Investment Performance Analysis (financed -> loan paydowns)

14 Replies

I have been financing all my properties, and analysis via Cash on Cash has been serving me quite well. With the market being the way it is right now, I've moved onto cash buys and paying down my loans for now.

Since the properties will all get an artificial bump in performance once the loan is extinguished, Cash on Cash doesn't seem the most appropriate for my situation.

What performance analysis metrics would you suggest to capture loan paydowns appropriately?

Letting my tenants pay them down for me...likethey are supposed to do.

@Joe Villeneuve They do do that. I'm just paying down the loans even further to increase cash flow by lowering payments in the future. It seems like a safe play for now since everyone thinks a downturn is going to happen soon.

Originally posted by @Jerry Poon :

@Joe Villeneuve They do do that. I'm just paying down the loans even further to increase cash flow by lowering payments in the future. It seems like a safe play for now since everyone thinks a downturn is going to happen soon.

 A - Increasing cash flow by using your own money is an illusion.  Before you get a profit from it, you have to catch up to the negative cash you spent to pay down the debt

B - How does a downturn impact your ash flow

A. I agree. But it is a safe option nonetheless.

B. I have not held my properties through a downturn before. I am uncertain of how they will perform in such an event, so paying down debt is hedging my bets.

Originally posted by @Joe Villeneuve :
Originally posted by @Jerry Poon:

@Joe Villeneuve They do do that. I'm just paying down the loans even further to increase cash flow by lowering payments in the future. It seems like a safe play for now since everyone thinks a downturn is going to happen soon.

 A - Increasing cash flow by using your own money is an illusion.  Before you get a profit from it, you have to catch up to the negative cash you spent to pay down the debt

B - How does a downturn impact your ash flow

A. I agree. But it is a safe option nonetheless.

B. I have not held my properties through a downturn before. I am uncertain of how they will perform in such an event, so paying down debt is hedging my bets.

Originally posted by @Jerry Poon :

A. I agree. But it is a safe option nonetheless.

B. I have not held my properties through a downturn before. I am uncertain of how they will perform in such an event, so paying down debt is hedging my bets.

 A - How is it safer?  From what?

B - How is paying down your debt hedging your bets?  If there is a downturn, do you think the number of buyers goes up or down?  Do you think the number of renters go up or down?  If demand for rentals goes up, do you think rents go up or down?

@Joe Villeneuve

A. Safer than buying on top of the market and being underwater in a loan. The return is significantly lower in what I'm doing though.

B. I understand your logic. Is that what happened in your market? Which market is that?

Originally posted by @Jerry Poon :

@Joe Villeneuve

A. Safer than buying on top of the market and being underwater in a loan. The return is significantly lower in what I'm doing though.

B. I understand your logic. Is that what happened in your market? Which market is that?

 A - If you already bought the property, how are you going underwater, and if you did go underwater, what difference would that make in the cash flow.  This is a a rental property...right?

B - Michigan...but if you buy right from the beginning, the Market is the Market.

@Jerry Poon Hmmmmm...if you have 30 year fixed-rate mortgages I wouldn't pay them down.  Money is "cheap" but if you have a commercial loan that's going to reset in a few years then you can reap the benefits then.  That said, you want to keep enough of a mortgage interest payment where you don't end up getting hit with taxes because depreciation isn't enough to offset the income.  Anyway, all my blah blah blahing aside...

What you can do is juxtapose the amortization tables with and without the prepayments that you're doing.  You'll see how much more is going to mortgage principal vs. mortgage interest when you do a prepaying.  It's not much but it's probably a 4%-5% return.  I did the exercise with a commercial loan that I have and it's nothing to get too excited about :-)  Still, it's better than the bank checking account.

Anyway, another way to skin the cat is to look at RoE (return on equity). But really, at the end of the day, you're going down the "pick a metric" road. I wouldn't worry too much about it. Just because one person looks at CoC and another looks at RoE doesn't make one right and one wrong.

Originally posted by @Andrew Johnson :

@Jerry Poon Hmmmmm...if you have 30 year fixed-rate mortgages I wouldn't pay them down.  Money is "cheap" but if you have a commercial loan that's going to reset in a few years then you can reap the benefits then.  That said, you want to keep enough of a mortgage interest payment where you don't end up getting hit with taxes because depreciation isn't enough to offset the income.  Anyway, all my blah blah blahing aside...

What you can do is juxtapose the amortization tables with and without the prepayments that you're doing.  You'll see how much more is going to mortgage principal vs. mortgage interest when you do a prepaying.  It's not much but it's probably a 4%-5% return.  I did the exercise with a commercial loan that I have and it's nothing to get too excited about :-)  Still, it's better than the bank checking account.

Anyway, another way to skin the cat is to look at RoE (return on equity). But really, at the end of the day, you're going down the "pick a metric" road. I wouldn't worry too much about it. Just because one person looks at CoC and another looks at RoE doesn't make one right and one wrong.

Thanks for the input! They are 15 year loans. Are you saying that paying off these loans might end up costing more, since I will be hit with taxes that I am not paying now due to interest deductions?

Can you go more into the mortgage interest payments? Or at least point me in the right direction on where to read up on that? I am not savvy when it comes to taxes and how to work around them.

the problem is that you're looking at REI as a hobby. if you look at it from a business perspective, I'm sure your strategy will change. reduce expenses, increase revenue.

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@Jerry Poon Right now I think money is "cheap" so 30-year fixed-rate loans are the way to go...if you can get them.  But, basically, you get to write-off mortgage interest and depreciation.  When you start out with the life of the loan you generally have more than enough mortgage interest and depreciation to offset any net income.  That's because in the beginning you have so little of your mortgage payment going towards principal.  Being on a 15 year amortization schedule changes things a little but the overarching principal still holds.  

If you look at your mortgage statement it should say what's going towards principal and what's going towards interest.  Also, if you're not talking to a CPA then you probably should be :-)  

You also have to consider if you have other income sources (like a W2 job).  That determines your marginal tax rate.  If someone is *only* doing real estate investment then they start at the bottom.  If you have (or a spouse has) a cool job making $300K per year those marginal real estate dollars are going to get hammered pretty hard.  

The further you move up the marginal tax bracket the more "valuable" tax-free (or rather, tax-offset) income becomes.  

Don't pay them down/pull out equity as it builds. Either way is preferred to force your cash to earn it's keep.

Cash has too high of a investor value to  allow it to languish away in a property. If you pull it out and reinvest in more properties all th ebetter otherwise there are many other places to put it (incomefunds, REITs etc.) that will generate much higher returnes.

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