Author Topic: rental properties: paid off or mortgage?  (Read 2363 times)

kenmoremmm

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rental properties: paid off or mortgage?
« on: May 09, 2018, 10:45:47 AM »
i have one fully paid off rental property and will have about $170k in proceeds from a recent sale of another rental property. i'm planning to dump the $170k back into the rental market, but somewhere that i can cash flow.

would you rather:
1. have 1 paid off property and purchase 6 $100k properties with $25k down each; or
2. have 3 paid off properties and have zero leverage?

i'm leaning towards 2 for several reasons:
a. i'm leery of leverage even though i understand its advantages
b. life circumstances have reduced our income due to starting a family and a stay at home parent, so more cash flow and less risk is appealing
c. interest rates have crept up, so leveraging is much less ideal than a few years ago; meanwhile, i don't think market prices have fully adjusted to the new rate environment.

Fishingmn

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Re: rental properties: paid off or mortgage?
« Reply #1 on: May 09, 2018, 11:05:41 AM »
If you are a real estate "investor" the correct answer is to almost always use leverage.

That said, there are many reasons to choose option 2 -

- It's hard to find good investment targets right now in such a hot market. Your best bet with $170k using leverage is to probably look at multi-family. This is especially true if you plan on using a 1031 Exchange to avoid taxes.
- You are risk averse as you mention and are willing to take less return
- You have less willingness to manage a larger portfolio of units/doors. Having fewer paid off places means it's easier to self manage which also means you are more likely to get better tenants and less vacancy than a PM would.
- It fits better with your lifestyle and goals

Personally, my places are all paid off and that suits our needs just fine as the income coming in provides 70% of our retirement needs.

kenmoremmm

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Re: rental properties: paid off or mortgage?
« Reply #2 on: May 09, 2018, 11:18:31 AM »
i looked at a 1031, but it only saves $35k in taxes and would require a purchase price of almost $400k based on the sale of my existing property. so, i would need a $200k loan, which doesn't appeal to me.

unfortunately, wherever we buy, it won't be personally managed. we'll need to hire a PM firm. we live in the seattle area, and the market is nuts. the 1% rule is more like the .3% rule here.

MaikoTsumi

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Re: rental properties: paid off or mortgage?
« Reply #3 on: May 09, 2018, 11:27:28 AM »
Option 3: Cash out refinance paid off rental and add even more to your portfolio.

LightStache

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Re: rental properties: paid off or mortgage?
« Reply #4 on: May 09, 2018, 09:11:53 PM »
You should consider total return on your equity for any investment, incl. a SFR or MFR. When you don't leverage RE, total returns tend to be poor in comparison to lower-risk alternatives. A SFR is especially risky due to concentration, liquidity, and legal risks. But I'm not suggesting you lever up -- just also consider a portfolio of REITs and fixed income instruments to similar effect at lower risk.

midwesterner1982

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Re: rental properties: paid off or mortgage?
« Reply #5 on: May 13, 2018, 03:46:44 AM »
Congrats on the rental success.  I agree with Maiko, lever up.  If you're not using leverage then rental properties are probably not the best use of your investment capital.
Consider this scenario:
$100,000 property, you put down $25k, bank $75k.  The property appreciates to $125,000 and while the bank's equity is capped, your equity doubles.  Why take the risk of owning property while giving up the opportunity for a big win like this?
If you need to avoid a mortgage in order to gain cash flow, then that's a sign the property isn't a good fit for a cash flow strategy and you should consider other markets for that strategy.

kenmoremmm

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Re: rental properties: paid off or mortgage?
« Reply #6 on: May 14, 2018, 10:18:09 AM »
i see it like this: if i finance and get $100-200 cash flow, fine. if i buy in cash, and get $800 cash flow with zero risk of having to foot the bill in the event of vacancies, that sounds pretty good to me.

i already have one fully paid off rental. planning to buy a 2nd in cash. then, with leftover cash, i might get a leveraged one. i think this would be a good blend of risk for my spot in life (single income, SAHM with a 20 month old and another likely on the way)

plus, as has been stated in many threads on BP and MMM, cash flow is the target, not appreciation. so, leverage + appreciation doesn't seem to fit the general narrative of buy and hold properties. i get what you're saying and have benefited greatly from leverage on the property i just sold (0 down, basically more-than-doubled in price). but, i don't think i care about property value since the goal is to take to the grave and pass on.

cloudsail

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Re: rental properties: paid off or mortgage?
« Reply #7 on: June 04, 2018, 09:41:50 AM »
OP, I'm of the same line of thinking. I totally understand that if you don't use leverage, investment in real estate does not generate the returns that it should. But I don't design our portfolio to maximize return. I design it be as foolproof as possible, with multiple sources of income. Having paid off rental properties is an important part of our retirement plan, despite it being frowned upon by almost every single real estate investor I know (though Paula of AffordAnything has the same mindset). I think each family's situation is different, and while you should understand the math behind the returns analysis, ultimately what you decide is best for your family doesn't have to be dictated by returns alone.

BTW, I am also in Seattle :) We are in the process of purchasing a second rental property in Lacey that we plan to pay off before we retire (assuming it turns out to be the nice steady rental property that we hope).

Nate79

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Re: rental properties: paid off or mortgage?
« Reply #8 on: June 04, 2018, 01:46:07 PM »
OP, I'm of the same line of thinking. I totally understand that if you don't use leverage, investment in real estate does not generate the returns that it should. But I don't design our portfolio to maximize return. I design it be as foolproof as possible, with multiple sources of income. Having paid off rental properties is an important part of our retirement plan, despite it being frowned upon by almost every single real estate investor I know (though Paula of AffordAnything has the same mindset). I think each family's situation is different, and while you should understand the math behind the returns analysis, ultimately what you decide is best for your family doesn't have to be dictated by returns alone.

BTW, I am also in Seattle :) We are in the process of purchasing a second rental property in Lacey that we plan to pay off before we retire (assuming it turns out to be the nice steady rental property that we hope).
Yup. Leveraged real estate is certainly the "in" thing these days. Anyone who doesn't believe in leveraging up to the max is called stupid and unsophisticated. Leverage = risk. Higher risk and higher reward go hand in hand. It's all peaches and cream until the next major market downturn wipes out all the leveraged investors.

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midwesterner1982

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Re: rental properties: paid off or mortgage?
« Reply #9 on: June 05, 2018, 04:11:24 AM »
Interesting discussion.  I guess it boils down to that risk vs return scenario that every investor needs to think about and build into their plan.  I'm gathering that those who were exposed to the last market downturn may have a different mindset on this.  I'll revisit this each year or so but for now I'm more interested in maximizing returns.  My area I think will always have renters so I need to maintain a cashflow cushion to leave room to reduce rents in a market downturn.  Their is a growing supply of units so I also need to watch that supply vs demand.
As an aside, those of you who are holding a lot of equity in your rentals may want to review your liability exposure.  If you haven't already it might be a good idea to increase liability coverage.  I recently increased liability coverage from $300k to $1M per property for about $2/mo.  You can also add an umbrella policy.  It's a cheap way to add extra protection, in my opinion.  Good luck to all of you in your investing!