Debt or debt free?

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Debt or debt free?

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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: $7,488With 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 $15,000Pay 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: $9,744with 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/yearYou Buy a new house 30k down make $15,000 and Pay down an additional 19,000 on the mortgageYou'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 $58kOn the other hand:Let's keep that mortgage on the first houseYou've effectively made $15,000Year 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 $15,000House 2: You've effectively made $15,000You'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.

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@Scott EwellCan't believe this just popped up. The answer is, and I'm gonna sound like an attorney, It depends.Depends upon your goals, your mindset, your risk tolerance. I wanted to scale a multifamily portfolio without investors, so I had to refi my properties and roll the capital into the next deal. Just be careful not to over lever, and to buy quality deals.Each strategy has its pros and cons. Slow and steady can win the race, but you need to be committed.Wondering which path you chose?Gino

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Interesting, this post came up for me today. We are getting ready to hold this debate at our monthly REIA meeting and there are a lot more factors - interest rates, appreciating properties, changing regulatory environment and more.

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@Troy Fisher I loved your thorough analysis speaking to why leverage is so powerful! I know this thread is two years old, but I'm trying to figure out the debt vs free and clear debate. I am comfortable with debt as like as I have not greater than ~70% LTV and cash flow. Man I love BP!

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IMO, direct REI is too much work to only earn the cap rate.

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thank you for all of the great responses.My original goal was to end up with approximately 10 SFH to supplement my retirement, but now that I have a couple in the works, I'm open minded to all aspects of RE. I will definitely use some of the equations above to look at my situation.Thanks again!Scott

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@Scott Ewell. Depends on what your GOALS are. do you like not being tied to the burden of debt service every month & sitting on equity? or do you prefer to utilize your cash differently to grow your property holdings. I'd run a leveraged return calculation on your existing rentals and compare that to your current yield. depending on the cost of funds- it could really be worthwhile to use leverage wisely

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@Scott EwellLeveraged vs debt-free is a personal decision to some extent.Leverage will give you a higher ceiling on your investment, whereas debt free provides the lower floor.While I can't say which is best for you in particular; I can say that, in my experience, every majorly successful investor I've come across uses debt in their strategy to some degree. Again, this has just been my experience, but it seems as if you are 'leaving somethings on the table' by not exploiting the benefits of leveraging your investments.

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Leverage is the secret sauce that makes real estate so attractive. W/o it, the returns aren't that great. If you want the least amount of stress and risk, that's fine, but financially you'd be much better off over the long term by using your cash flow to buy more leveraged properties instead.