Valuing Equity over Cash Flow

[Jordan Blanton]

Hello all, 

Requesting some advice for my next purchase. I'm 31 years old with two properties that already cash flow very well. I'm ready to go with purchasing a third property but when analyzing properties, it seems difficult to find one that cash flows well. It is possible, but not a considerable amount and certainly not as much as my other two properties. 

My question that I would like one to consider is this: Should I target a property that slightly cash flows with a 30 year fixed, or buy a home with a better rate 15 year fixed and target fast accumulating equity and a big fat cash flow egg that will be gifted to me in 15 years? I understand the added risk with a 15 year fixed (always have an exit strategy) which I will have with cash reserve tucked away that will fund major repairs / emergencies if they come up. I also have a good w-2, live below my means, no debt, and due to get wage increases in coming years. 

My thought is since cash flow is more difficult at the moment, and with my age, it seems more immediate and appealing to get a 15 year fixed that will set me up very, very well when I turn only 46 years old. When analyzing properties and doing calculations, this strategy does not provide a good return for the first few years, but it most definitely does give me faster equity accumulation and gives me the quickest/biggest cash flow per year that trumps other situations with properties on 30 year fixed mortgages. 

Thoughts and opinions would be appreciated! 

[Ellis San Jose]

15 yr mortgage rarely maximizes your returns vs 30yr. I’m in the camp of maximize cash flow today.

[Jordan Blanton]

Quote from @Ellis San Jose:

15 yr mortgage rarely maximizes your returns vs 30yr. I’m in the camp of maximize cash flow today.

Correct, it doesn't initially. But my calculation reports show that as the years go on, the return rate growth is rapid, at the same time that equity buildup is the same..specifically after year 10. Seems to be more valuable than making $2400/year cash flow and that's without large capital expenditures.

[Ko Kashiwagi]

Hi Jordan,

What is your outlook on appreciation in the area? Paying down a mortgage quicker gives advantages if you believe the appreciation outlook is high because the debt pay down will give you more benefits when the property appreciates. Average is 3-5%.

[Jordan Blanton]

Quote from @Ko Kashiwagi:

Hi Jordan,

What is your outlook on appreciation in the area? Paying down a mortgage quicker gives advantages if you believe the appreciation outlook is high because the debt pay down will give you more benefits when the property appreciates. Average is 3-5%.

When I do calculations, I assume 3% appreciation to be conservative.  I should have mentioned to that I would do this approach with a property that is in a good neighborhood with very above average school system and safe, desirable community.

[Benjamin Stickler]

Most financing does not have early prepayment penalties.  You could get a 30-yr with the cash flow and always pay it down like a 15 yr note.  Yes the interest rate is higher but it gives you optionality, in case your extra money for helping pay the 15 yr note disappears or your investment goals or priorities change for that money.

[Steve Vaughan]

I've always analyzed the 15 vs 30 case by case.  Sometimes the 15 rate is significantly less than the 30, like in 2012 when it was over 20% cheaper. 

In 2012 I refied a few 30s I got from 2003-7 in the high 6s to 15s in the low 3s. The discount was .75% then.

My criteria was the 15 had to be at least .6% less than a 30 when 30s were 5%.  That's 12%.  So my discount needed to do a 15 with rates at 7.2% today would be .86%. 

So many 30-only rooters completely dismiss the lower rate but that's where the magic happens.  A 15 payment is much less than double a 30 because of the discounted rate. 

I've paid off several 15s and don't regret going that way on any of them.  As long as you are fiscally secure enough to make that higher payment no matter what, when a 15 is paid off, a 30 still has like 70% left to go.  Mind-blowing @Jordan Blanton. 1 house alone the interest savings was $180k. 

[Jason Park]

@Jordan Blanton

Hey Jordan

I would look at it from multiple angles as real estate investing is multidimensional

As it depends on your situation I would lean towards cash flow today. I also say that because as the property appreciates you can always refinance the loan to gain more cash flow or cash out etc..

Rarely have I seen investors hold their loan for the full term.

Cashflow today is certain (from what you mentioned) appreciation may not always be guaranteed and as mentioned above you can always take advantage if appreciation does occur in the future

Hope this helps and lmk if I can assist you any other way

[Robert Jones]

I thought about this with my own house. What I figured is that I can always pay it off in 15 or less by making more payments. The bank doesn’t get mad at me for prepaying but they do if I can’t make a payment. By getting a 30 I can pay it faster but I also have a choice not to prepay if I want to use the cash for something else. 

[Don Konipol]

Quote from @Jordan Blanton:

Hello all, 

Requesting some advice for my next purchase. I'm 31 years old with two properties that already cash flow very well. I'm ready to go with purchasing a third property but when analyzing properties, it seems difficult to find one that cash flows well. It is possible, but not a considerable amount and certainly not as much as my other two properties. 

My question that I would like one to consider is this: Should I target a property that slightly cash flows with a 30 year fixed, or buy a home with a better rate 15 year fixed and target fast accumulating equity and a big fat cash flow egg that will be gifted to me in 15 years? I understand the added risk with a 15 year fixed (always have an exit strategy) which I will have with cash reserve tucked away that will fund major repairs / emergencies if they come up. I also have a good w-2, live below my means, no debt, and due to get wage increases in coming years. 

My thought is since cash flow is more difficult at the moment, and with my age, it seems more immediate and appealing to get a 15 year fixed that will set me up very, very well when I turn only 46 years old. When analyzing properties and doing calculations, this strategy does not provide a good return for the first few years, but it most definitely does give me faster equity accumulation and gives me the quickest/biggest cash flow per year that trumps other situations with properties on 30 year fixed mortgages. 

Thoughts and opinions would be appreciated! 

The answer partially depends on the outlook for future rental rates vs future expenses.  I’ve had many properties that over 10 years rental rates increased significantly, turning a break even cash flow into a cash cow. 

[Mike Dymski]

In this market, cash is more important than a fractional difference in the rate.  Having some dry powder to take advantage of opportunities is valuable.  You can invest excess cash flow and get 5% return (online savings, CDs, treasuries) (or simply pay down principal).  And a refinance in the future is likely (our government can't manage the country with high rates for extended periods).  Take the flexibility.

[Joshua Janus]

Quote from @Jordan Blanton:

Hello all, 

Requesting some advice for my next purchase. I'm 31 years old with two properties that already cash flow very well. I'm ready to go with purchasing a third property but when analyzing properties, it seems difficult to find one that cash flows well. It is possible, but not a considerable amount and certainly not as much as my other two properties. 

My question that I would like one to consider is this: Should I target a property that slightly cash flows with a 30 year fixed, or buy a home with a better rate 15 year fixed and target fast accumulating equity and a big fat cash flow egg that will be gifted to me in 15 years? I understand the added risk with a 15 year fixed (always have an exit strategy) which I will have with cash reserve tucked away that will fund major repairs / emergencies if they come up. I also have a good w-2, live below my means, no debt, and due to get wage increases in coming years. 

My thought is since cash flow is more difficult at the moment, and with my age, it seems more immediate and appealing to get a 15 year fixed that will set me up very, very well when I turn only 46 years old. When analyzing properties and doing calculations, this strategy does not provide a good return for the first few years, but it most definitely does give me faster equity accumulation and gives me the quickest/biggest cash flow per year that trumps other situations with properties on 30 year fixed mortgages. 

Thoughts and opinions would be appreciated! 

 Recycling equity is how you scale in my opinion. Cash flow makes the journey easier and gives you the returns you are looking for quicker but it will take years for your cash flow to produce enough excess to purchase additional assets. If you stick to finding equity, refinancing/flipping, you can turn that into cash flow (+ cost seg) to keep as much of your hard earned money as possible.

[Ellis San Jose]

Quote from @Jordan Blanton:

Quote from @Ellis San Jose:

15 yr mortgage rarely maximizes your returns vs 30yr. I’m in the camp of maximize cash flow today.

Do a time value of money analysis of each scenario. Income today is worth more than income tomorrow. If you can reinvest the income at a higher return % than your mortgage rate why would you put it toward accelerating your amortization?
Correct, it doesn't initially. But my calculation reports show that as the years go on, the return rate growth is rapid, at the same time that equity buildup is the same..specifically after year 10. Seems to be more valuable than making $2400/year cash flow and that's without large capital expenditures.

[Jordan Blanton]

Quote from @Ellis San Jose:

Quote from @Jordan Blanton:

Quote from @Ellis San Jose:

15 yr mortgage rarely maximizes your returns vs 30yr. I’m in the camp of maximize cash flow today.

Do a time value of money analysis of each scenario. Income today is worth more than income tomorrow. If you can reinvest the income at a higher return % than your mortgage rate why would you put it toward accelerating your amortization?
Correct, it doesn't initially. But my calculation reports show that as the years go on, the return rate growth is rapid, at the same time that equity buildup is the same..specifically after year 10. Seems to be more valuable than making $2400/year cash flow and that's without large capital expenditures.

 While I think that is true, it is much more difficult to simply attain this strategy with 7.5% interest rates. It was an easy decision a few years ago when rates were lower, but now I don't think as much. 

Also, which I've only seen one person mentioned, the interest saved in the loan is monumental. Assuming a 250k house with 20% down, you're saving close to 150k on interest alone. Not only that, in 15 short years, the cash flow will be massive...close to 25k a year. In my mind, that is quite a difference maker. 

[Jordan Blanton]

Quote from @Steve Vaughan:

I've always analyzed the 15 vs 30 case by case.  Sometimes the 15 rate is significantly less than the 30, like in 2012 when it was over 20% cheaper. 

In 2012 I refied a few 30s I got from 2003-7 in the high 6s to 15s in the low 3s. The discount was .75% then.

My criteria was the 15 had to be at least .6% less than a 30 when 30s were 5%.  That's 12%.  So my discount needed to do a 15 with rates at 7.2% today would be .86%. 

So many 30-only rooters completely dismiss the lower rate but that's where the magic happens.  A 15 payment is much less than double a 30 because of the discounted rate. 

I've paid off several 15s and don't regret going that way on any of them.  As long as you are fiscally secure enough to make that higher payment no matter what, when a 15 is paid off, a 30 still has like 70% left to go.  Mind-blowing @Jordan Blanton. 1 house alone the interest savings was $180k. 

Absolutely and well put! There's many ways to be successful in real estate and depending on each investor's income/age/situation/approach/knowledge, their approach should be tailored to them. I think this strategy is good due to my age, my projected increase w-2 in the coming years, and the reality of the current real estate market. I know a good deal when I it pops up on MLS, but it's gone in a day or there are 5-7 offers. And with four children, wife, job that takes up a lot of my time, and being a little fish in the big sea of investing, I don't have the time/resources to find deals otherwise. I attempt to, but it's a no go.

The interest saved on the loan, and the returns after year 10 are significant. What is most significant, is after 15 years and 1 day...your cash flow turned from a little creek, to a flooded Ohio River. The approach just seems more immediate and appealing as a 31 year old investor with a lot more time. And that's assuming appreciation could be out the window. Even with no appreciation, your equity is still building fast which could result in acquiring another opportunity that may cash flow better immediately. 

[Benjamin Aaker]

As long as you don't go into negative cash flow territory, I recommend that you build equity. You'll do that faster with a 15 year mortgage and its lower rate (usually) than the 30. There is risk that you will need to refinance with the 15 year, so there needs to be some cash flow for reserves. Since you have a good W2, why have the cash flow to report income and pay more taxes on? Let the equity build and pay the lower cap gains tax later.

[Jeremy H.]

Let me ask you this...

You could do a 30 and pay it off in 15 if you wanted...but you can't do a 15 and pay it off in 30. Give yourself the option to pay it off early and the flexibility of getting a little extra cashflow today. 

If you're doing a conventional you can generally recast the mortgage as well - not a refi. You would essentially put some extra $$ down and they would essentially re-amortize the loan back to 30 years. I haven't totally figured out the usefulness of a recast but I actually heard of it for the first time a few weeks ago...

The other thing - I don't see a huge benefit in paying off a house early...with higher rates - ok maybe. I'm at 4.5% or under on most of mine - did one last year that's at 7.25% and another DSCR (no prepayment penalty) that's at 10% (was hoping to refi this year but who knows). The thing is equity costs you to access. Unless you plan to retire and do a cash-out refi and then live off the loan as opposed to income.

[Jordan Blanton]

Quote from @Jeremy H.:

Let me ask you this...

You could do a 30 and pay it off in 15 if you wanted...but you can't do a 15 and pay it off in 30. Give yourself the option to pay it off early and the flexibility of getting a little extra cashflow today. 

If you're doing a conventional you can generally recast the mortgage as well - not a refi. You would essentially put some extra $$ down and they would essentially re-amortize the loan back to 30 years. I haven't totally figured out the usefulness of a recast but I actually heard of it for the first time a few weeks ago...

The other thing - I don't see a huge benefit in paying off a house early...with higher rates - ok maybe. I'm at 4.5% or under on most of mine - did one last year that's at 7.25% and another DSCR (no prepayment penalty) that's at 10% (was hoping to refi this year but who knows). The thing is equity costs you to access. Unless you plan to retire and do a cash-out refi and then live off the loan as opposed to income.

 One, it's the discipline of having a 15 year that I would follow. If I had a 30, then the extra principle payments might not look as attractive and maybe I don't follow it as strict. Secondly, I may not tap into the equity, but after year 15 on a 15 year fixed, the cash flow is flowing. 

[Jeremy H.]

Quote from @Jordan Blanton:

 One, it's the discipline of having a 15 year that I would follow. If I had a 30, then the extra principle payments might not look as attractive and maybe I don't follow it as strict. Secondly, I may not tap into the equity, but after year 15 on a 15 year fixed, the cash flow is flowing. 

If you need a mortgage lender in order to stay disciplined...by all means. I can't relate to that so I'd suggest doing what you need to do

[Jordan Blanton]

Quote from @Jeremy H.:

Quote from @Jordan Blanton:

 One, it's the discipline of having a 15 year that I would follow. If I had a 30, then the extra principle payments might not look as attractive and maybe I don't follow it as strict. Secondly, I may not tap into the equity, but after year 15 on a 15 year fixed, the cash flow is flowing. 

If you need a mortgage lender in order to stay disciplined...by all means. I can't relate to that so I'd suggest doing what you need to do

 It was a figure of speech. Meaning at different individual times, I may feel extra funds going towards that principle will go elsewhere to what I feel at the time. 

[J. Mitchell Bernier]

@Jordan Blanton

Dont think there is a wrong answer. We personally have a mix, some are on 15yr, 20yr, and 30yr. Reason being is we have good w2 roles and were looking for minimum monthly cashflow and once we hit that we were happy to pay more towards the loan to build up equity. Plus, we use local banks so to get access to the equity is not hard if we need it. 

As a banker and investor, I have a hard time understanding why the extra little cash flow you get from the 30yr is better when your rate is 8% or higher. Any loan over 7% rate I want to pay down faster anyway. Paying down a loan at 7% is a better deal than stocking away the extra cash every month in an account earning 5%.... 

[Caleb Kim]

One of them is your financial stability and risk tolerance. The second is long-term goals. Buying a property with a shorter fixed rate term may offer a greater rate of capital accumulation, but may come with higher payments. However, if your financial situation allows you to repay the loan in a shorter period of time and you are willing to take on the additional risk, this may be a smart option. It is also important to consider your long-term goals and plans for the future.