With 200k cash should i pay off my rental property or buy more?

27 Replies

It's hard to say from that information alone. 

It depends on your personal risk aversion, point in life, and overall goals as an investor. Generally speaking, if you were to compare what you could save collectively in interest by paying off the existing loan today, versus the capital gains that could be made by buying another (or multiple) cash-flowing, properly wedged deal(s); buying a second property will win in the long run (and by a sizable margin).

The only way this theoretical second property wouldn't win in the long term would be if property A was held with an ARM and subject to a crazy high interest rate or something like that, and the ROI on property B couldn't outperform the interest rate on property A.

Is your mortgage rate at like 10% or higher? Let your tenants pay your mortgage. What's dead equity going to do for you? Sleep better? I sleep better knowing I have more money. If you don't know what to do with that much money, I recommend Vanguard VTSAX. 

By more.  No question.  If you pay off your property you're spending that money for no reason...your tenant is already doing it for you.  Before the property you paid off starts making a profit, you have to get all the money YOU spent back.  Don't add to that number...just let the tenant do it for you...that's their only job, and they do it so well.

@Anthony Wick

Actually, my interest rate on the rental is 3.875%. I was just thinking if I pay it off I will have cash flow and no debt on the mortgage so that’ll give me some peace of mind. Although, a part of me also wanted to increase my income potential as well.

I appreciate your input and reminding about the tenant is actually paying my mortgage. :)

Originally posted by @Belinda Mata :

@Anthony Wick

Actually, my interest rate on the rental is 3.875%. I was just thinking if I pay it off I will have cash flow and no debt on the mortgage so that’ll give me some peace of mind. Although, a part of me also wanted to increase my income potential as well.

I appreciate your input and reminding about the tenant is actually paying my mortgage. :)

if its a nice quality rental that is treating you well then I would keep that low interest in play..  nothing says you have to buy more rentals.

you could find folks to partner with on flips or find really good HML to put your money out in short term fix and flip loans and make 8 to 10% pretty easy.. if you want to stay in the real estate space.

@Joe Villeneuve I’ve seen you say this many times and I can’t understand what you’re saying. I am new to rei so maybe it’s different than the stock market. How would you have to make all the money back you put into it before you start making a profit? You still have the capability of getting some or all of that money through refinance, home equity loan/line of credit, or just selling the house correct? So if they were to pay off the mortgage and make an extra $600 a month for a year or two then decide to sell the house, they would have made that $600/ month and got all the money back once they sell the house. So that $600/month would be profit. Not saying one way or the other is right, I just don’t understand your statement about having to make all your equity back before making a profit.

Take another investment for example. In your scenario if I invest $250,000 in a stock market fund that pays dividends, those dividends would have to pay me $250,000 before I start making a profit if I look at it from that point of view. That doesn’t make sense to me. I still have my principle even though it may not be as liquid as cash.

Can you explain your thoughts on that to me? I just see it as holding that capital in an investment while you make a little higher return with less risk and waiting to get the principle back once you sell or restructure the loan. Won’t make you as much as leveraging, but it’s another option for a risk averse person.

@Belinda Mata

At 3.875% I would borrow all the money people would give me. I would not pay any of it back early, Even in 2008. Think long term. You’d have to try real hard not to get a better return on your money.

Originally posted by @Tyler Hampton :

@Joe Villeneuve I’ve seen you say this many times and I can’t understand what you’re saying. I am new to rei so maybe it’s different than the stock market. How would you have to make all the money back you put into it before you start making a profit? You still have the capability of getting some or all of that money through refinance, home equity loan/line of credit, or just selling the house correct? So if they were to pay off the mortgage and make an extra $600 a month for a year or two then decide to sell the house, they would have made that $600/ month and got all the money back once they sell the house. So that $600/month would be profit. Not saying one way or the other is right, I just don’t understand your statement about having to make all your equity back before making a profit.

Take another investment for example. In your scenario if I invest $250,000 in a stock market fund that pays dividends, those dividends would have to pay me $250,000 before I start making a profit if I look at it from that point of view. That doesn’t make sense to me. I still have my principle even though it may not be as liquid as cash.

Can you explain your thoughts on that to me? I just see it as holding that capital in an investment while you make a little higher return with less risk and waiting to get the principle back once you sell or restructure the loan. Won’t make you as much as leveraging, but it’s another option for a risk averse person.

 OK.  Let me see if I can break this down into the basics.

1 - Follow the money...your money...that's what matters.
2 - When your money stops moving, it becomes a "cost" to you.
3 - The face value of your money, cash or equity, is the same. The difference is, your cash can be used again for free. In order to access your equity, you have to pay for it again (refi, HELOC, etc...).

Let me use another example to show you this. Free checking from a bank isn't free checking if you have to keep $5,000 in the checking account all the time to get it. That free checking costs you $5,000. You see what's ridiculous about this is when you run the actual numbers. If you write 200 checks a year, and if you had to pay for them ($1/check) it would cost you $200/year. That means it would take you 25 years before you broke even...and the savings of $200/yr actually started. It's the same basic principle for REI. What ever comes out of your pocket, is your cost. Until you recover it all in the same form you spent it (cash), it's a cost to you...and must be recovered before you start making a profit.

Buying equity, isn't a profit.  It's the same money...just in a different location.  The difference, as stated above, is it's free to use when it's still cash.

Take this a step further...paying off the principle in a rental property:

Any money that comes out of your pocket is money you spend, and must be recovered before you make a profit.  The true cost to you is ONLY what comes out of your pocket.  So, if the only money you spend is the down payment, and the rest of the money comes from the rent (the tenant), you are NOT the one that is paying the rest of what's owed on the property (principle and interest).  This means you only have to recover the DP before you start profiting.

@Belinda Mata   If you plan on buying more properties down the road, I'd use the money to buy another rental (or two).  Don't rush to spend it and keep some reserves.  Take the time to look at your options, talk to your banker to see if you can get a mortgage for a new place.

@Joe Villeneuve I think what we are missing each other on here is the definition. You are referring to money put into a bank account or a house or any other vessel as a “cost”, when I think what you mean is maybe “opportunity cost”. The minute you pay off your rental and collect the next rent check, you profit from it. You don’t need to make the money back to profit. But there is an opportunity cost to leaving your money in the house. And I think that’s where we are getting wires crossed. There is certainly missed opportunity when paying off a home. Just a matter of how risk tolerant someone is to know what’s best for them. Thanks for your clarification!

Originally posted by @Tyler Hampton :

@Joe Villeneuve I think what we are missing each other on here is the definition. You are referring to money put into a bank account or a house or any other vessel as a “cost”, when I think what you mean is maybe “opportunity cost”. The minute you pay off your rental and collect the next rent check, you profit from it. You don’t need to make the money back to profit. But there is an opportunity cost to leaving your money in the house. And I think that’s where we are getting wires crossed. There is certainly missed opportunity when paying off a home. Just a matter of how risk tolerant someone is to know what’s best for them. Thanks for your clarification!

No, I mean a "cost" when you spend it to get free checking.

Your money in the bank isn't a cost...it isn't anything until you move it.  When you have to put the money in the bank, and leave it there, not being able to use it, it's a cost to you since you can't use it for anything else.

When you put your money into the house, it's a cost.  Yes, it is put into an investment and it now equals equity, but you had to buy that equity in order to get it...therefor it's a cost to you.  When you let the tenant "buy your equity for you", that allows you to use your cash elsewhere.

Profit, in any business, is made after you recover your costs.  If you spend money on your equity, you have to get that back first.  If you look at the whole picture, that equity you bought with the cash from your bank didn't get you anything more in value.  It's the same value it had in the bank...it's just in a different location...and it will now "cost you" even more to access it (refi interest).  If you left it in the bank, and let the tenant buy your equity for you, it would cost you nothing...and your cash would still be available to use as a down payment on the next property.

Originally posted by @Tyler Hampton :

@Joe Villeneuve I think what we are missing each other on here is the definition. You are referring to money put into a bank account or a house or any other vessel as a “cost”, when I think what you mean is maybe “opportunity cost”. The minute you pay off your rental and collect the next rent check, you profit from it. You don’t need to make the money back to profit. But there is an opportunity cost to leaving your money in the house. And I think that’s where we are getting wires crossed. There is certainly missed opportunity when paying off a home. Just a matter of how risk tolerant someone is to know what’s best for them. Thanks for your clarification!

 Here's an example what I mean when I say your profit comes after you recover your costs (cash you put in):

Property Terms:  Purchase Price = $100k

Option #1:  Buy all cash
1 - Cash in (cost to you) = $100k
2 - Cash Flow = $10k/year
3 - Years to full recover of cash/cost = 10
4 - Profit during years 1 - 10 = $0
5 - Next purchase using same Option Method (all cash) = Year 11 = 2 properties ($20k cf)
6 - Next purchase using same Option Method (all cash) = Year 16 = 3 properties ($30k cf)



Option #2: Buy $20k DP; finance $80kcash
1 - Cash in (cost to you) = $20k
2 - Cash Flow = $5k/year
3 - Years to full recover of cash/cost = 4
4 - Profit during years 1 - 10 = $30k (last 6 yrs)
5 - Next purchase using same Option Method (20% DP) = year 5. 
...if you buy a new property every time you accumulate $20k in CF for the DP (and add $5k in new cf/property)...

6 - In year 16 (when the other Option has 3 properties and $30k CF/year) this option would have = 17 properties and $85k in cf/yr)
7 - In year 21, this Option would have 53 properties and $265k in cf/yr...if they continued buying new properties using the same Method.

@Joe Villeneuve I guess we will agree to disagree. My whole point is, you don’t have to earn enough cash flow to pay for your investment before you make profit. If you purchase a home with cash and get a better cash flow, once you sell the house, you will get back your principle amount plus the inflated cash flow. I don’t see how that’s not profit. But there’s no use continuing to debate these things, as it just wastes time and gains no outcome. I will bid you good luck in all your ventures!

The big key to growing wealth is to make your $$ work for you....not just sit there doing nothing.....or next to nothing..... by paying off a rental property, you are essentially depositing all that $$ into one account and generating one revenue stream. On paper the "cash flow" is huge....but a big part of that "cash flow" is actually you just pulling $$ out of the account you made a huge deposit into..... you are "cash flowing" your own $$ back to you to use somewhere else. Its not "cash flow" or profit until you get all your money out of that big deposit you made.......

Unquestionably use the $$ to buy other investments....make it work for you....don't tie it all up in one area that will take a LONG time for you to benefit from. Unless you are very risk aversive, this is the smarter play.

I did pay off my own personal property....... from a financial aspect, not necessarily the smartest choice, but the satisfaction and stability of not having that debt appealed to us...... no matter what happens in my life, I don't have a mortgage on my own house to pay each month. I have ZERO plans to pay off my rentals quickly..... I'll use other people $$ to build off and use my $$ to work for me in other ways

@Joe Villeneuve I've seen you post this example before and while it seems technically accurate, the reason your example works so well is that this is almost a "too good to be true" rental property.  I mean, $5000 cash flow a year on a $20,000 (i.e. 20% down) investment is a pretty darn good cash-on-cash return.  Rework your numbers with a still-good (to many investors) 10% cash-on-cash return and the "ratio" of cash flow for the leveraged investor to the all-cash investor is now $2000 vs $7000, instead of the $5000 vs $10000 you cite.  This, in turn, increases your "Years to full recover of cash/cost" to ten years in your Option 2 and fourteen years in option 1, which in turn changes your whole calculus.

Perhaps you can get that kind of return in your market, but really, it's not common lately....many many posts on BP recently about where to go to get better returns and "how are investors making money paying $###?!"

That said, one thing we can all agree on, for the OP, we know the return on investment for paying off the mortgage will be 3.875% (or maybe we can slightly adjust this return depending on how the additional rental income is now invested).  As @Anthony Wick says, "You’d have to try real hard not to get a better return on your money."

Originally posted by @Ned J. :

The big key to growing wealth is to make your $$ work for you....not just sit there doing nothing.....or next to nothing..... by paying off a rental property, you are essentially depositing all that $$ into one account and generating one revenue stream. On paper the "cash flow" is huge....but a big part of that "cash flow" is actually you just pulling $$ out of the account you made a huge deposit into..... you are "cash flowing" your own $$ back to you to use somewhere else. Its not "cash flow" or profit until you get all your money out of that big deposit you made.......

Unquestionably use the $$ to buy other investments....make it work for you....don't tie it all up in one area that will take a LONG time for you to benefit from. Unless you are very risk aversive, this is the smarter play.

I did pay off my own personal property....... from a financial aspect, not necessarily the smartest choice, but the satisfaction and stability of not having that debt appealed to us...... no matter what happens in my life, I don't have a mortgage on my own house to pay each month. I have ZERO plans to pay off my rentals quickly..... I'll use other people $$ to build off and use my $$ to work for me in other ways

 Thank you...you get it.

Originally posted by @Jim D. :

@Joe Villeneuve I've seen you post this example before and while it seems technically accurate, the reason your example works so well is that this is almost a "too good to be true" rental property.  I mean, $5000 cash flow a year on a $20,000 (i.e. 20% down) investment is a pretty darn good cash-on-cash return.  Rework your numbers with a still-good (to many investors) 10% cash-on-cash return and the "ratio" of cash flow for the leveraged investor to the all-cash investor is now $2000 vs $7000, instead of the $5000 vs $10000 you cite.  This, in turn, increases your "Years to full recover of cash/cost" to ten years in your Option 2 and fourteen years in option 1, which in turn changes your whole calculus.

Perhaps you can get that kind of return in your market, but really, it's not common lately....many many posts on BP recently about where to go to get better returns and "how are investors making money paying $###?!"

That said, one thing we can all agree on, for the OP, we know the return on investment for paying off the mortgage will be 3.875% (or maybe we can slightly adjust this return depending on how the additional rental income is now invested).  As @Anthony Wick says, "You’d have to try real hard not to get a better return on your money."

The example I gave for cash flow is based on actual numbers...not an imaginary percentage of returns. I don't like percentages since they tell you nothing in REI. If you can't get a property where the Purchase Price is $100k, that generates a cash flow of $400/month with financing, then you're investing in the wrong markets.

@Joe Villeneuve I don't really disagree with you, folks should scale up and invest in markets with good returns.  For sure, I've mostly given up on my local market (save for continuing to seek an off-market deal), and instead I'm considering an opportunity where I used to live where numbers work much better (and I'm familiar with the area).  But let's be fair to @Belinda Mata , who asked about the pros and cons, and certainly some of the cons we can list is "may need to look outside your local market for good returns and be comfortable with that" and "good cash flow properties are harder to find."

The "pros" are already well documented on this thread, so long as you're ok with additional efforts associated with more properties.  To the question of taxes, all property investors love the tax advantages, but as soon as you pay off that property, you'll show more income on which you'll be taxed (by way of less mortgage interest deduction).  In the end, there's no stopping you from doing a little of both...buy more properties to your comfort level, and you could still drop $25k (or whatever) on that other mortgage if paying it off earlier is appealing to you.  

Originally posted by @Jim D. :

@Joe Villeneuve I don't really disagree with you, folks should scale up and invest in markets with good returns.  For sure, I've mostly given up on my local market (save for continuing to seek an off-market deal), and instead I'm considering an opportunity where I used to live where numbers work much better (and I'm familiar with the area).  But let's be fair to @Belinda Mata , who asked about the pros and cons, and certainly some of the cons we can list is "may need to look outside your local market for good returns and be comfortable with that" and "good cash flow properties are harder to find."

The "pros" are already well documented on this thread, so long as you're ok with additional efforts associated with more properties.  To the question of taxes, all property investors love the tax advantages, but as soon as you pay off that property, you'll show more income on which you'll be taxed (by way of less mortgage interest deduction).  In the end, there's no stopping you from doing a little of both...buy more properties to your comfort level, and you could still drop $25k (or whatever) on that other mortgage if paying it off earlier is appealing to you.  

The number of properties was used only to make a point of the impact of not paying off the properties yourself, and what it can be done using a compounding effect.

Instead of buying the same property over and over, you can take the accumulated cash flow (growing at each step), and move up into larger properties, or commercial, or just more expensive but with the same cash flow returns.

@Joe Villeneuve

Thanks for your examples.

I have a question in the future is it better to put my rentals in an LLC for tax-saving purposes? Currently, my husband and I are not able to fully take advantage of the tax deductions from our rental because of the income cap? Your thoughts. Thanks.