Author Topic: Pay off rentals early?  (Read 3558 times)

FrugalSaver

  • Pencil Stache
  • ****
  • Posts: 758
Pay off rentals early?
« on: December 28, 2016, 01:23:19 AM »
I'm fairly new to rental properties and welcome any advice on these options.

I also was curious about pros / cons of paying off these properties early.

I'm considering 3 main options in no particular order:

1) pay them out over 30 years

2) take 100% of profits from monthly rents to pay down the note as quickly as possible (typically that would reduce the layoff period to 7-9 years from date of the loan inception)

3) pay 100% of profits against the note PLUS additional funds in order to pay off the note even sooner.

Other than the obvious benefit of paying less money in interest, are there other reasons or tax benefits to not pay them down quicker?  Is there a reason option 2 would be preferred over option 3 or vice Versa? 

The other obvious benefit is leverage and gathering more rentals into the portfolio so there's certainly pros / cons but beyond that pro id like to learn more about the other tax advantages and how paying early may affect depreciation and if that's a negative, etc.

K-ice

  • Pencil Stache
  • ****
  • Posts: 961
  • Location: Canada
Re: Pay off rentals early?
« Reply #1 on: December 28, 2016, 01:44:52 AM »
Historically, mathamatically #1 is the best as long as you invest the money you would have used in 2 & 3 into ETF etc.

So I think it becomes more of a question of your investing character.

Are you just a "frugal saver" or also a "frugal investor"

If you are a regular knowledgeable investor do 1. If you let your savings stock pile in a savings account do 2 or 3.

If you blow most of your extra cash on consumer goods, which I doubt, definitely do 3.

I know some very successful real-estate investors, who don't touch stocks, who do 3.

If you do value paying off the mortgage be sure to prioritize paying the home you live in before rental properties.  You can remortgage your paid off home later to leverage commercial properties but borrowing at the lower residential mortgage rate.

In Canada there is a tax benifit only on rental property mortgages, as you can deduct the interest.



marty998

  • Walrus Stache
  • *******
  • Posts: 7039
  • Location: Sydney, Oz
Re: Pay off rentals early?
« Reply #2 on: December 28, 2016, 02:33:35 AM »
Use the money from #1 to buy more properties.

Why stop at 1?

FrugalSaver

  • Pencil Stache
  • ****
  • Posts: 758
Re: Pay off rentals early?
« Reply #3 on: December 28, 2016, 07:55:16 AM »
Is there a way to move this to the real estate sub forum?

Crazycarl

  • 5 O'Clock Shadow
  • *
  • Posts: 47
Re: Pay off rentals early?
« Reply #4 on: December 28, 2016, 09:16:21 AM »
Is this property held by you? or in an LLC or S-corp? What is the rate of the note?

I have 3 properties, 2 are paid off, 1 is halfway as I took over the payments/assumed the note when I bought it. That rate is at 5.5% and all are owned by my S- Corp. I get some depreciation help during tax season, but if I sell to soon, then I think I have to pay that back or something depending on capital gains of the sale.

I think it really depends on if you want more properties, how active you are with them and the condition / location of them.

If your property is in a good location with good tenants and the rate is relatively low, then I would hold off and buy more or invest the money elsewhere. If the property is in much lower class and may have problems with tenants, then pay off asap in case you have trouble renting out later. The less fixed costs you have, the easier it is to ride out bad situations that may arise.

The net rental income will just fall to your normal income in either situation. FYI - I am not a CPA and have only owned my properties for about 3 years. So hopefully someone else can add on.

FrugalSaver

  • Pencil Stache
  • ****
  • Posts: 758
Re: Pay off rentals early?
« Reply #5 on: December 28, 2016, 08:06:07 PM »
Is this property held by you? or in an LLC or S-corp? What is the rate of the note?

I have 3 properties, 2 are paid off, 1 is halfway as I took over the payments/assumed the note when I bought it. That rate is at 5.5% and all are owned by my S- Corp. I get some depreciation help during tax season, but if I sell to soon, then I think I have to pay that back or something depending on capital gains of the sale.

I think it really depends on if you want more properties, how active you are with them and the condition / location of them.

If your property is in a good location with good tenants and the rate is relatively low, then I would hold off and buy more or invest the money elsewhere. If the property is in much lower class and may have problems with tenants, then pay off asap in case you have trouble renting out later. The less fixed costs you have, the easier it is to ride out bad situations that may arise.

The net rental income will just fall to your normal income in either situation. FYI - I am not a CPA and have only owned my properties for about 3 years. So hopefully someone else can add on.

Thx for the thoughts. I welcome any others to join in if they have a perspective.

powskier

  • Bristles
  • ***
  • Posts: 381
Re: Pay off rentals early?
« Reply #6 on: December 29, 2016, 12:00:38 AM »
1) Put aside a solid reserve of cash for unexpected major expenses on property or prolonged unexpected vacancy.

THIS IS VERY IMPORTANT.

Drifterrider

  • Handlebar Stache
  • *****
  • Posts: 1118
Re: Pay off rentals early?
« Reply #7 on: December 29, 2016, 08:31:50 AM »
1) Put aside a solid reserve of cash for unexpected major expenses on property or prolonged unexpected vacancy.

THIS IS VERY IMPORTANT.

+ 1M

If your goal is to own real estate, pay off as quickly as possible (after making sure to keep a cash reserve.  HVACs are expensive and unlike roofs, don't usually slowly show their age: they just break).

If your goal is to cash flow monthly, pay according to the mortgage.

Another Reader

  • Walrus Stache
  • *******
  • Posts: 5217
Re: Pay off rentals early?
« Reply #8 on: December 29, 2016, 08:48:02 AM »
There is no effect on depreciation for income tax purposes.  Interest is deductible as an expense.

As long as leverage is positive, it generally makes sense to keep the mortgage.  If leverage is negative, sell the property, refinance to a more favorable interest rate, or pay the mortgage off.  If the free and clear cap rate, using realistic expenses (usually around 50 percent of gross income) is not acceptable, sell the property.

Cash reserves are critical because of vacancy, repairs, and capital improvements that can come up suddenly.  A/C units and roofs are good examples.

Acquisitions must make sense and you must be able to sustain your reserves when you acquire them.  Right now, in my markets, nothing makes sense.

Drifterrider

  • Handlebar Stache
  • *****
  • Posts: 1118
Re: Pay off rentals early?
« Reply #9 on: December 29, 2016, 09:50:09 AM »
Another Reader, where is your market?

fishnfool

  • Bristles
  • ***
  • Posts: 350
Re: Pay off rentals early?
« Reply #10 on: December 29, 2016, 10:34:26 AM »
I'm in the pay off early camp and keeping 3 to 6 months worth of mortgage payments in a reserve account for vacancies and or repairs.

Another Reader

  • Walrus Stache
  • *******
  • Posts: 5217
Re: Pay off rentals early?
« Reply #11 on: December 29, 2016, 04:26:57 PM »
Another Reader, where is your market?

Arizona.  And California, where it never makes sense.

Drifterrider

  • Handlebar Stache
  • *****
  • Posts: 1118
Re: Pay off rentals early?
« Reply #12 on: December 30, 2016, 05:43:05 AM »
OK, was just wondering.  Mine is NC where houses can be had for under $50K (yes, they are habitable too).

FrugalSaver

  • Pencil Stache
  • ****
  • Posts: 758
Re: Pay off rentals early?
« Reply #13 on: January 03, 2017, 10:51:33 PM »
Thanks for the thoughts everyone.

Landlady

  • Bristles
  • ***
  • Posts: 251
  • Location: WA
Re: Pay off rentals early?
« Reply #14 on: January 04, 2017, 11:45:33 AM »
One perspective to consider which no one has mentioned yet is--does paying off the mortgage give you FI? If you value getting to FIRE as quickly as possible (like I do) it may make sense to throw lots of money at a mortgage in order to get rid of that monthly expense in order to RE on the income the property generates. I don't know your math or your goals, so I don't know if this works for you, but it's an avenue to consider.

SeattleCPA

  • Handlebar Stache
  • *****
  • Posts: 1607
  • Age: 60
  • Location: Redmond, WA
    • Evergreen Small Business
Re: Pay off rentals early?
« Reply #15 on: January 06, 2017, 03:20:03 PM »
Is this property held by you? or in an LLC or S-corp? What is the rate of the note?

I have 3 properties, 2 are paid off, 1 is halfway as I took over the payments/assumed the note when I bought it. That rate is at 5.5% and all are owned by my S- Corp. I get some depreciation help during tax season, but if I sell to soon, then I think I have to pay that back or something depending on capital gains of the sale.

I think it really depends on if you want more properties, how active you are with them and the condition / location of them.

If your property is in a good location with good tenants and the rate is relatively low, then I would hold off and buy more or invest the money elsewhere. If the property is in much lower class and may have problems with tenants, then pay off asap in case you have trouble renting out later. The less fixed costs you have, the easier it is to ride out bad situations that may arise.

The net rental income will just fall to your normal income in either situation. FYI - I am not a CPA and have only owned my properties for about 3 years. So hopefully someone else can add on.

In general, it is a really bad idea to own real estate inside an S corporation. Don't do that.

BTW, at this point, you probably can't undo the error. (Though if you have a property that hasn't appreciated much, you should maybe try to get it out of the S corporation.)

The problems with S corporation ownership of real estate investments are (1) you can't take the property out of the S corp without paying a tax on the appreciation and depreciation... (2) you don't get a step up in basis if something happens to you or your spouse...(3) you incur costs because of the S corporation but you get no benefits... (4) if something ever happens and you inadvertently terminate your Sub S status, you've now moved from a situation where your gains would have been long-term capital gain to one where you'll pay corporate income taxes on the gain plus qualified dividends tax when you draw out the money.

Crazycarl

  • 5 O'Clock Shadow
  • *
  • Posts: 47
Re: Pay off rentals early?
« Reply #16 on: January 10, 2017, 09:32:28 AM »
Is this property held by you? or in an LLC or S-corp? What is the rate of the note?

I have 3 properties, 2 are paid off, 1 is halfway as I took over the payments/assumed the note when I bought it. That rate is at 5.5% and all are owned by my S- Corp. I get some depreciation help during tax season, but if I sell to soon, then I think I have to pay that back or something depending on capital gains of the sale.

I think it really depends on if you want more properties, how active you are with them and the condition / location of them.

If your property is in a good location with good tenants and the rate is relatively low, then I would hold off and buy more or invest the money elsewhere. If the property is in much lower class and may have problems with tenants, then pay off asap in case you have trouble renting out later. The less fixed costs you have, the easier it is to ride out bad situations that may arise.

The net rental income will just fall to your normal income in either situation. FYI - I am not a CPA and have only owned my properties for about 3 years. So hopefully someone else can add on.

In general, it is a really bad idea to own real estate inside an S corporation. Don't do that.

BTW, at this point, you probably can't undo the error. (Though if you have a property that hasn't appreciated much, you should maybe try to get it out of the S corporation.)

The problems with S corporation ownership of real estate investments are (1) you can't take the property out of the S corp without paying a tax on the appreciation and depreciation... (2) you don't get a step up in basis if something happens to you or your spouse...(3) you incur costs because of the S corporation but you get no benefits... (4) if something ever happens and you inadvertently terminate your Sub S status, you've now moved from a situation where your gains would have been long-term capital gain to one where you'll pay corporate income taxes on the gain plus qualified dividends tax when you draw out the money.

I wish I would have used an LLC from the beginning, but I originally had a partner and was advised by our lawyer to use an S-corp because of that. The big thing that I really do not like with the S-corp is the required salary and all the book keeping that goes along with that. Its been 3 years since I have started and owned these properties, and will look to start selling them off before I FIRE and move onto our sailboat to travel. Thanks for the insight, wish it was a few years ago...haha