paying down the mortgage on your primary residence you may not even be costing yourself the mortgage interest deduction, since a lot of people aren't going to be itemizing anymore anyway.

However, using your cash this way is very conservative. Most people get into real estate with grander goals than that. If you ever want to use real estate to do more than just supplement your income, then you need scale. To scale, you need capital - for down payments, operational costs, what have you. You can get this by involving other investors, but if you're trying to maintain 100% ownership of all your properties, you have to have some money to bring to the table to start the BRRRR cycle or whatever other mechanism you are using to make profit and cash flow in real estate. If you're looking to scale, then you need to hold on to cash flow and use it to build up the war chest to do more deals.

So, that's the choice - if you're not trying to expand, paying down mortgages can be okay. If you're going to do more deals, then that's not what you want to do.

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Eric D.

OP

Maplewood, NJ · Member since 2016 · 38 posts · 8 votes

7y

Thanks for all the replies! My goal is to retire early (I am 45). Thing is, BBBR does not really work in NNJ. I think self managing two properties is my limit. If I get a third, I would need a Management Co. and that would cut into my profits.

OTH, I hate to just give extra money to the banks each month.

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Thomas S.

Member since 2016 · 13k+ posts · 12k+ votes

7y

Diversify. Invest in REITs or mutual income funds. The options are unlimited and most are fairly conservative with higher returns than 5%. Keep in mind your tenants are actually paying the interest on your mortgages and you get to claim the deduction.....win/win.

It is OK to hoard cash through paying down a mortgage but if you are that conservative why invest in real estate. When you have cash you have no use for why park it in high risk real estate.

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Evan KirkpatrickBusiness Member

Accountant · Round Rock, TX · Member since 2018 · 5 posts · 7 votes

7y

Originally posted by @Eric D.:

Thanks for all the replies! My goal is to retire early (I am 45). Thing is, BBBR does not really work in NNJ. I think self managing two properties is my limit. If I get a third, I would need a Management Co. and that would cut into my profits.

OTH, I hate to just give extra money to the banks each month.

Paying off the mortgage early isn't likely to help you retire early. When you pay extra principal, you are chopping off payments on the back end of the amortization schedule, so you're creating financial gains you wouldn't realize until you were already retirement age. You could do a re-finance later on to strip the equity out, but if we're doing that, what's the point of paying down the mortgage now? Otherwise, you're talking about having to sell the property to get the money back, but why would we sell something like this if our aim is steady cash flow?

While a management company might cut in to your cash flow, if you acquire good properties, you should have that cash flow to spare and still realize a strong cash-on-cash return. If you're not the sort of person who can efficiently manage a lot of rentals, you're going to have to bring a property manager in eventually, and they can really help you grow by giving you time to pursue more deals. I'd encourage you to run some model deals and see how they look including a property manager, and then evaluate your situation with that in mind.

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Strategies for Allocating Cash Flow

Strategies for Allocating Cash Flow

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