What you could do with your equity and what's your long term plan

Question

Most seasoned landlords don't borrow enough. Especially medium size landlords, they sit on a ton of equity, but they self manage and pinch pennies. They get so obsessed with paying down mortgages that this becomes the purpose and we forget we went into real estate for a better life. What's the point if you are 65 and you need 7 more years to pay everything off?

So what are better options? You could sell the property and pay the depreciation recapture. Once you fall below 50% LTV it's really time to look at your return on equity. You could sell a property and pay the capital gains tax and depreciation recapture, but that's IMO not a great solution. It just creates a one time windfall and you have lost a cash flow stream. Maybe a better way is to borrow more, at the very least you should stop using cash flow to pay for capex. Let equity handle capex and use that cash flow for what it was meant in the first place - profit. Careful not to compromise your interest write offs. Another option is of course to 1031 exchange into better assets, but that does not always solve the cash flow and ROE issue.

So what are you guys thinking? Better pay to the taxes and be done with it or something else?

Henry Clark · Answer

OP. My wife and I for the last 5 years have been working with a Financial Planner and addressing several issues. They only cover the Financial Investments for their pay, but we look at our entire portfolio to make our decisions. For the above conversation I would narrow down to a person 50 or older that has a big enough portfolio and have LTV at 50% or lower.

Considerations:

Cash Flow- maintenance, P/I and personal living expenses.

Appreciation- ????

Risk management-????

Estate Planning-???

Taxes- I would disregard. I actually like to pay taxes when selling a property versus 1031, because we can take that money and 4X it in REI. Lot more flexible than 1031.

A. Before even addressing the above, I would Product Prune my investments. See if there are any you want to get rid of.

B. The next step we did was to identify the following: 1. Cash flow for the next X years for personal needs, 2. Mid Term investments, 3. Long Term Appreciation plays

C. Take your assets and then strategize per the above buckets.

D. Cash flow for near term personal. Either live off of cash flow, or Sell (no), refinance and take cash out (no), or take out a working line and never pay off (yes).

E. Working Line will be higher interest rate and floating rate, so it is bad from that standpoint.

F. Refi- since commercial, either say a 5- or 7-year balloon term. SBA 20 and lead bank 10 years 5/5. I would list your loans, balance, balloon terms, rates, etc. Then refit them to B above. If long-term assets you might do the SBA and lock in the loan terms and rates, then forget them. Have them at as low an LTV% as possible, say 10% with SBA. If Mid-term, then lock in with a higher LTV% 50% or better. Since you are planning to either sell/1031 or refi into a long-term asset category. But like always have an asset to roll over into if you go that way.

Personally:

• Our house we paid off. This is probably the worst financial play since lower interest rate and downpayment. But my wife wanted the non-risk. So, it was a great decision.
• We do Country Subdivisions- around 75 acres. Subdivide and develop infrastructure. Then sale just lots, we don't build houses. This is one of our Mid Term investments. Will take 1 to 7 years to sell. Don't build Houses and cashflow this investment. Low Risk.
• Teak Plantation in Belize- Longterm investment. Only cash going in and non coming out for either 10 or 25 years depending on age of trees. Super low risk. Grows with inflation, grows just physically, grows in value due to scarcity- new planting can't keep up with old forest harvesting only about 2% of what is being cut down, Populations who mainly use teak are both growing in population and GDP per person making the wood more valuable. Low Risk.
• Estate Planning- Trust set up and all assets have a designation. Our Son can either grow from our knowledge base or start on a fresh investment strategy.
• Financial Assets- sold 1/2 of our Stock positions a year ago. Low Risk, loss of higher returns. MM, notes and CDs- lower risk/lower return. Losing value due to inflation and also USD debt expansion (printing money). Higher risk/lower return if we stay heavy in this position for 3 to 5 years or longer.
• Another finance play we have done and are actually trying on a new loan. Move your cash types of assets to the bank or lenders company. You might get a lower return rate but then ask for 1% point on your loan. Say you move $100,000 and get 4% at the lender, let's say 1% less than if you were on the open market. But you ask for 1% less on your loan of $400,000. This will help a bank with their Federal Lending limits and more funds to lend out depending on the ratio of your deposits versus your loan. These assets however will be locked in at their bank with no access except going thru them.

Our house we paid off. This is probably the worst financial play since lower interest rate and downpayment. But my wife wanted the non-risk. So, it was a great decision.

We do Country Subdivisions- around 75 acres. Subdivide and develop infrastructure. Then sale just lots, we don't build houses. This is one of our Mid Term investments. Will take 1 to 7 years to sell. Don't build Houses and cashflow this investment. Low Risk.

Teak Plantation in Belize- Longterm investment. Only cash going in and non coming out for either 10 or 25 years depending on age of trees. Super low risk. Grows with inflation, grows just physically, grows in value due to scarcity- new planting can't keep up with old forest harvesting only about 2% of what is being cut down, Populations who mainly use teak are both growing in population and GDP per person making the wood more valuable. Low Risk.

Estate Planning- Trust set up and all assets have a designation. Our Son can either grow from our knowledge base or start on a fresh investment strategy.

Financial Assets- sold 1/2 of our Stock positions a year ago. Low Risk, loss of higher returns. MM, notes and CDs- lower risk/lower return. Losing value due to inflation and also USD debt expansion (printing money). Higher risk/lower return if we stay heavy in this position for 3 to 5 years or longer.

Another finance play we have done and are actually trying on a new loan. Move your cash types of assets to the bank or lenders company. You might get a lower return rate but then ask for 1% point on your loan. Say you move $100,000 and get 4% at the lender, let's say 1% less than if you were on the open market. But you ask for 1% less on your loan of $400,000. This will help a bank with their Federal Lending limits and more funds to lend out depending on the ratio of your deposits versus your loan. These assets however will be locked in at their bank with no access except going thru them.

Major point is at this time of their life and RE Assets, I think you need to strategize from the above standpoints, rather than just an REI strategy.

Marcus Auerbach · Answer

That's a really comprehensive plan and I love how original your strategies are: non of them involve any plumbing (assume you still do self storage?). The one that makes me uneasy is 5 and it's for the reason you mentioned. The outlook for the USD is not great, the gov has an incentive to weaken the exchange rate (which means we loose overseas buying power, all the sudden tariffs may make some sense, WTH!?) keep inflation elevated to melt down with our national debt. We will see if the Fed does another BS 0.25% "rate hike" - that's just pretending to do something about inflation.

Diana Khan · Answer

@Marcus Auerbach, I think you raise a good point about remembering why we invest in real estate in the first place. Paying off properties can provide peace of mind, but I also think it's worth looking at whether the equity could be working better elsewhere. Personally, I wouldn't make that decision based on taxes alone. I'd look at cash flow, borrowing costs, and long-term goals before deciding whether to sell, refinance, or hold.

I'm a real estate attorney and broker based in Maryland, and I've worked with investors and property owners on real estate transactions and contracts. I've seen how important it is to understand the terms and obligations involved before making major changes to property ownership or financing.

I appreciate you starting this discussion, @Marcus Auerbach! It's an interesting perspective on balancing financial growth with the lifestyle investors are working toward. Happy to stay connected!

Denise Supplee · Answer

It really depends on what the owner is trying to accomplish. Having a lot of equity isn't necessarily a problem if the property is producing the return you want and you don't need the money elsewhere. I also wouldn't borrow against a property just because the equity is there. More leverage can improve your return on equity, but it also adds risk and another payment. I'd look at what that equity is actually earning today and what I could reasonably do with the money if I pulled it out. If there's a better use for the capital, then it may be worth considering. If not, there's nothing wrong with having a property that's well paid down and producing cash flow.

Marcus Auerbach · Answer

Agree, low RoE is not necessarily a bad thing if you are satisfied with the cash flow. But you are missing the point: a lot of investors I talk to are using ALL of the cash flow and direct it right back at the business. They don't use the cash flow as profit, but they reinvest it back into the business to pay for large capex items and whatever is left goes towards principal.

If you have multiple units you pay for several roofs, HVAC systems and driveways every year. And whatever is left they apply against outstanding loans, because having to pay off the loans somehow has become the number 1 goal and priority of their life. Meanwhile, the wife wants to go to Italy and soon they will be to old to enjoy a trip - just an example. Cashflow should not pay for capex!

Your assumption is that cash flow equals owners distributions, but from what I see that is often not the case. That's why I am calling it a limited believe. 20 years ago they started buying real estate, because they wanted to afford a better life. But now they have become slaves of their real estate (and by extension the attached loans) instead. I think it warrants revisiting your life priorities: you can keep your LTV at 30% and enjoy the fruits of 20 years of nights and weekends, instead of spending the next 10 years driving that number down to zero. In a way, those are just numbers on a screen and once you get there, you wake up the next morning and your life looks exactly the same it did the day before you paid off your last mortgage.

Nicholas L. · Answer

@Marcus Auerbach

I've been thinking about this a lot lately. With interest rates where they are, high debt LTRs don't yield any cash flow, and low debt LTRs product a pretty low ROE. You can still BRRRR... so it seems like the optimal play is to BRRRR, hold for a while, and then sell before those big capex items hit.

Marcus Auerbach · Answer

Yes, but it does not have to be an either-or decision. You can do AND - if you have a portfolio. Paying down properties into your 70s while you are roughing it is really a limiting believe - and people have a blind spot and can't see it. I have started moving in that direction and it feels wrong, even though I am intentional about it - I have to go back to the math and reassure myself. The psychology of this is surprising.

The nice thing about a portfolio vs owning just one large MF is that you can employ different strategies at the same time. If you have 100 properties, you can cash out refinance 3 every year and still stay below appreciation. You can pay off some properties to take advantage of step up basis. You can consolidate loans on fewer assets. You can sell a couple a year tax optimized.

Eugenia Chetverechenko · Answer

I see this with my tax advisory clients all the time! I feel like sometimes it's partly emotional attachment. After spending decades paying down mortgages, owning properties free and clear becomes the goal.

But for some of my older clients (older than 65 you are referring to), holding onto appreciated properties is actually intentional estate planning. They want to pass them down to their heirs, who can generally benefit from a step-up in basis. With heavily depreciated properties, that can be a pretty compelling tax strategy.

Marcus Auerbach · Answer

Agree, taxes should not drive strategy, that's the tail wagging the dog - but they are certainly part of the considerations, especially on a fully depreciated asset. Most of us here are very cash flow focused and not sure what to do with the equity, which is piling up. What first got me thinking about this are financial advisors who suggest that you should draw 4% from your paper portfolio every year. With expected returns greater than 6% you can basically do this until forever without tapping into the principal. You can actually do this with real estate as well, just keep the refi rate under the portfolios annual projected appreciation, it will not increase your LTV. Most older investors I speak to are still trying to pay off their last properties and when I ask them why they don't have a good answer.

What you could do with your equity and what's your long term plan

What you could do with your equity and what's your long term plan

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