Applying the Debt Snowball To RE?

[Jon Bon]

So disclaimer some of this is emotion talking, I realize leverage the advantages of the leverage but sometimes it feels like too much leverage.

So I have a small rental portfolio. I manage them all myself. They provide a a awesome side income with very little work. I am feeling like I have "enough" I could buy more, hire management, and just get really rich. But I dont think that I want that.  This is my issue. All these houses have large (to me) loans on them. I think I have about 40-45% average equity which is great, but that also means I have 55-60% debt.

Has anyone applied the debt snowball to their RE portfolio? They throw off a good amount of cash every month. And in the past I have plowed that all back into acquiring more properties. Now that I have 'enough' What about paying down some principal?

Maybe a 50/50 split between investing in boring mutual funds and paying down debt? Has anyone done this? What would you do with a large loan(s) amount and large net worth. Selling a property is an option but comes with a butload of tax.

The smallest loan is ~130 probably could knock out in 3 years, or ~5 years if I did a 50/50 debt pay down/stock market

[bearman]

I've struggled with the exact same question. Where I landed is to make sure everything is 30-yr fixed, and keep 10%+ of the total debt amount in high interest savings. That's basically psychological comfort, reserves for major economic problem, etc. I've concluded making extra payments on debt isn't worth it, because that money has an ROI of zero, functionally speaking, until the balance is paid off, plus you have less liquidity. So I plan to pay off a mortgage all at once, when the reserve in savings is too big (and there's no where better for it).

[Jon Bon]

I mean does kind of feel like the same situation that many folks on here face. When is it enough?

I am thinking about it like I am a tech company, I've done my growth and massive stock price increase, now its time to pay a dividend. There are other projects I could invest in, but maybe only pursue 1/2 of what I would go after before.

I am refinancing the primary residence first and going after that I think. I gotta live somewhere after all. Ill probably pile up cash for a year, and invest about half. Then decide what to do with the other half depending on where the economy is.

[kenmoremmm]

while i don't have the RE portfolio you do, i would certainly debt snowball, especially as we are seemingly at the end of a bull run and vacancies become more likely when unemployment increases.

paying off the mortgages, on schedule, does nothing to reduce your cash outlay each month. if you save the money in cash (high yield savings) and then do a single lump sum to pay off the lowest balance mortgage, you free up that P&I payment. no brainer to me.

i think the guy investfourmore did this years ago. he had a blog. other bloggers have done this. i think it's a matter of risk tolerance (see DPOYM and POYM threads). to me, save cash (= safe, but not spectacular), then kill the debt seems pretty ideal.

[sammybiker]

@Jon Bon  I think about the same and worked out a snowball spreadsheet to organize the order of the payoffs to achieve timely release of debt.

Still not sure what I'll do.  Right now, not doing much, just hoarding cash.  But 100% paid off with unused lines of credit attached to some of the portfolio to quickly grab once a year opportunities sounds ideal right now. My debt level is a little higher than yours, probably closer to 70% and coming from a paid off background, it doesn't feel comfortable, no matter what the calculators/bloggers say.

[feelingroovy]

You may want to think of this as two separate questions.

1. If I have enough rentals, should I start paying them off to reduce leverage?

2. If so, is a snowball approach the best one?

For #1 I would say this gets closer to a sure yes the closer you are to your FI goals. Does enough mean that you are FI from the current cash flow? Then hell, yes. It's time to deleverage and serial.

If you are still far from FI, then do some math. Would paying off mortgages or investing in index funds get you there faster?

I guess all that comes down to: if you don't need to build more wealth then yes, switch to wealth preservation.

As for question 2, how high are your interest rates? If they are high, a snowball could make sense. But that would make me nervous to have a mortgage partly paid down for 3 years in case SHTF during those three years.

So I think I would go with an approach mentioned by other posters. Fill up a savings account until you can pay one off in one fell swoop. The lower the interest rates, the less of an interest hit this takes.

Also could you mitigate your risk by refinancing one house to pay off others? I haven't thought this through but is it better to have the same amount of total debt but concentrated on fewer houses?

[SeattleCPA]

This doesn't really directly address your question, but more and more I find myself thinking that a reasonable asset allocation formula for younger investors may be to allocate a big chunk to direct real estate investment, a big chunk to equities, and then a chunk to bonds.

To build on David Swensen's asset allocation formula which allocates 30% to real assets and 30% to riskless assets and is shown below:
US stocks 30%
Developed international 15%
Emerging markets international 10%
REITs 15%
Intermediate term treasuries 15%
TIPs 15%

Perhaps what someone decides to do looks like this:
Intermediate term treasuries 30%
US stocks 25%
Developed international 10%
Emerging markets international 5%
Direct real estate investment 30%

Caution: One would want to be very smart about the real estate and very careful. Losts of unsystematic risk with real estate in a single local market. Ugh.

And then reconnecting to the point of this thread, if you start thinking about direct real estate as a component in your overall portfolio, you would not just keep leveraging up. Rather you would at some point, deleverage just to maintain your desired asset allocation formula.

[Jon Bon]

Yes we are pretty close to fire. However I'd probably like to have a house or 2 paid off before we go that direction.

I have been listening to some Dave Ramesy lately, I think he has some good points but I am not nearly as extreme as he is. Mainly I just have built the portfolio that I wanted to have. Now that I have it I am not sure what in fact is next.

I do like they idea of saving up maybe six figures or so in cash before deciding on anything. Worst case is I keep making my payments and have 100k to invest is something else. Now that there is no benefit to mortgage debt I might pay off my primary residence first. Now that I am cash flowing better, and no longer saving "for the next one" it is making me think about what is next. Some of my loans are also with in 2-3 years of me being able to pay them off sort of a striking distance if you will. Something that I could not achieve before when I was making less.

[former player]

The whole point of FIRE is recognising when you have enough, rather than mindlessly accumulating.  If your property portfolio has reached the point at which you are most happy with it, then of course you should stop there.

I'm risk averse and so my inclination would always be to pay off debt: paid-off property is a level of security in uncertain times that not much else can match.  My grandparents survived the Great Depression with 4 children mostly because they had a few paid-off, very basic (later demolished) rental homes.  Because they were paid off it didn't matter that the rents coming in were low and getting lower through the depression.  The potential problems are if environmental conditions turn against you (flood, coastal erosion, earthquake, forest fire, drought severe enough to limit drinking water supplies) or the area massively depopulates.  You should be able to tell whether any of those are a likely risk for you.

In your case, I think you should start by looking at your overall picture.  You don't say what proportion of your wealth is in property and what is in equities/bonds/pensions/social security.  If you look at the balance of your whole asset picture then you will get an idea of where to put further investment: do you think you are overinvested in any one area or underinvested in another?  But on the whole I would certainly put at least some money into paying off the property debt, the only question I think is whether you should be sending some to other investments as well, and I like kenmoremm's idea of the debt snowball.

[macmoneysaver]

From my perspective, the answer to your question is "yes," use the snowball.  If you are content with the degree of rental investments, then snowball them.

While the "avalanche" approach (pay off higher interest first) makes more sense mathematically, the snowball approach offers more flexibility/options.  If you try to avalanche and are strapped for cash when a big expense pops up, you need to find another approach.  If you snowball, as the lower limit items get paid off, you can back off on the extra principal you pay down if you get in a pinch.  It also offers emotional peace of mind (which I believe is why you are asking).

If you think the previous paragraph is bunk, then avalanche it.  Either approach is good IF paying off the mortgage is your strategic vector.

Take care, and I wish you the best.

[Jon Bon]

Thanks for the replies everyone. Any anyone refinanced an investment property lately? What kind of rate were you getting?

I think I am going to save up a low six figure amount in investments. Then decided what to do with it then. My primary residence and 1 rental have a relatively low balance so I will probably attack on of them. All the rates are pretty good ~4.5 so I am not in a hurry to attack the debt. Hey look its almost the first of them month! *Goes and waits by the mailbox like a puppy*

With no tax implication on mortgage interest is makes even less sense to have a mortgage on my house. If I can get my rentals to cover my living expenses that't pretty gravy. That would make retirement accounts/ appreciation/ etc a nice back up for when I reach traditional retirement age.

[Car Jack]

While the "avalanche" approach (pay off higher interest first) makes more sense mathematically, the snowball approach offers more flexibility/options.  If you try to avalanche and are strapped for cash when a big expense pops up, you need to find another approach.  If you snowball, as the lower limit items get paid off, you can back off on the extra principal you pay down if you get in a pinch.  It also offers emotional peace of mind (which I believe is why you are asking).

I don't agree.  With either snowball or avalanche, if the OP has an extra $1000, he can apply it to a 2% loan of $15,000 or a 10% loan of $100,000.  He doesn't clear either loan but by putting the money towards the 10% loan, he saves more in interest.

I do agree with the emotional part.  For people who need financial attaboys of clearing a loan, snowball does that faster.

[SwordGuy]

While the "avalanche" approach (pay off higher interest first) makes more sense mathematically, the snowball approach offers more flexibility/options.  If you try to avalanche and are strapped for cash when a big expense pops up, you need to find another approach.  If you snowball, as the lower limit items get paid off, you can back off on the extra principal you pay down if you get in a pinch.  It also offers emotional peace of mind (which I believe is why you are asking).

I don't agree.  With either snowball or avalanche, if the OP has an extra $1000, he can apply it to a 2% loan of $15,000 or a 10% loan of $100,000.  He doesn't clear either loan but by putting the money towards the 10% loan, he saves more in interest.

I do agree with the emotional part.  For people who need financial attaboys of clearing a loan, snowball does that faster.

And they'll only be $14,000 away from that benefit instead of $99,000 away.    So it's still true.

Sometimes it makes a real money difference because the interest rates are so very different.   But if some debts are fairly small and will be gone within a year, it often doesn't make that much difference.    Some years ago I would take different scenarios people would present and math test them.  I'm know it's possible to get a different result given the "correct" set of debt amounts and interest rates, but every time I tested the real-life scenarios presented it only made a few months' difference in final payment date.   In other words, the debtor got years of less monthly stress to make ends meet for two to three months more payments.    Depending on one's situation that might be a great trade.

 

[macmoneysaver]

While the "avalanche" approach (pay off higher interest first) makes more sense mathematically, the snowball approach offers more flexibility/options.  If you try to avalanche and are strapped for cash when a big expense pops up, you need to find another approach.  If you snowball, as the lower limit items get paid off, you can back off on the extra principal you pay down if you get in a pinch.  It also offers emotional peace of mind (which I believe is why you are asking).

I don't agree.  With either snowball or avalanche, if the OP has an extra $1000, he can apply it to a 2% loan of $15,000 or a 10% loan of $100,000.  He doesn't clear either loan but by putting the money towards the 10% loan, he saves more in interest.

I do agree with the emotional part.  For people who need financial attaboys of clearing a loan, snowball does that faster.

And they'll only be $14,000 away from that benefit instead of $99,000 away.    So it's still true.

Sometimes it makes a real money difference because the interest rates are so very different.   But if some debts are fairly small and will be gone within a year, it often doesn't make that much difference.    Some years ago I would take different scenarios people would present and math test them.  I'm know it's possible to get a different result given the "correct" set of debt amounts and interest rates, but every time I tested the real-life scenarios presented it only made a few months' difference in final payment date.   In other words, the debtor got years of less monthly stress to make ends meet for two to three months more payments.    Depending on one's situation that might be a great trade.

 

I agree about the lowered stress.  But there is an additional factor that people never discuss.  As you pay off the lower balance loans, you actually increase your cash flow.  So when bad stuff happens, you have more freedom and flexibility to pay that $500 to fix you car rather than take on another loan.  So you have the ability to stay even rather than falling backward.

In the end, debt snowball, debt avalanche, or saving up cash to pay it all off are all good options.  It is whatever you feel is right for you.  Taking substantive, positive action is much more important than the method used.