Acquire more or aggressive payoff?

Question

What's up BP!

I have submitted my first offer on a SFH that I intend to rent out. The purchase price of the property, and what I intend to be a similar price of properties I expect to purchase in the future, is around $70K (I will buy SFH from 70-100K). The properties are in a 20K town in a more rural area.

My question is: with my current income, I could rapidly pay down a property using my own personal funds in a 2-3 year time frame. My ultimate goal is to replace my wife's income with rental properties.

Would you:

A. rapidly pay down the properties in the 2-3 year time frame

B. use the cash to instead acquire more rental properties

Just want everyone's general thoughts. I was leaning toward A.

Thanks!

Josh

Jaysen Medhurst · Answer

@Josh Bast, it's not that your strategy is "bad," it's that it won't produce the best financial results over the long term. Every year that you put money towards paying down debt on existing properties instead of buying more is a year those additional properties aren't making you money through CF, depreciation, mortgage paydown, or appreciation. Consider this example:

$100k house rents for $1k/month; 2% appreciation/year

A: Buy the house outright: CF $500/month (50% to expenses). Value after 1 yr = $102k; Return on Equity (ROE) = 8% ($6k CF, $2k appreciation)

B: Buy 5 properties using 20% down and debt (30yr, 4.25%) on each: CF of $530/ month ($106/unit/month after debt service). Value after 1 yr = $510k; ROE = 16.4% ($6360 CF, $10k appreciation)

Extrapolate that over 10, 15, 30 years. Putting CF aside, at the end of 15 years the value of A will be ~$135k, a ~35% return on the $100k, but B will be worth ~$675k, ~175% return on your $100k.

This doesn't even factor in depreciation or mortgage pay down.

Let us know if you have more questions.

Joe Villeneuve · Answer

First, your Plan isn't a plan...it's a concept...kind of.  You're missing all the important parts...the Number$.

Second, the cash flow and personal income is the same money as the HELOC money.  They're just in different places at different times.  So, why would you pay for the same money (HELOC) when it's free now (cash flow and personal income)?

Third, any payments made towards the property out of your pocket, is a cost to you.  Any payments made towards the property by the tenant (rent/cash flow) is NOT a cost to you.  You're not paying it.  When you use your money (cash flow and personal income) to pay down any debt that the tenant is paying (thanks to positive CF), you are adding to what the property costs YOU.  Let the tenant buy your property for you.

Forth, take your cash flow and personal income and buy more properties where the tenant buys it for you (positive CF) and you get added Cash Flow.

Jacob Karasch · Answer

@Josh Bast Like others mentioned, it's leverage vs cash aka growth vs income.  The basic reason you would want to keep getting more properties is because the return in real estate is higher than the cost of borrowing, so you want to borrow as much money as you possibly can and make it all generate profit for you.  Your returns will be higher and you'll ultimately make a lot more money being leveraged.  The better the returns, the faster you reach your goals.

As for strategy on your goal.. let's simplify and say your goal is $5k/month in cashflow.  Keep buying properties until the paid-off cashflow would equal your goal.  Then pay them all off as fast as possible. That is the fastest way to hit your goal.

The way to make the most money is to just keep buying and leveraging as much as you can.

Joe Villeneuve · Answer

Why would you exchange free cash (income) for money that has a price tag. Your tenant is buying your property for you... don't help them

Mike V. · Answer

This has been discussed in a lot of detail.  Try a google search for something like "biggerpockets leverage vs cash"  or "biggerpockets pay off mortgage vs leverage" etc and you'll be busy for hours.  Heres a blog I found and it does a decent job of explaining.

https://www.biggerpockets.com/renewsblog/2015/04/1...

And a similiar thread with lots of answers and opinions.

https://www.biggerpockets.com/forums/52/topics/568352-pros-cons-to-paying-off-rental-property-early

Mike V. · Answer

You're basically asking the age old question of, "to leverage or not to leverage".  In a growth phase (which you are in with only 1 property) the optimal answer is B.  The very basic idea is that you're borrowing money for cheap and allowing your renter to pay it down for you.  Additional funds should be saved and used to replicate purchase 1 and repeat.  After you've acquired 'enough' you can then consider the snowball method if you'd like... or just be patient and let the renters do their job.

Option A only becomes relevant when you're no longer in a growth phase or unless it's a personal comfort issue.  Some people can't sleep at night with a lot of leverage and for them A is the way to go.

Joe Villeneuve · Answer

B...and only B.

Matthew Medlock · Answer

And then the market crashes, you have to service your loans yourself and you lose everything because you were leveraged. No one ever talks about the hundreds of thousands of dollars saved on interest by actually owning your assets outright. The interest money not paid is yours, not the banks. Take the CF of the first and apply it to the next one with the aggressive paydown included and keep rolling until you have met your goals. You find out who is swimming naked when the tide goes out!

Scott Morongell · Answer

@Josh Bast I would buy more assets. As long as your not over leveraged, you want good debt on your side.

Acquire more or aggressive payoff?

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