Inheritance. Pay off mortgage or invest in rental ?

Question

San Diego CA

My father passed away a couple of years back and we recently finished distributing his estate. My father left me a $300k condo that I am in the process of selling this spring.

I don’t know what would be best to do with the money.

I have a rental property that I purchased back in 2005 for 500k. It started as my primary residence but turned it into a rental 10 years ago. It has a value of 600k and I owe $350k (APR 2.75) on it. Rental income is $2700/month and mortgage is $2800 with 14 years left on it.

I was hoping to find a rental property that made sense either in Arizona or Nevada but I feel the market is due for a reset.

Should I just pay off the rental and own it fair and square and pocket my rental profit or look for another rental.

A buddy of mine recommended this site and said I should refinance the full 600k and buy 2-3 properties out of state so I own 4 instead of just 1.

Thoughts ?

Age 39

Cash: 160k

Retirement :140K

Salary: 150K

Alexander Szikla · Answer

2.75% is a very low rate - I'd keep that mortgage intact and deploy the equity from the condo elsewhere

Either buy another property yourself and lever up again or invest in someone else's synidcation.

You can also invest in more passive investments like stocks/bonds or RE notes.

Tim Winter · Answer

As has been mentioned previously, the 2.75% loan is like a free line of credit. It would be in your best financial interest to keep that loan as long as possible and deploy that equity elsewhere. Just about anything you invest in will have a higher than 3% return if done right, so you'll make money on the spread.

Your friend is right, diversifying is your best bet against future risk. If something bad happens with one of your rentals, and you only own one, that can set you back. If its only 1 out of 4-5, then the income of the others can usually carry you through that bad spot.

As for refinancing it, just be careful if they try and increase the rate on you now that rates have spiked. You might be better off getting a HELOC or line of credit if you can on that property, as has been mentioned before.

What I didn't see mentioned before is the possibility of lease option or wrapping that loan. Since your rental income is not exceeding your monthly expenses, it might be time to rethink how you're cash flowing on that property. A lease option you should be able to make above market rent and bake in increases over time. I would focus on getting the cash flow right before doing anything further on that property.

Then when its stable and you can show income on it, then get some credit to access that equity and redeploy that capital into something that makes you even more money.

Also, if you're waiting for a market reset in Arizona, you might be waiting well into 2022 or 2023. I wouldn't wait that long to sit on your capital without deploying it as there are plenty of opportunities out there. We're chasing many different avenues here in AZ, during one of the hottest recorded markets.

Allie Pfannenstiel · Answer

@Juan Mora What do you have for a primary residence? Is that paid off? Are you planning on building a big rental portfolio?

Scott Wolf · Answer

@Juan Mora, I did not fully read all the comments, so I apologize if this has been said.  Not sure why anyone here is telling you not to sell the condo.  If you were renting it out, I'd try to do a 1031 into something with positive cash flow.  Also, you could have paid off the 30 year loan at a higher rate while still cash flowing positively.  It doesn't hurt(or cost anything) to call a lender or two and see your financing options, perhaps you can go from the 15 year to a 30 year.

If you enjoy being a landlord, buy more property.  If not, find what you enjoy and use it there.  Stock market, private lending, house flipping.  $300K (minus whatever taxes) is a good chunk of change to play with.

Juan Mora · Answer

Hi Dan

This particular property does have some emotional value since it was our first home where our kids grew up.

My intention was to keep it in the family and pass it down to my daughter.

I was hoping to get some cash flow when I retire in 10 years.

Juan Mora · Answer

Thank you guys.

I am selling the condo specifically because I do not like to deal with HOAs. They have increased their dues to over $600 a month. It’s crazy and I want out.

Now, I wanted to hear opinions on what to do with the cash once I sell it.

It sounds like paying off my OTHER rental where I owe 350k doesn’t make much sense either cuz it’s only at 2.75 either. I’m actually considering refinancing to 30 years and taking cash out; maybe 250k since it’s valued at 660k.

Joe Edwards · Answer

@Juan Mora

Ok I would most certainly invest in more real estate. I will assume because you own a rental property already and your smart enough to get out the HOA your a critical thinker.

1. The 2.75% property do not touch that rate. Paying it off is useless.  HELOC that property so you can use those funds.

2. When you sell the 300k condo make sure you 1031 exchange it so you can roll those funds into 1 or 2 other properties that cash flow.

In short use the sale of the condo, your credit and your 150k W2 salary and leverage it to borrow cheap money to create more cashflow. If you are concerned about more pay down pay a extra payment or 2 a year and you will cut the mortgage down 7.5 to 15 years.

Just remember its all abiut your life goals and what amount of passive income you need to live comfortably so you can let go of the full time gig if you want.

Best of luck

Dan H. · Answer

As I indicated f/f debt is basically free money.  Having F/f debt with current inflation indicators is a fine investment.  However, your investment in your ex-home is a poor investment.  If you cash out (75% LTV from your <60% LTV), you likely will not get a significantly better rate.  Your negative cash flow will increase significantly.  You will improve your return from appreciation, but it will cost you with the negative cash flow.  There are many better investment options including many in local RE (I am sure there are quite a few agents on this site who could point out many on the market today that will project a better return).

Do you have an emotional attachment to this home?   Is there some reason to keep what is clear to me to be a poor investment.  I refer to it as a poor investment even if it has produced positive return due to appreciation because in the San Diego RE market there are investments that have done much better.  Also REI is not passive.  For me that means I need a projected return far better than S&P to consider RE as an investment.  If I can get >9% historically from S&P (or even better from other investment options), why would I choose something so much more labor intensive for less than 20% projected return?  I expect a lot better return than 20% on our RE investments.

Determine why you want to keep this property.  Determine if that reason justifies the poor investment.

Good luck

Dan H. · Answer

Sorry about your loss.  My view is 2.75% APR is free money.   There is no way I choose the pay it off option and keep the property.  Here are some thoughts:

• The lifetime return of the s&p500 is over 9%.  You did not list the terms on the condo but if we use similar numbers to you ex-home, The S&P lifetime return is over 6% higher than your loan.  My view is that having Fannie/Freddie (F/F) long term debt at these rates, with the present inflation risk, is a great investment.  I used S&P just as an example.   There are countless investment options that should be able to return significantly higher rate of return than a f/f loan.  Find the one with risk/reward that meets your goal.  That may or may not be an investment property. The decision to sell the condo should be made on the merits of the condo as an investment.  I have always been concerned about the power of condo HOAs and do not like others to have such a say in my investments.  Therefore, I am not an advocate of condo buy n hold rental investments.  However, if the numbers make sense as an investment, I would consider keeping it.   If the numbers do not make sense as a rental then sell it.  Your ex-home is very cash flow negative.  With that equity position (you have over 40% equity), I’m surprised it is this cash flow negative.  We have an ex-home in our RE investments.  It is by far our worst cash flow property.  It was purchased to be a good home to my family and not necessarily to be a good rental.  Due to a recent cash out refi (75% LTV) it is cash flow negative, but not as much as your ex-hone.   Your ex-home is a terrible RE investment today.  You have $250k of equity for negative cash flow.  I do realize there has been appreciation, but other properties in San Diego have similar appreciation, but at that equity position would have much better cash flow.   If you are charging near market rent, this is not a good buy n hold investment.  I seldom recommend selling due to San Diego’s historical appreciation, but in this case I advocate selling.  You could look into 1031 exchange the proceeds to postpone taxes on the gain. 
• I believe both markets you listed are fine markets.  However, I recommend against OOS RE investments (REI) until you have significant experience.    REI is not passive.  I think OOS REI is more risky than is often realized. You have a lot of options.   The decisions you make need to reflect your investment goals.  Risk vs reward.  Long-term vs short-term.  Etc.   you are the only one that can make these decisions.

good luck

Kenneth Donaghy · Answer

@Juan Mora The good news is you have many options. I also agree one of them should not be to paying off a loan when you have such a great rate. I suggest looking into the future, what would you like you life and your investments look like 3 years, 5 years, 10 years from now?  Then work backwards to come up with a plan to get there. Now which moves would serve you best to achieve those goals.