Pay off buy and holds or let the tenants pay?

Tempe, AZ · Member since 2017 · 27 posts · 8 votes

Here's a question I can't seem to answer myself as I'm deciding how I want to go about things. For example a unit payed off could CF at 1000 per month which would be worth 5 units CF at 200 per month BUT if you pay the one unit off you are technically spending some of your own capital that could be reinvested to gain more units. So what's better? Aggressively paying off your units so you are taking more cash flow or reinvesting and gain more units and getting more cash flow that way? Maybe I'm missing a perspective here. Would love to hear what you guys think.

0 Reply

28 views

Most Popular Reply

Michael Seeker

Investor · Louisville, KY · Member since 2011 · 1k+ posts · 1k+ votes

@Kimberly Garrido - what's better will depend on the current interest rate environment and your personal goals. If you want to continue growing, then having cash available to do so will be more important than paying down loans quickly. If you have 10 units that could generate $1000/mo each and your goal is to have $10K/mo in income so you can retire...then it might make sense to start paying the loans down aggressively.

Having fewer units paid off will result in much higher cashflow per time spent. But leveraging allows you to purchase more property and grow more quickly while somebody else pays off your debt.

If you are in a situation where your interest rate exceeds your CAP rate (very unlikely unless you bought with hard money loan and cannot refinance) then you'd be much better off paying down debt than buying more property.

3 Reply

See this reply in the discussion

12 Replies

Jump to latestLatest

Sort by

Michael Seeker
Investor · Louisville, KY · Member since 2011 · 1k+ posts · 1k+ votes
9y
@Kimberly Garrido - what's better will depend on the current interest rate environment and your personal goals. If you want to continue growing, then having cash available to do so will be more important than paying down loans quickly. If you have 10 units that could generate $1000/mo each and your goal is to have $10K/mo in income so you can retire...then it might make sense to start paying the loans down aggressively.
Having fewer units paid off will result in much higher cashflow per time spent. But leveraging allows you to purchase more property and grow more quickly while somebody else pays off your debt.
If you are in a situation where your interest rate exceeds your CAP rate (very unlikely unless you bought with hard money loan and cannot refinance) then you'd be much better off paying down debt than buying more property.
3 Reply
Brian Nordman
Oregon, IL · Member since 2016 · 104 posts · 32 votes
9y
@Michael Seeker very well explained! The kicker will always be your cost of debt (interest rate) and the return you are getting. If your cost of debt exceeds your return, pay down that loan! If your return is higher than your cost of debt, then use that extra money to keep growing!
0 Reply
JD MartinBusiness Member
Moderator
Rock Star Extraordinaire · Northeast, TN · Member since 2015 · 10k+ posts · 16k+ votes
9y
It also depends where you are in life. A lot of landlords will end growth and invest in current assets as they near retirement. Technically, equity sitting in a house is dead, so (in theory) the smart money would not leave any equity behind so long as the cash pulled can be put to better use. In reality maximum leverage on all units is dangerous unless you're loaded with liquidity elsewhere, so the LLs I know keep a mix of leverage & cash units.
Podcast Guest on Show #243
Skyline Properties
View Page
0 Reply
Thomas S.
Member since 2016 · 13k+ posts · 12k+ votes
9y
The biggest mistake, or misconception, novice investors have is that paying down a mortgage on a income property increases cash flow. In fact it has the exact opposite effect, it reduces cash flow, when the investor begins to understand the value of cash.
If a property can not cash flow with a hypothetical 100% financing scenario it will never cash flow. The reason for this is because cash/equity has a value and generates a separate income stream from the property itself. Income properties have two separate income streams.
For every 100K in equity, having a opportunity value of 10%, you deduct $833/month from your rental income. This shows that equity will very quickly reduce the income, generated by the property itself, to a point where actually owning the property becomes a liability not a asset. At that point you would be farther ahead selling and parking your cash in a moderately conservative mutual fund to generate a higher return.
Ideally you would want all properties 100% financed and having positive cash flow. Obviously this is very difficult to achieve but the reality is that maximum leverage produces the greatest TRUE positive cash flow. Cash flow created by paying down a mortgage is forced or fake cash flow and at the very best will only provide a return equal to the prevailing interest rate, which today would be considered a dismal return on investment.
Equity kills cash flow.
0 Reply
Andrew Johnson
Real Estate Investor · Encinitas, CA · Member since 2016 · 3k+ posts · 3k+ votes
9y
Kimberly Garrido You're getting good feedback so far but I'll chime in with a little more. This can also depend heavily on your tax bracket. At higher income levels you want mortgage deprecation to offset property income (giving you, effectively, tax free income). Tax-free income is much more valuable if you make $300K a year vs. $30K a year. Goes back to the old adage, it's not what you make...it's what you keep!
0 Reply
Kimberly Garrido
OP
Tempe, AZ · Member since 2017 · 27 posts · 8 votes
9y
Brian Nordman Michael Seeker Jd Martin Thank you guys for your input that really helped! Definitely need a new perspective. Being far from retirement I'm thinking paying down wouldn't be a good strategy for me as of right now I should focus on growing and picking up property with solid cash flow! And I'll let my tenants pay the debt so 20-30 years from now I'll be set!
0 Reply
Kimberly Garrido
OP
Tempe, AZ · Member since 2017 · 27 posts · 8 votes
9y
Thomas S. Yes that definitely makes a ton of sense thank you for saying it like that!! Love it!
0 Reply
Kimberly Garrido
OP
Tempe, AZ · Member since 2017 · 27 posts · 8 votes
9y
Andrew Johnson Thanks for the feedback totally agree with you on that adage as well. Kiyosaki would say the same!!! Time to get back to the drawing board.
0 Reply
Alex ShaughnessyPro Member
Real Estate Investor · Spring Valley, CA · Member since 2016 · 288 posts · 98 votes
9y
This is all great feedback. nothing to really add from myself.
0 Reply
Max T.
Investor · Philadelphia, PA · Member since 2015 · 3k+ posts · 3k+ votes
9y
I think Thomas S. killed @greg S and took his last name and BP persona.
0 Reply
Ralph R.
Investor · Bethel, AK · Member since 2013 · 1k+ posts · 852 votes
9y
Andrew Johnson Kimberly Garrido Andrew some of the tax advantage runs out if you are using rental depreciation to lower your W2 taxes. Your depreciation rate starts decreasing at $100,000 a year and stops completely at $150,000 a year. While you cannot use this depreciation you can bank it for future years. I'm not a CPA but I believe when you sell you must pay 2 taxes. One is Capitol gains and one is not an actual tax but you must pay back all depreciation. I don't remember the term but I'll call it depreciation recovery. Maybe some CPA or other qualified person can chime in here but I THINK this recovery Is assumed to be the full amount whether or not you were actually able to use it. RR.
0 Reply
Andrew Johnson
Real Estate Investor · Encinitas, CA · Member since 2016 · 3k+ posts · 3k+ votes
9y
Ralph R. Yup, you're right, I'm only talking about getting tax free rental income. I'm not talking about using a loss to lower your effective W2 tax rate. I guess that is a "good problem to have". So when I look at the "appropriate" amount of debt my ideal situation is when I take on just enough debt to get that marginal tax free income from the property. Capital gains and depreciation recapture really drive a large portion of the 1031 ecosystem.
0 Reply

Join the conversationCreate a free account to reply, vote on answers and follow this thread.