Challenging Question for Experience Investors!

Tax Liens & Mortgage Notes
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Challenging Question for Experience Investors!

Brad Fry
Investor · Peoria, AZ · Member since 2014 · 12 posts · 0 votes

Hi I have a small portfolio of rental properties and notes and have a debate I am having with myself and wondering if anyone with experience in this area can shed some different light on the scenario.

I am debating on paying off a property that has a 15 year note, 5% rate (will be paid off in 7yrs).  My cash flow is negative -$421.41 on this property. principle balance is $90k. is rented with a long term tenant.

I am thinking of paying the mortgage off.  This would equal a 12.8% COC (962.67 per month after rental property expenses) return on the 90K.

Opportunity Cost: I also have opportunities to loan funds out at 16% to flippers, so I can use the 90K for that and generate $1200.00 a month

I am trying to factor in all elements and variables. Off the top the 12.8% return is guaranteed, and I have to keep turning the 16% money.  The 16% money will generate more cash flow.  I have a tax write off with the interest from the mortgage if I don't pay it off.  I can always refi and pull the money out again(pain in the butt) to loan.  Does any one have experience here where they would like to share?   Thank you for your time.

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Brad Stout
Saint Louis, MO · Member since 2015 · 6 posts · 2 votes
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Bear in mind I'm not a seasoned investor but rather a financial risk professional. I think a relatively low risk 12.8% return (did you account for future vacancies? long term costs?) is fantastic. Stock market investors make around 7% long term and they're constantly in short-term risk. Flipper investing is somewhat risky (why else would you get a 16% return...) and my fear would be that you'd lend that to -one- flipper and expose yourself to possible drastic loss.

Then again, why not use that capital to do another purchase? You're still building equity despite being cash flow negative. What is your total gain each month? (Equity and cash)

In other words: investing is a balance between risk, diversification, and reward. Carefully consider all three.

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  • Karen Rittenhouse
    Flipper/Rehabber · Greensboro, NC · Member since 2010 · 623 posts · 615 votes
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    Starting out, it is never a good idea to tie up that much capital in one property, and the write offs are a plus you never have with free and clear. However, you say you have negative cash flow of $421.41 - is that per month?? If so, the first thing you need to focus on is how to correctly structure hold properties. That is a HUGE bleed.

    Can you begin raising rents?

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  • Brad Stout
    Saint Louis, MO · Member since 2015 · 6 posts · 2 votes
    11y

    Bear in mind I'm not a seasoned investor but rather a financial risk professional. I think a relatively low risk 12.8% return (did you account for future vacancies? long term costs?) is fantastic. Stock market investors make around 7% long term and they're constantly in short-term risk. Flipper investing is somewhat risky (why else would you get a 16% return...) and my fear would be that you'd lend that to -one- flipper and expose yourself to possible drastic loss.

    Then again, why not use that capital to do another purchase? You're still building equity despite being cash flow negative. What is your total gain each month? (Equity and cash)

    In other words: investing is a balance between risk, diversification, and reward. Carefully consider all three.

    1Reply
  • Bill Gulley
    Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
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    Need to understand that being a hard money lender has requirements, can't really be in the lending business off a street corner, so you need to be compliant.

    Without cranking any numbers, lending it is the better route if you can keep the money in outstanding loans.

    As to your COC, looks like you used gross rents, need to take out taxes, insurance and maintenance and the value you would assign as management as you don't work for free to compute COC, beyond investment management.

    You'll also pay yourself for the lending activities, an economic assumption with your opportunity costs.

    Consider a "Manager's rate of return" with opportunity costs, match the risk assumptions, look at the "break even formula" with the cost of your mortgage.

    But, I can tell you, if you can keep the velocity of money moving, lending at 16% will be your better option, been there, don't that. Good luck :) 

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  • Bob Malecki
    Investor · Kingston, WA · Member since 2008 · 1k+ posts · 1k+ votes
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    If you pay off that loan you will have a large chunk of equity in the property which sits there doing -- a whole lot of nothing. Its static and not making you any money. I'm a proponent of safely leveraging my properties to keep my capital liquid and making me money. I would redeploy that cash into private lending or buy a note or another rental with leverage to keep your velocity going. 

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  • Steve Babiak
    Real Estate Investor · Audubon, PA · Member since 2009 · 13k+ posts · 8k+ votes
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    That just sounds like a bad rental. Have you considered selling it?

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  • J ScottPro Member
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    Investor · Sarasota, FL · Member since 2008 · 18k+ posts · 17k+ votes
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    If an all-cash purchase can generate a 12% CoC, I see no reason why you couldn't use leverage at today's rates to generate positive cash flow *AND* still have access to the cash.

    The key would be to amortize the loan over longer than 15 years.  Can you qualify for a 30 year conventional?  Or perhaps a portfolio loan amortized over 20-30 years (though it will have a balloon)?

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  • Bob E.
    Queen Creek, AZ · Member since 2014 · 2k+ posts · 1k+ votes
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    There will be a recession before you pay this off in the next 7 years.  If you are cashflow negative on this property how well will you sleep at night if you are cashflow negative during a downturn?  That would be my guide.

    On a side note thanks for posting this, it has given me perspective on how we want to grow our own portfolio.

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  • J ScottPro Member
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    Investor · Sarasota, FL · Member since 2008 · 18k+ posts · 17k+ votes
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    Originally posted by @Bob Malecki:

    If you pay off that loan you will have a large chunk of equity in the property which sits there doing -- a whole lot of nothing. Its static and not making you any money. 

    Why do you say it's not making any money? It would be generating 12% CoC...which is certainly not nothing. And from an IRR standpoint, it's probably better than a leveraged property losing money every month (depending on the hold time).

    The best option is to generate a good CoC *and* still have access to the cash, but if that's not possible, the best option *may* be to roll it into the property until it can be sold or refinanced at more favorable terms.

    Podcast Guest on Show The Truth About Real Estate Investing in 2024 (What Investors NEED to Know)
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  • Brad Fry
    OP
    Investor · Peoria, AZ · Member since 2014 · 12 posts · 0 votes
    11y

    Thank you all for the responses,  I will try to address all questions below.

    This would be a net 12.8% COC (tax liability after depreciation not taken into account) return including all expenses, vacancies, maintenance...if the property was paid off today

    The property could probably have the rent increased a max of $50 a month.  It is at close to current market rental rates.

    -$421 per month is negative cash flow

    property has about 85K in equity and is gaining about $700 a month in equity with the payment as well. yes refi to a 30 yr conventional is an option

    This is my only alligator in the portfolio the rest of the hold properties are structured correctly, positive cash flow.

    I am hearing keep the money loaned out at 16%...Please let me know if this above info stems any other input...It is just hard to see a property not producing a positive cash flow and waiting for the gain to occur once the property is paid off with OPM...and partially mine down the road in 7 years. thanks you

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  • Kendall T.
    Real Estate Investor · Fort Pierce, FL · Member since 2014 · 132 posts · 57 votes
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    I am more safety conscious, I also appear to be in the minority here as I think it would be best to pay off loan.  You would be able to quickly generate more funds and lend that to flippers if you so desired.

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