Overcoming the Idea That Paying Off Mortgages Is A Good Idea
Overcoming the mindset of paying down mortgages is a dilemma for me. Considering the low interest rates I am going to refinance a couple of my SFH rentals and my primary residence. It makes financial sense to me to refi and use the proceeds to buy more and better assets. On the other hand its hard for me accept reduced cashflow and new 30 year terms. I understand all the reasons to use leverage and pull equity out. I have no desire to pay off any RE other than maybe my primary residence and even that goes against financial sense. Has anyone else had this struggle?
Why do you want to overcome that mindset? It really has more to do with figuring out what your end goals are. Leverage can be very useful but also multiplies your risk. Don't take that concept lightly. I have seen many people lose their shirt because of their use of leverage.
@Clinton Miller , you can be a passive investor and control your properties by using a master lease. Some people refer to a master lease as a triple net lease.
Beware of high fees involved with syndications. Fees of 15-20% are common.
Where is it reported what Praxis averaged in returns in the past?
You can get copies of P&Ls from their past projects if you ask.
Originally posted by @Tim Boehm:This is totally age dependant. There is no right or wrong answer. We have 6 rentals, all SFH's, F/C, we'd love to sell and get out of the rental business but we can't get a decent rate on some long term CD's. We are sitting on huge cash reserves also and making nothing from that. This was not the promise made to us by our government when we were young. It was work hard and save, save for what? so you can get 1/2% on two million dollars? No spend every dime you make having a good time then cry about how hard you worked all your life and get government housing, food stamps, a ticket to the local food bank and meals on wheels.
You might look into commercial bonds and dividend paying stocks, or municipal bonds. All have yields higher than bank CDs. While not much better than 0.05%, my credit union CDs do beat that rate.
Don't overlook the return on equity you are getting from your rental holdings. If each of your $300K free and clear properties is generating $3K monthly cashflow, that is a 12% return on equity. Why do you want to trade all that in on something that gives a lower yield? You may find that you get the best return on your investment by buying more rental properties with your idle cash.
Originally posted by @Wade G.:Overcoming the mindset of paying down mortgages is a dilemma for me. Considering the low interest rates I am going to refinance a couple of my SFH rentals and my primary residence. It makes financial sense to me to refi and use the proceeds to buy more and better assets. On the other hand its hard for me accept reduced cashflow and new 30 year terms. I understand all the reasons to use leverage and pull equity out. I have no desire to pay off any RE other than maybe my primary residence and even that goes against financial sense. Has anyone else had this struggle?
See, I don't really understand that mindset. Yes, I want assets and positive cash flow, especially passive income, but think about it like this. WHY do you want the cash flow? It's so that you have more coming in than going out, correct? So, if you pay off your residence (maybe not your rentals, because leverage is helpful there), then you have less going out, which is half of the wealth equation.
I want both - positive cash flow (passive income) AND low expenses, that's how you get out of the rat race. Over-leveraging just so you can get more cash flowing assets but keeping your expenses high can lead to disaster if market circumstances go bad on you. I feel like whittling down my expenses (especially interest) is a very safe investment and half of the wealth / early retirement equation, so I tend to put at least as much focus there. People always say 3-4% is cheap money, but you end up paying for two houses over 30 years and only getting one. That's not cheap to me! Anyway, good luck.
Originally posted by @JD Martin:This was a pretty interesting thread to read.
Before I post, my disclaimer: most of my portfolio is free and clear. I'm more conservative than many others financially and while I fully realize my velocity is not what it could be, I've also lost a bundle of money before and am not in my 20's where I would be going pedal to the floor.
That said, virtually no one discussed one of the most valuable parts of leverage: inflation. Whenever you live in an inflationary environment, asset-focused fixed debt is incredibly valuable for building wealth and hedging against the reduction in purchasing power. It's also what makes a long-term mortgage on a personal home make more sense, financially speaking and in broad terms, than being a renter over the same period of time.
When you borrow money today to buy an asset, even if the asset doesn't change in value in inflation-adjusted dollars, you are repaying the note with devalued dollars - in essence, you are paying less, in real-time adjusted value, than you borrowed in the first place, when it comes to the principal. The interest you pay is a partial hedge for the lender against inflation, but even it may not make up for the loss of purchasing power. If inflation is rising at 4% annually, and you have a note at 3.5%, the entity that lent you the money in the first place is losing money every year - the 4% annual loss of purchasing power of the original note and .5% of the interest that should be partially making up the difference. On a 25 year note (let's skip compounding effects for simplicity), if someone lent you $100k, they've effectively got less than $100k in inflation-adjusted dollars when you complete payment. Meanwhile, if your real estate sat vacant, or you lived in it, and it appreciated at just the rate of inflation, you have an asset worth $200k in inflation-adjusted dollars. If you started with zero, you've significantly increased your net worth, while the guy that gave you the money lost part of his (if he only started with $100k). Now imagine that your RE did not sit vacant, and you didn't live in it, but you rented it to someone else. Even forgetting about any tax value (interest write-off, depreciation), assuming you rented the property out and that the rent kept up with inflation, what you started off renting for $1k/month (let's assume 1% rule) is now renting for $2k/month. If 50% of that went to pay for the costs of the property (PITI, maintenance, etc), you've made ANOTHER $200k+ on that property.
That is how leverage builds massive wealth. Do that a dozen times and in short order you've made a serious amount of money. Yes, in order to make money you have to absorb risk, and that is the spread between taking on leverage and owning it free & clear. Yes, the older you are, the more difficult it is to absorb what tend to be natural peaks and valleys of the marketplace, so as you age reducing risk makes sense. If you can't wrap your head around this, think of it as the "Dave Ramsey Snowball Method" in reverse, where instead of taking all your dollars and eliminating high-interest, no-asset obligations, you took all your dollars and turned them into low-interest, high-income producing assets.
If I was 20 again I would have lived in a van, saved enough to buy one property for cash, rehab & rent, refinance, repeat again and again and again until the snowball was so large I had more money than I'd ever want or need in a month, and then I'd start reducing that exposure as I aged.
For me, I've kept a big chunk of paid-off stuff as my backstop against other properties that are leveraged. But I'm not in my 20's, either, and since I'm not immortal (as far as I know!) I don't have 40 more years to make the portfolio grow.
I always find inflation so interesting and almost "confusing" in the sense that there are a couple different ways to look at it. For example, if I bury one dollar today and dig it up in ten years it has lost value in the sense that it's purchasing power has gone down, but it's still ONE DOLLAR - it hasn't changed. So, another way to look at inflation (that I find much less abstract) is that the dollar hasn't lost any "value" at all, but things have gotten more expensive over time. In other words, inflation is a function of price increases rather than value. I can take that dollar today and buy a can of coke, but if I want to buy the SAME CAN OF COKE IN TEN YEARS (this is key), I need to dig up that dollar plus add another 50 cents or whatever. Either way, the can of coke that goes in my tummy has exactly the same "value", but the cost / price went up over time. My mom always told me she could never fathom that a can of coke used to be a nickel and now it's a dollar, but remember - same exact product / value in your tummy, but the price went up.
If you need another example of this, think about a house or a car. Its "value" is that you can live in it or drive it to work, but this is separate from the price you pay to own it. If I pay $100K for a house and then the "price" goes down in terms of how much I can sell it for, but I can still live in it, has it lost any "value" or did the "price" go down? I would argue that the price went down and the value has stayed the same, which is another reason why I prefer to look at inflation as a matter of price movements instead of a matter of value. In other words, it's less abstract, but I think it's also more accurate. Even if no one will buy my house and the "price" is $0, if I can live in it the value is the same. I think people confuse the two ideas.
Anyway, if I apply that idea to what you're saying here, the lender has given me $100K and I've given him back $100K + 4% ($71,869.51) in 30 years. According to SmartAsset's inflation calculator, $100K today will be "worth" $209,757 in 2050 (@ 2.5% avg yearly inflation), but think back to the can of coke and examine what that means. If I bury the $100K and dig it up in 30 years, now my giant, fancy can of coke will "cost" me $209,757, but it's the same can of coke just at a higher price. Same as before, when I'm digging up the money, I need to add to the amount to make the purchase, but I'm getting the same goods either way.
To me, it almost seems like you're saying you'll be able to buy a bunch of cans of coke down the road, but it's the same can of coke whether you buy it today or in 30 years, it's simply way more expensive if you wait. You can correct me if I'm misunderstanding, obviously, but when you're talking about sort of multiplying your money because you're paying less back to them in real time value, that's how I understand your point. When you think about the idea that you're getting the same goods either way and just paying more in the future, I don't see how you could sort of be multiplying your money / getting over on the lender with leverage.
The funny thing is, I feel like it made a lot of sense reading what you wrote, so I'm not necessarily differing with you, but when I examine it through this other lens I'm not sure which way is right or if it's just two ways of explaining the same thing (obviously compounded by the idea that I'm not sure if I understand your point). The only other thing that I would say is that viewing it through your perspective, if lenders are barely hedged against inflation, how would they ever make any money? It seems like a losing proposition to loan out money and then essentially ask for the rate of inflation as your compensation. That seems to point to my explanation, doesn't it? Thanks.
Originally posted by @JD Martin:This was a pretty interesting thread to read.
Before I post, my disclaimer: most of my portfolio is free and clear. I'm more conservative than many others financially and while I fully realize my velocity is not what it could be, I've also lost a bundle of money before and am not in my 20's where I would be going pedal to the floor.
That said, virtually no one discussed one of the most valuable parts of leverage: inflation. Whenever you live in an inflationary environment, asset-focused fixed debt is incredibly valuable for building wealth and hedging against the reduction in purchasing power. It's also what makes a long-term mortgage on a personal home make more sense, financially speaking and in broad terms, than being a renter over the same period of time.
When you borrow money today to buy an asset, even if the asset doesn't change in value in inflation-adjusted dollars, you are repaying the note with devalued dollars - in essence, you are paying less, in real-time adjusted value, than you borrowed in the first place, when it comes to the principal. The interest you pay is a partial hedge for the lender against inflation, but even it may not make up for the loss of purchasing power. If inflation is rising at 4% annually, and you have a note at 3.5%, the entity that lent you the money in the first place is losing money every year - the 4% annual loss of purchasing power of the original note and .5% of the interest that should be partially making up the difference. On a 25 year note (let's skip compounding effects for simplicity), if someone lent you $100k, they've effectively got less than $100k in inflation-adjusted dollars when you complete payment. Meanwhile, if your real estate sat vacant, or you lived in it, and it appreciated at just the rate of inflation, you have an asset worth $200k in inflation-adjusted dollars. If you started with zero, you've significantly increased your net worth, while the guy that gave you the money lost part of his (if he only started with $100k). Now imagine that your RE did not sit vacant, and you didn't live in it, but you rented it to someone else. Even forgetting about any tax value (interest write-off, depreciation), assuming you rented the property out and that the rent kept up with inflation, what you started off renting for $1k/month (let's assume 1% rule) is now renting for $2k/month. If 50% of that went to pay for the costs of the property (PITI, maintenance, etc), you've made ANOTHER $200k+ on that property.
That is how leverage builds massive wealth. Do that a dozen times and in short order you've made a serious amount of money. Yes, in order to make money you have to absorb risk, and that is the spread between taking on leverage and owning it free & clear. Yes, the older you are, the more difficult it is to absorb what tend to be natural peaks and valleys of the marketplace, so as you age reducing risk makes sense. If you can't wrap your head around this, think of it as the "Dave Ramsey Snowball Method" in reverse, where instead of taking all your dollars and eliminating high-interest, no-asset obligations, you took all your dollars and turned them into low-interest, high-income producing assets.
If I was 20 again I would have lived in a van, saved enough to buy one property for cash, rehab & rent, refinance, repeat again and again and again until the snowball was so large I had more money than I'd ever want or need in a month, and then I'd start reducing that exposure as I aged.
For me, I've kept a big chunk of paid-off stuff as my backstop against other properties that are leveraged. But I'm not in my 20's, either, and since I'm not immortal (as far as I know!) I don't have 40 more years to make the portfolio grow.
Just to clarify my last post, I guess what you're saying is that when you give them the $100K back, THEY need more money to purchase the proverbial can of coke, so you're in essence short-changing them. They're not getting a very good return, because they're sort of burying the money in the house that you bought and when they dig it up 30 years later it's worth half the amount (they need twice as much to buy the can of coke). I guess that's the part that I was missing initially. Interesting. Mortgage lending, then, is a losing proposition, because in a sense they're burying their money and it's worth less when they get it back. They are paid back with interest, of course, but that doesn't necessarily make up for what is lost in the inflation. Crazy.
I was leaning more toward thinking that since you're paying them back with a "devalued" dollar you'd be the one getting less purchasing power, but the principal doesn't go from $100K to $200K in that time, it stays the same. In a sense you're giving them back less than you borrowed when you factor in inflation. It's like you're asking your kid brother for $20 and then giving it back to him in 30 years when it's practically worthless. It's a good thing that lenders' balance sheets aren't accountable for inflation, because you know they'd stick us with inflation AND interest. Thanks for pointing this out, it's a great catch.
Originally posted by @Joshua S.:Originally posted by @JD Martin:This was a pretty interesting thread to read.
Before I post, my disclaimer: most of my portfolio is free and clear. I'm more conservative than many others financially and while I fully realize my velocity is not what it could be, I've also lost a bundle of money before and am not in my 20's where I would be going pedal to the floor.
That said, virtually no one discussed one of the most valuable parts of leverage: inflation. Whenever you live in an inflationary environment, asset-focused fixed debt is incredibly valuable for building wealth and hedging against the reduction in purchasing power. It's also what makes a long-term mortgage on a personal home make more sense, financially speaking and in broad terms, than being a renter over the same period of time.
When you borrow money today to buy an asset, even if the asset doesn't change in value in inflation-adjusted dollars, you are repaying the note with devalued dollars - in essence, you are paying less, in real-time adjusted value, than you borrowed in the first place, when it comes to the principal. The interest you pay is a partial hedge for the lender against inflation, but even it may not make up for the loss of purchasing power. If inflation is rising at 4% annually, and you have a note at 3.5%, the entity that lent you the money in the first place is losing money every year - the 4% annual loss of purchasing power of the original note and .5% of the interest that should be partially making up the difference. On a 25 year note (let's skip compounding effects for simplicity), if someone lent you $100k, they've effectively got less than $100k in inflation-adjusted dollars when you complete payment. Meanwhile, if your real estate sat vacant, or you lived in it, and it appreciated at just the rate of inflation, you have an asset worth $200k in inflation-adjusted dollars. If you started with zero, you've significantly increased your net worth, while the guy that gave you the money lost part of his (if he only started with $100k). Now imagine that your RE did not sit vacant, and you didn't live in it, but you rented it to someone else. Even forgetting about any tax value (interest write-off, depreciation), assuming you rented the property out and that the rent kept up with inflation, what you started off renting for $1k/month (let's assume 1% rule) is now renting for $2k/month. If 50% of that went to pay for the costs of the property (PITI, maintenance, etc), you've made ANOTHER $200k+ on that property.
That is how leverage builds massive wealth. Do that a dozen times and in short order you've made a serious amount of money. Yes, in order to make money you have to absorb risk, and that is the spread between taking on leverage and owning it free & clear. Yes, the older you are, the more difficult it is to absorb what tend to be natural peaks and valleys of the marketplace, so as you age reducing risk makes sense. If you can't wrap your head around this, think of it as the "Dave Ramsey Snowball Method" in reverse, where instead of taking all your dollars and eliminating high-interest, no-asset obligations, you took all your dollars and turned them into low-interest, high-income producing assets.
If I was 20 again I would have lived in a van, saved enough to buy one property for cash, rehab & rent, refinance, repeat again and again and again until the snowball was so large I had more money than I'd ever want or need in a month, and then I'd start reducing that exposure as I aged.
For me, I've kept a big chunk of paid-off stuff as my backstop against other properties that are leveraged. But I'm not in my 20's, either, and since I'm not immortal (as far as I know!) I don't have 40 more years to make the portfolio grow.
Just to clarify my last post, I guess what you're saying is that when you give them the $100K back, THEY need more money to purchase the proverbial can of coke, so you're in essence short-changing them. They're not getting a very good return, because they're sort of burying the money in the house that you bought and when they dig it up 30 years later it's worth half the amount (they need twice as much to buy the can of coke). I guess that's the part that I was missing initially. Interesting. Mortgage lending, then, is a losing proposition, because in a sense they're burying their money and it's worth less when they get it back. They are paid back with interest, of course, but that doesn't necessarily make up for what is lost in the inflation. Crazy.
I was leaning more toward thinking that since you're paying them back with a "devalued" dollar you'd be the one getting less purchasing power, but the principal doesn't go from $100K to $200K in that time, it stays the same. In a sense you're giving them back less than you borrowed when you factor in inflation. It's like you're asking your kid brother for $20 and then giving it back to him in 30 years when it's practically worthless. It's a good thing that lenders' balance sheets aren't accountable for inflation, because you know they'd stick us with inflation AND interest. Thanks for pointing this out, it's a great catch.
That's exactly right. The only two things that make it possible for a profit is the spread between the rate of inflation and the interest rate of the loan, and (more importantly) the fractional reserve lending ability. Because banks only have to have a fraction of what they actually lend on hand, they are in essence creating money and (theoretically) future value by lending that money into existence. So in their case, even if their return is below the rate of inflation, they are being paid back with money they never had in the first place. Even further, they offload that risk by selling the future promise to someone else, or recover that non-existent money from someone else if the note isn't paid (Freddie, Fannie, Ginnie). If not for that, loans would be way more expensive and there wouldn't be too many of us hanging around Bigger Pockets!
It doesn't take much imagination to see that the whole system is precarious. It relies far more on faith and credit rather than hard assets. That's why you still hear people clamoring for a return to the gold standard. It's also a reason I like having more money in hard assets like houses than cash and derivatives. Yes, I get paid rent in the same affected dollars, but a lot of dollar reality gets realized in that rent - if inflation takes off, so will my rents up to the limit of the ability of the consumer to pay.
It does not make sense to pay off the full mortgage on a rental property, because the (IRR) internal rate of return will decline. The magic of using good debt leverage & a conservative DSCR debt service coverage ratio!!!
@Clinton miller can you get history of cash flow payments made to investors from past deals?
@clinton miller when looking at P&L statements where does it disclose the cash flow paid to investors? I seriously doubt these syndicated deals are cash flowing to the investor from operations more than 7% ROI.