Expand Or Payoff

[Paul Novak]

I am debating my next move with my rental business.  I am not that big.  I have 3 total properties and 5 doors, 2 multifamily properties and a single family.  My goal is to retire off of my monthly rental profits and my target number is $11K per month.  To hit that $11K per month I plan on having all my properties paid off.  I would rather have 10 paid off properties that make $11K per month then 30 properties with debt on them.  My current portfolio generates $2,790 per month with debt and would generate $4,900 per month if paid off in full.  This leaves me with needing to pay my current properties off but also needing to purchase more properties to achieve my goal.  Now for my decision:

I won't purchase a rental unless I can cashflow at least $500 per month.  With interest rates, home prices, and rent prices in my market to hit that goal of $500 per month I am looking at purchasing a house around $200K, putting down $100K, and renting it out for around $1,500 per month.  My wife and both make a high income for our area and I feel we could save about $100K per year to keep buying.  If we did a deal using the numbers provided above we could cashflow around that $500 per month.  My other option is to pay off the balance on one of our mortgages and cashflow more.  For example the last rental property we purchased we owe on it about $86K and if paid off would cashflow an additional $600 per month.

Because of our household income I am worried that paying off properties would bring us into tax brackets.  Trying to keep the logic simple if every house you own you can deduct 3 main categories on your taxes (property taxes, depreciation, mortgage interest) if I paid off a house I would make more with only two primary deductions.  If I purchased another house I would have 6 main deductions because each of the three would double up with two houses.  Honestly I don't see the market lowering home prices anytime soon or rates dropping any time soon.  I also am not a fan of timing markets.  I am a fan of saving up and investing when you have the capital to do so, sometimes your timing is good, sometimes it's not, but over the long term you will win.  Does anyone have any advice on how they would proceed?

[Marcus Auerbach]

@Paul Novak here is the key to your question: nothing grows faster than leveraged equity. Once you get to retirment age you trade your equity for cash flow. You can sell a few to pay off the rest or 1031 them into passive income.

Any property you buy today should appreciate about 4.9% p.a. that's been US average (insert a % you believe is right, I believe Milwaukee may actually beat this number) over the next decades and your downpayment is leveraged 4:1, so that in itself produces a lot more equity over decades than you could ever safe up. Meanwhile you are also deleveraging debt using tenants income, in 30 year (or 25) you have it paid off. 

The more equity you have when you are ready to retire, the more cashflow it will turn into.

So you can optimize for two things: higher priced properties with a bigger potential to appreciate (find the sweet spot, don't go too high) and harness more tenants with higher income to pay higher rents (= higher monthly paydown).

When you start thinking this way, you quickly realize that today's cashflow is not that important as long term equity. Play with a BP rental calculator to simulate. You need to grow your portfolio wide before you grow it deep, which means more properties before more equity.

If you buy one property every year, you'll have 35 by the time you are 68. That's probably some $10 million in equity in todays money. You could do a 1031 into a DST, thats entirely passive.

If you extract 10M equity equity and invest conservativley with a 5 CAP thats $500,000k a year in todays money. I belive the big misunderstanding is to think you you grow your cash flow linear until you reach 11k, like a ramp. It is much better to grow your equity in a compounding way and the transform it into cash flow when you want to.