Evaluating Rental Property Mortgage Pay Off

[Chris Boyd]

I am looking for some feedback on paying off a rental property. I am not currently planning to buy additional real estate. The rental property was acquired with $35K down at $350K, with 22 years left on the mortgage. My all-in expenses put the total investment at around $43K. I have $260K remaining on the mortgage at 3.8%. It has been 100% occupied and currently returns a positive cash flow of $1,000. I am considering paying off the mortgage lump sum, which would avoid around $135K in interest payments and generate an additional $1,400 positive cash flow ($28.8K annually). The market value of the property is around $500K. I have already set aside a repair and maintenance fund that will cover the needs of the house. 

The alternative would be to invest $260K in the stock market. 

I am looking to understand the ROI on the investment under the two scenarios and how to correctly estimate the differences in total return between the two options, assuming the positive cash flow ($28K/year w 3% growth rate) is reinvested and compared to keeping the $260K in the stock market. I will assume the same rate of return for reinvested money.

I have a few questions about doing this properly; there are certainly others I missed. Would I reduce the return on the $260K by the 3.8% mortgage? Since both scenarios pay off the principal (year one vs. year 22), how is the principal handled when calculating the total return comparison? I will be able to invest the rental payments that went towards the principal in year one vs year 22. Increased positive cash flow will return at a higher rate than 3.8%. What is a reasonable way to apply an estimated tax benefit of the interest deduction vs. the tax on increased positive cash flow vs. invested income? 

Thank you for your insights and for pointing me to resources that should be reviewed so I can build a model in Excel to evaluate this decision.