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Pay Off Properties vs Purchase More Properties
Greetings Everyone!
My name is KB and I am currently serving in the military. I have 2 rentals (one I previously lived in and converted into a rental, and the other purchased as a rental) Question: Does it make sense to put forth as much $$ as possible toward the two rentals...in order to pay them off within the 6yrs of active military service I have remaining....to more effectively (recieve 100% rental income from both rentals) supplement my retirement?? Or should I concentrate on building my portfolio by trying to accumulate more properties. (by saving up for down payment, or by rerfinancing). Your experienced opinions are greatly appreciated. Thanks in advance for your help! :D
That depends on your goals and plans, but in my professional opinion, you are best served to apply the appropriate amount of leverage in your RE investments.
While owning free and clear provides more cash flow, it actaul does not. What it does provide is a return on your cash invested and applying l;everage almost always makes your ROI better.
One of the greatest advantages to RE investing is leverage and the second is the tax deductions (depreciation). With leverage, you can control more properties which provide more tax deductions. While owning free and clear offers safetly in not having a mortgage payment, you have a lot of cash tied up in the walls which only produce the cash flow return and expose you to lawsuits due to your equity position.
Thanks for your quick response Nationwide! I know I have lots to learn, but is paying off a rental something I would "ever" focus on? Meaning applying both principles: Aquiring more and more properties, but pay off the older ones .....to help pay for the newer ones. Is that possible....does this make good realestate investing cents??
The great thing about rentals is, assuming they are cashflowing and not a money pit for you, the renter will pay off your mortgage in due time. You can pay down the mortgages until you own them, then cashflow a certain amount per month, or use that cash to leverage another 2-3 properties.
All depending on your goals.
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Real Estate Agent CO (#14161n)
- Podcast Guest on Show #235
Greetings, KB...best of luck in your investing activity!
It might help to keep in mind a simple fact: Mathematically, paying down a loan which bears interest at X% is identical, in terms of net economic value, to investing that same amount at X%.
Putting it another way, if you have Y dollars available to employ somewhere, just think of 'loan paydowns' as one more investment possibility, among your other options.
Suppose, for example, you could either use your discretionary Y dollars to pay down a 6% loan, or could instead deploy the Y dollars into an 8% investment. Paying down the loan is economically equivalent to investing at 6%, making it (obviously) the inferior choice in this particular fact set.
Without a doubt, you MUST also evaluate other factors. You might, for example, want to de-leverage your personal balance sheet for other reasons (risk; too much leverage; anticipated future financing), and this might override the simple "rate of return" rule of thumb I've described.
Nevertheless, it's a simple, and usually valuable, rule of thumb when evaluating your options.
Cheers!
...it was early and I was full of no coffee...
I understand Anson, thx..... Cash is flowing on these 2 rentals, but it's not into me! I guess that is the main reason i want to pay them off... paying them off will basically ease the pain.(can payoff both in less than 5yrs) The cashflow currently covers the mortgage payments (P&I) but nothing else. I initially purchased one of the rentals as an owner occupied at what it was worth in '03. The second rental was purchased as a rental after reading RichDad/Poor Dad, it wasn't a "good deal" I just wanted to get in the game. I didn't search enough to find detailed info about how to do it, and i was sooo excited...i just took action and didn't buy it cashflowing from the start. I was told "don't wait to buy realestate....buy realestate and wait....even if you didn't do a good job on the purchase. Maybe that wasn't the best advice. :-)
KB, by your explanation, you don't have "true cash flow" on your rentals. Rent less mortgage paymnet taxes and Insurance does not equal cash flow.
Read into the forums involving the 50% rule and the landlording forums. They will give you great insight into calculating cash flow properly.
That said, paying down your mortgages in 5 years certainly gives you X rate of return on those funds, but a better return would most likely come from putting that X money into a third rental, and then a 4th and so on. Let the tenants pay down the mortgage and let your cash work for you.
David, great post. It was only your 2nd post and it was right on. You appear to have the knowledge and experience to speak guide others. Stick around and participate more. We are glad to have you. I voted for your post as it was an excellent one!
David,
Thanks for shedding light and giving me a different way to look at this!
You are saying that the $$ I'm employing are gonna be the same....regardless of where I direct it, but would net me more of a benefit long term to reinvest in more rentals instead of paying down the loan. Ok, what about this: Since my main concern is neg cashflow on these rentals, would it make sense to pay these down for a year or so to build equity....then refi for the balance in order to lower the monthly payment...which then should change my status to positive cashflow! Does this make REI cents??
KB, the question is, why are you negative cash flow on them? If it is due to a bad loan, then doing a refi could help. If it is due to you paying too much upon purchase, then you really have only two choices, sell or eat the negative cash flow and do better on your next ones. Don't add into what is already a negative property. Move on to a better one and sell the first or at least make enough cash flow on the next few to even out the score.
Nationwide,
You are exactly right, I don't have "true cashflow". That said, what would your advice be for the future?? What should I do about the 2 neg cashflow rentals I have....if anything?
One more thing: Since the military keeps me on the go, I'm moving to another state and will buy another home to live in and this home will eventually become a rental. Any advice?
You are 2 steps ahead of me Nationwide! The negative cashflow is due to me paying too much for the property. I have a fixed rate, biweekly, 30yr loan.
I guess I was thinking that I could add money to this negative and turn it into a positive by paying them off.... oh well!
If you can sell to break even or come out ahead, do that. Most likely you will need to retail it to an owner occupant.
If that is difficult in yoiur area, perhaps you could carry your own note via a wrap mortgage. This way, the buyer is responsible for all repairs, taxes, and insurance and as long as you charge them a higher interest rate than what you pay, you then have positive true cash flow.
Make sure you get a sizable downpayment though, at least 10%, and preferably 20%. Then, if they default, you have all that cash from the deal and repeat the process to a new buyer (with more cash in the bank)
Thanks Nationwide,
I think because of the area the house is located in.....it may be a challenge to get it sold at retail, but I will definitely look into a wrap mtg a little more.
Any advice on purchasing an owner occupied then converting to a rental in say 3yrs? Would the process be different from reading the numbers and using the 50% rule??
Thanks for your help!
there is some great discussion happening here. i love it!
kb, if you are looking to convert from a OO to a NOO within 3 years, then buy solely from a NOO standpoint. don't buy off of what you would want, buy what a renter would want. be sure to not throw tons of money into the 'nicer things' and focus on the necessities.
know your market and what rent you can demand. use the 50% rule to weed through different properties and their potential.
with your first 2 properties, you learned a lesson. we've all been there at some point. dust yourself off and move on.
welcome to the board!
KB,
To calculate the cash flow in the real world, subtract the mortgage payment (P & I only) from 1/2 of the monthly gross rent.
As an example, if the rent was $600 per month and your mortgage payment is $400 per month, here's how that calculation would look:
Gross rent: $600
Operating expenses: $300
NOI (1/2 of the gross rent): $300
Less Mortgage Payment: $400
Equals Cash Flow: -$100 OUCH!
In the real world, operating expenses run 45% to 50% of the gross rents (plan on 50%).
If the properties you have are losing money, I'd sell them to some other wide-eyed newbie that wants to get in the rental business. Once you get your money back, then you can start buying rentals correctly - so that you actually MAKE money!
Good Luck,
Mike
Thanks for chiming-in Josh,
I guess that's the way I was tracking/thinking....just needed confirmation. I definitely learned a valuable lesson with the first 2, but will take my time and read the numbers in order to make decisions in the near future. I guess my biggest priority now is to find these deals in ND. Looking at different websites (realtor.com, yahoo realestate, frontdoor.com, etc.) doesn't look too promising in the ND area i'll be moving to. Must find other sources! Thx!
Thanks for the details Mike,
It really paints a clearer picture. As much as I "don't" want to sell them, I feel that you are right on the mark (+) if i get my money back....I haven't really lost anything except Time. Big pill to swallow! Thank you!
Mike,
Is it really that easy to calculate if a deal is good or not??
it is that easy.
as mike stated, figure half the rent (over time) will pay for maintenance, taxes, insurance, vacancy, etc and the other half will pay YOU (half of rent - p&i = cashflow)
just in case you haven't read the other threads on the 50% rule (which i STRONGLY suggest you read)
always factor the p&i payment based on a 30 year fixed mortgage on the PURCHASE PRICE (not just the loan amount).
if you are looking at a property for $100k and put down $20k, you factor the payment at the full $100k and not the 80k. if not, you aren't calculating the true return as you are basically paying your own cashflow. any and every deal would appear to cash flow if you paid cash for them.
Thanks Josh,
My assignment for tonight is to get spun-up on the 50% rule and peruse the landlording forums..
Correct me if I'm wrong, but the most demanding part of REI is finding the deal??
Thanks for all your help guys!!!!!!!
i think the most demanding part of REI isn't 'finding' a deal.....it's ACTING on it!
Let's be clear...
The 50% rule is a quick analysis. It helps you to determine if you should even consider further research into the proposed property. We use a similar formula and call it the "Mini Analysis".
If a property passes the mini. We do a driveby, then a walkthru, then start crunching numbers and reviewing tax docs. If it does not even pass the mini we quit and move on.
Thanks for clearing that up for me Christian,
So once I find a prospect, I use the 50% rule.....once the property passes this analysis, (walkthru) how/where do I get more detailed numbers in order to get a more accurate analysis? Are the tax docs located at the courthouse? Are they used to get a more accurate estimate of total cost?
(Is this all in a thread i haven't read yet?)
Basically, if you use the 50% rule for most single family homes & duplexes for that matter, you should have a good estimate as to the total expenses, both operating, vacancy, and capital expenses, all inclusive. It is possible to have lower expenses over a period of time and it is also possible to have higher. The main reason to use this when analizing a deal, is to get a quick snapshot of the ask price. Is it, or is it not in the ballpark.
Don't make it more complicated than it really is. As Josh stated, it really is THAT EASY. Forget about everything else. If you hit $100 cash flow+ using these calculations, you will be in the drivers seat and should have a green light to proceed with the purchase.