Recently, I was at a breakfast with an investor buddy, and I was telling him that I was thinking about paying off my properties, as I’m starting to get closer in age to retirement.
Those of you who know me know that for most of my life I’ve been more of a leverage type of guy, who was always looking to keep the equity in my properties working, especially as long as I had earned income. I’ve always been in what I call “accumulation mode,” but lately I’ve been in more of a “preservation mode,” or in other words, thinking about simplifying my life.
At least, that’s what I thought I was going to do until I ran into my buddy.
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The Great Debate
I’m not talking about the Democratic or Republican debates, but rather the big debate on BiggerPockets: to pay down your mortgage debt or to utilize more leverage.
In the past, I was never really afraid of debt, and I was willing to go after a lot of residential and commercial real estate before I ventured into note funds.
Lately, I’ve been thinking about things like gaining more peace of mind. But as my buddy pointed out, “Do we ever really own our properties?”
He was then referring to some folks we both knew who had lived in an adjacent town where we grew up. Their houses were condemned in order to expand the Philly airport (72 homes to be exact).
It made me think back to when I was a young kid and my parents sold the home that they had built because Interstate 95, which connects Florida to Maine, was being built literally three doors away, at the end of our street.
My friend then mentioned that our neighbors over in the next town who got bought out probably would’ve been paid more money by the government if they had bigger mortgages on their properties, especially since real estate values had been down since the economic downturn.
He was right. I’m not sure we ever own our houses; we just think that we do. Try not paying your taxes, and you’ll quickly learn who really owns your property.
He then proceeded to point out the huge opportunity cost and amount of liquidity I’d have lost by paying down the debt. Not only would I lose the write-offs from the mortgage interest, I’d be using my hard-earned money or cash flow from my tenants to pay them down, when I could have been using that money to invest in more real estate or something more liquid, like notes.
He said that one of the worst things was when people like us who get older sell off their properties in retirement, pay a lot of taxes (especially capital gains and depreciation recapture tax), and then pass on, leaving whatever was left of their estate to their heirs. It was then that he pointed out the insurance option.
Life Insurance Options
He went on to say that a better option may be to keep his cash and his cash flow from his properties and put some of that money into insurance contracts instead. This way, he has peace of mind that upon his death, his heirs would have more options. Besides, they would be able to inherit his real estate with a stepped-up basis (meaning they’d be starting off with the current market value, thus avoiding capital gains taxes if they decided to sell his properties after he passed).
If he needs money, he can always borrow it out, and if he leaves his heirs a few million dollars from insurance, they can either pay off the real estate, keep the real estate “as is” and keep the insurance money, or they can sell the properties and keep the insurance money.
Now, that’s what I call using leverage in a smart and strategic way. To be honest, this concept sounds pretty good to me, especially if it gives me the freedom to do what I want now, instead of living some frugal lifestyle while paying things down.
Related: Used Wisely, Debt Can Absolutely Produce Wealth: Here’s How
After all, who cares when you pay down good debt in this scenario?
If I keep my cash and keep re-tapping the equity in my properties, I can buy some performing notes and put some money into private money deals (similar to hard money). I do love the diversification of notes and mortgages that are backed by real estate and the fact that I can sell my notes very quickly for cash, or to pay off a property at any time, if I do decide to go that route someday.
As you can see, I’m starting to rethink what I’m going to do. Maybe more leverage isn’t so bad, with plenty of insurance, more total assets, more cash flow, more liquidity, and a lot more options.
So, what do you think my strategy should be this New Year?
Let me know your thoughts with a comment!