Are we holding a great investment — or a great mortgage attached to an average one?

Question

My partner and I are trying to decide what this LTR should do for us over the next 20 years:

• Age: 44
• Property: 1910 brick bungalow, 4bd/2ba, 2,000 sq ft
• Purchase: $600K in 2016
• Financing: 3.5% fixed; originally financed as a second home due to out-of-state employment
• Current use: LTR/investment property; primary is 1mi south
• Current value: $1.1M
• Debt: $350K
• Gross equity: $750K
• Rent: $4,200/month
• Mortgage + escrow: $3,000/month
• PM: 5%
• Vacancy: essentially zero
• Repairs: minimal
• Current cap rate: mid-3% range
• 1031 experience: several successful exchanges; mechanics aren’t the issue
• Need for current cash flow: none; we’re optimising for long-term total return

Our FA’s shorthand is: bring him a 1031 with a meaningfully better cap rate and stronger overall economics, and he’ll rubber-stamp it.

The wrinkle is that the 3.5% debt may now be the best part of the deal. We suspect much of the easy appreciation is behind us and rents are near a ceiling.

Pure appreciation feels speculative. Midwest fourplexes could improve cash flow and ROE but add work. We’ve also considered investment properties in the Colorado mountains or PNW; either would need to pencil on day one, with geographic optionality as a bonus.

Our goal is total return, reasonable cash flow, low operational burden and optionality — not maximum yield.

At what expected forward return does an irreplaceable 3.5% mortgage stop being a sufficient reason to keep $750K of equity tied to the underlying asset?

We know how to execute the next deal. We’re trying to define what would make the next deal materially better than doing nothing.

Michael Eskenasy · Answer

The 3.5% mortgage is valuable, but I wouldn’t let it become the tail wagging the dog.

You don’t own a 3.5% mortgage. You own a $1.1M asset with $750K of equity trapped inside it.

That distinction matters.

At $4,200 rent, you’re grossing about $50K a year on $1.1M of property. After management, taxes, insurance, maintenance, vacancy and the actual interest expense, the return on today’s equity is probably not especially exciting. The house may have been a fantastic investment from $600K to $1.1M. That does not automatically make it a fantastic investment from $1.1M forward.

I’d run the decision this way:

Hold return = cash flow + principal paydown + realistic appreciation, all measured against the current $750K equity.

Then compare that with:

Replacement return = cash flow + debt amortization + conservative appreciation, minus the economic cost of replacing the 3.5% debt, transaction friction and any additional operational headache.

I would not exchange this property because another deal has a 6% cap instead of a 3.5% cap. Cap rate alone is nowhere near enough.

But if I could move the same $750K into something that I reasonably expected to produce, say, an 8–10% forward total return with comparable risk and manageable operations, while this property looks more like 4–6% going forward, I’d happily give up the mortgage.

That 3.5% note might be worth a couple hundred basis points of advantage.

It is not worth accepting mediocre economics for the next 20 years.

My hurdle would also be fairly high because you don’t need the cash flow and you already own the easy option: do nothing. I’d want the replacement to beat the hold case by at least 2–3 percentage points annually after realistic expenses and friction, not on a broker’s pro forma.

And I’d be very careful with the phrase “we think appreciation is mostly behind us.” Don’t sell because of that thesis. Build three boring forward cases—0%, 2%, and 4% appreciation—and see what happens to ROE.

The question I’d put at the top of the spreadsheet is:

If I had $750K in cash today, would I put it into this bungalow at $1.1M simply because someone offered me 3.5% financing on $350K of it?

If the answer is no, you’ve learned something.

Cheap debt can make a good investment better.

It cannot make an average investment great.

Dan Handford · Answer

Chrissy, I would treat the low-rate mortgage as one component of the hold case, not the decision itself. Build a forward return on today's equity using realistic cash flow, principal reduction, capital expenditures, and conservative appreciation. Then compare it with a replacement after transaction costs, new financing, reserves, and the additional operating burden. Because doing nothing is a viable option, the replacement should clear a meaningful margin rather than merely showing a higher cap rate. Have you calculated the current property's expected five-year return on the roughly $750,000 of equity using zero appreciation as the base case?

Joe Piccirello · Answer

One financing angle worth pricing before you decide: a cash-out refinance on the existing property is not the only way to access equity, and it would cost you the 3.5% note. Compare that against a HELOC or second lien behind the existing first, which leaves the low first mortgage intact and only prices the new money. Run the blended cost of the first plus the second against what a full refinance at today's rates would cost you across the whole $350K plus whatever you pull out. Also note the loan was originated as a second home and is now a rental, so if you refinance the new loan gets underwritten as an investment property, which usually carries different pricing and LTV limits than what you have today. If you do go the 1031 route into a rental, financing on the replacement can be conventional investment or DSCR, where the loan is qualified off the property's cash flow rather than personal income, and a mid-3% cap rate asset will typically not carry a DSCR loan without meaningful money down. I'm a loan officer licensed in Colorado.

Joseph Zimmerman · Answer

I track equity per property in my custom P&L for exactly this question. On your numbers, the $750,000 is earning about 2%. Rent of $4,200 against $3,000 of mortgage and escrow leaves $1,200, less the 5% management, so roughly $1,000 a month before a repair and CapEx line on a 1910 house. Add the principal paydown and you're still in the low single digits on $750,000.

The 3.5% saves about $12,000 a year against a market rate on a $350,000 balance. So the cheap debt is worth $12,000 while the equity behind it earns 2%.

Stacy Raskin · Answer

Sure, you're welcome, Chrissy. I think having a tremendous amount of equity and a low rate in a metro market is an incredible asset. Having worked with investors for decades, rental properties in general, have rents and appreciation that go up- it varies by the market- that is the general trend. It really depends on what opportunities you are looking at as far as what might make sense- you are in a strong position.

Chrissy C. · Answer

Thanks so much, Stacy — I really appreciate the thoughtful response. I think you’ve captured exactly why this is hard: we know the current setup is strong, and the 3.5% debt is a big reason we’re reluctant to touch it.

The real question for us is less, “Was this a good investment?” and more, “Is this still the best place for $750K of equity?”

The HELOC idea is interesting because it preserves the first mortgage, but at today’s rates we’d want a very compelling spread to justify the added leverage.

I think it ultimately comes down to forward ROE: what should this property realistically earn from here, and how much better would another opportunity need to be before giving up the cheap debt makes sense?

Stacy Raskin · Answer

Perhaps getting a HELOC can help you get some cash out for other investments? To meet your goals, you probably know by now if you are reaching them since you have had the investment since 2016 regarding reasonable cash flow, low operational burden and optionality.

You bought before the huge appreciation wave that accelerated in 2020 during Covid times and you have a low rate. My brother lives in Denver and he bought in 2019 and has a similar rate. The difference is that he lives in his home and yours is a rental making cash monthly while it appreciates. Real estate in the long term especially because of being able to make money through both appreciation and actual monthly cash flow while buying with leverage is a pretty amazing combination for wealth building. Especially if your repairs are minimal and vacancy is essentially zero as you mentioned. You know best if meeting your long term goals. Objectively, you seems to be in a strong position especially considering what the landscape is now with rates and how that impacts cash flow. Unless you were going to take the cash and buy multiple properties in a less expensive market that would be an option but that would require more management or having someone else manage if you don't want to manage yourself.

Are we holding a great investment — or a great mortgage attached to an average one?

Are we holding a great investment — or a great mortgage attached to an average one?

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