If asked when it makes sense to pay off my properties, my answer during most of my investing career would have been never.
I do understand that people have different investing strategies, levels of risk tolerance, and goals — especially at different stages in their lifetime. For me, up until recently, my strategy has been one of leverage and reserves.
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Leverage, Cash Flow, and Reserves
If you own $3 million in real estate and have $2 million in debt against your portfolio, with $2 million in accessible reserves in another more liquid investment, then what’s the difference if the real estate was paid off or not?
For me, I would have lost hundreds of thousands of dollars if I hadn’t tapped into the equity I had built in my portfolio. At one point, I had acquired 11 lines of credit on my SFRs and apartments, which I was able to borrow against at 3-5%. Then, I lent that money out to fellow rehabbers at 15-18%.
People say you want your money working as hard as you do, but I wanted my equity working that hard, too.
From an asset protection and accounting point of view, it may make more sense to keep the real estate leveraged with debt (especially if any of your properties are in your own name) and to keep pulling the cash out of the real estate (in other words, sweeping the account). Then you could put the cash into safer, more liquid buckets, such as retirement vehicles, insurance contracts, or even other asset classes. For example, notes, private lending, and tax liens could all be a viable investing alternatives. You can also write off the mortgage interest while your tenants continue to pay on the debt on your behalf.
Two Deals Instead of One
Often, I encounter real estate investors who want to use their money or their lines of credit to finance their acquisitions and rehabs. For a period of time, that’s what I did too — at least, until I had a better comfort level and more experience under my belt.
Today, instead of using my own money for real estate deals, I use other people’s money (OPM). Then, I use my money for other things like hard money deals and notes. For example, I can even borrow money out of insurance contracts to invest in note deals that pay a higher yield than the loan rate. Now, if you think about it, I’m doing two investment deals at once instead of one. Anytime I can use someone else’s capital to build wealth in a safe way, I will.
As for cash flow, I’ve always valued it more than equity. Over the years, I’ve seen equity rise and fall and even go away, but cash flow is the saving grace when this occurs.
When it comes to paying things off, I just figured my life insurance could take care of that if it’s something my heirs decide to do after I’m gone. That was my viewpoint up until now, but sometimes things change.
Financing Constantly Changing
For many people, paying down their properties can psychologically feel good, bringing peace of mind.
As I’m approaching retirement, I’m starting to reconsider some of my strategy. Would it be so bad to have some properties paid off in retirement? Maybe my heirs really don’t want my properties, and some now live out of state. It’s not like they want to help me take care of them.
Much of the change in my viewpoint is due to financing. Banks just don’t want to let me refinance too much unless I go commercial, and some of the terms are pretty crappy, with me taking on way too much risk. Some of my properties have higher rates from before the downturn, and things like property taxes and flood insurance have been starting to skyrocket. Township rental licenses and inspections, along with everyday maintenance, have been taking a real bite out of the amount of cash flow I get.
So, if you have money on the sidelines, maybe it’s time to work on paying some mortgages off.
Did I really just say that?
[Editor’s Note: We are republishing this article to help out our newer members.]
What would you do if you were me, continue to re- leverage or start to consolidate and pay things down?
Be sure to leave a comment below!