Debt or debt free?

[Scott Ewell]

just wanting to get BP people's opinion on what way is the best route to go with regards to buying RE with leveraging or getting properties paid off as soon as possible and why?

I currently have two SF rentals and my goal is to pay off the first one as fast as possible (within the next 24 months), then hammer down on the next one while looking for my third one and so on... My goal is to be able to pay one off every 24-48 months...

Thoughts?

Thanks from Fort Worth TX

[Troy Fisher]

The first question is, what are your goals?!?   This is essential in determining how you are going to borrow/invest.

Are you looking for cashflow?

Are you looking for asset collection?

Are you planning on holding these properties forever?

What tax purposes do you have?

Are you doing Appreciation Plays/Asset protection/Inflation Protection?

Let's do a quick (I hope) and dirty look at it:

1 - 100k SFH bought with a standard NOO Mortgage at 5% which rents for $1k, and lets assume; that unicorns exist and fart rainbows, you have 100% Lease Up, and $0 for repairs for the first, lets say, 5 years on all of your properties, and that we buy everything on the first day of the year.

Year 1: You Spend 30k to purchase house, you owe 70k your payments are: 376 a month giving you a free cash flow of 1000 - 376 = $627! Sweet deal! x 12 months: $7,488

With Depreciation (lets take the 30 year, not worry about re-coup costs, and assume the value is all in the building and none in the land) ~3,333, add in the fact that you have a tax shelter (~$3,000) 

You've effectively made $15,000

Pay off in 24 months: Now lets keep the math simple and pay off 1/2 of the remaining mortgage:  69,000 / 2 = $34,500 - $15,000 = -$19,000!

Let's not buy anything in year 2 just to make things easier:

Still renting for $1000/mo - your new payment of $188 gives you: $812 x 12: $9,744

with depreciation, $3333 and taxes $1733 (because we can only write off our interest payments!) you've only made: $14,810!  A pay cut!  But your net worth has grown because your assets have grown and you've lowered your liabilities! (Hopefully!)

Let's settle our Mortgage payments: $34,000 - $14,810 = -$19,910!

Year 3 we get $1000/month x 12 Months $12,000 + Depreciation (~3333) and we make a whopping $15,333/year

You Buy a new house 30k down make $15,000 and Pay down an additional 19,000 on the mortgage

You've spent: 30k 2x (60k), and payed all your rent to the bank ~15k x 3 (45k) and put in an additional 19k each year to lower the mortgage 19x3 $58k

On the other hand:

Let's keep that mortgage on the first house

You've effectively made $15,000

Year 2, let keep the mortgage (our interest is still significant and our assets have grown much)

You've effectively made $15,000!

Year 3, we've saved up enough to put a down payment on a new property:

House 1: You've effectively made $15,000

House 2: You've effectively made $15,000

You've made $30,000 compared to $15,333!

HOWEVER, and to the crux of your point:

Year 3 in the first Scenario you have put $163k into the system for $200k worth of assets!  Not to shabby we've still made $37k and we have assets! 

Year 3 in the Second Scenario we've put $60k into the system we have $60k worth of assets (we still owe 140k on the two $100k houses) and we've made $45k in income!

So we've got a return of 23% on our first and a return of 175% on our second.

TL;DR - Are owning free and clear assets better than having high rate of return? 

Back to my original question, what are your goals and situation? Do you want a fixed income in 3 year? A large asset base for some certain reason? Do you want to have monthly cash flow to be able to enjoy things with your family/friends?

That was not quick and easy.  And there are a ton of numbers in there.