Paying Off Loans vs Waiting and Leveraging

[Hariharan Elavarasan]

I bought my first rental property earlier this year. Cash flow after I move out (house hacking) and renovating should be 200-300. 30 yr fixed mortgage @ 6.625% with about 76,000 left. Over time, I'll end up paying 96k in interest payments. I had originally planned to buy 9 more properties, hopefully around or below 150k with a 200 cash flow. Then I wanted to snowball pay off all 10. Of course these are approximate numbers and anything can happen, but I anticipated it taking 25-30 years to do this process. At one point, I'd approx. be 1 million in debt, and it will always be hinging on all 10 rentals' tenants paying on time, and no major major problems. 

Into my Youtube feed comes ye olde Dave Ramsey (surely you know where this is going). I'm wondering if I should just pay off this property in full before moving to my next one. I'm young, and I make a very good salary for my age. By summer I should have a good emergency fund, and even if my future share of rent when I move in with my partner is $1,800, I could still have an extra $1,100 to contribute to the loan. I could go from making a $780 payment to a $2000 ($780 from tenant rent - cap ex, utilities, prop mgmt etc, $200-$300 from cash flow, $1100 from personal). I could get this paid off by late 2027/early 2026, and save 90k in interest. 

I'd then be sitting on $900-700 cash flow without considering rent increases. Then I'd pick up another mortgage and do the same thing. I'd be snowballing these one by one, but at any given time have 100-150k real estate debt (not considering personal home debt, personal car loan) 

What makes more sense? The payoff method sounds slower, I'd probably only get to the same 10 properties in 35 years (I haven't considered how quickly it'll snowball, maybe the last 5 may take only 10 years to do with all the cash flow from 5 paid off properties), but I'm not desperate for real estate cash flow. Without it I can very comfortably live and retire. Just doing this to help my parents in retirement, and help my future children get through college debt free as my parents did for me. 

For context, during this time, I'd always be maxing out my company match for 401K, maxing out my Roth IRA, have 15k for emergency fund. I'd have to cut back on my travel budget for the month, pay off the car I bought my parents (50k loan in Sep 2022, 28k left to go, my dad and I pay it together), and ensure that lifestyle doesn't change as rapidly. I understand that I'd probably only get my dream home when I'm 50, and that major things like changing budgets, children, health will impact this timeline, but it seems like a low risk real estate method, that will have a similar enough payoff due the fact that I'm fortunate to be making a good salary.

Apologies to anyone reading this thinking I'm trying to brag in anyway. We all come from different walks of life and I'm incredibly fortunate/grateful to have hard working parents that were able to get me to this position. And I respect those of you who aren't as fortunate and have had to work hard to claw their way up to where you are today, that definitely is and always will be a bigger achievement then where I may end up. Just looking for the advice of those hard workers if they could start over in my position. Thank you all!

[Sean Hudgins]

How much cash do you currently have invested in the deal? There is something to be said for every strategy, but the significant advantage that we have in real estate is leverage. You could approach this in a more hybrid manner, one that would make you feel better about saving money on the interest and snowballing into more properties quickly. There is no need to wait for the first property to be paid off before buying the next property, and putting some extra money toward the principal is an excellent option to reduce that interest payment. The thing to be careful of is optimizing your capital and leverage. 

For example, if you pay off your property, what is your ROI on that cash invested? I'm going to assume your property is worth around $110,000 (based on what you are saying), so it fully paid off, making $700-$900 cash flow. Your ROI is 8.7%. Now, on the same property with the leverage you have, assuming 34,000 in the deal currently and $250 cashflow, your ROI is 8.8%, so the same after the cost of debt. 

DISCLAIMER: This is not a super in-depth evaluation of the numbers. I am using a lot of rough numbers and generalities but trying to demonstrate a point.

Option 1 Leverage: We will assume you plan to hold all properties for the next 30 years. Lets assume that you are buying similar properties to the one you have now. I'm going to assume you are able to save up downpayment money for a new property every 24 months, which would leave you with 15 properties over the next 30 years. Now, let's assume a modest 3% appreciation over that period. Your first asset would be worth $267,000, and your total portfolio balance would likely be around $2.5+ Million. Your first house would be paid off, and every two years after, another house would be paid off. You would have needed to bring approx. $500,000 as a down payment, and considering an ROI of 8.8%, you would be bringing in $44,000 per year, and that would grow exponentially as you paid off each house. Your appreciation for year 31 would be on the $2.5 Million, so around $75,000. (Total Portfolio Value: $2,575,000 | Portfolio Debt: $1,470,000 | Portfolio Net Worth $1,030,000) Honestly, the returns are even better than this when you take into account tax benefits, but I'm trying to simplify for an example.

Option 2 Pay Off: In this example, you buy a new property every 4 years after the first is paid off. It's the same 30-year time frame, so you would end up with 7 paid-off properties at the end of 30 years. Your total portfolio would be valued at around $1 Million. Now, assuming you are at the same 8.7% ROI on that you would be bringing in $87,000 in cashflow and your year 31 appreciation would be $30,000. (Total Portfolio Value: $1,030,000 | Portfolio Debt: $0 | Portfolio net worth $1,030,000)

Conclusion: your ROI looks about the same at year 31 one option has a higher portfolio value and is leveraged. The other is cash flow heavy with a lower total value. Now, let's look at year 40 (remember 3% appreciation).

Option 1: Total Portfolio Value $1,384,000 | Portfolio Debt: $0 | Portfolio net worth $1,384,000 

Option 2: Total Portfolio Value $3,359,000 | Portfolio Debt: $550,000 | Portfolio net worth $2,809,000

Ok, this is a super long post with some rough numbers, But I'm mostly trying to demonstrate that leverage helps snowball faster, and the advantage of appreciation on a larger total portfolio balance can be a huge tailwind when investing in real estate. You mentioned that you are less concerned with cash flow right now, and that signals to me that you are probably better off finding the sweet spot for you with leverage.

I would leverage and take on extra risk now while you are young and able to make great money, and maybe 20 years down the line, switch things up and start pushing to pay these properties off early. You could also build up an emergency fund for each property, and then once you have plenty set aside for repairs, put all your extra cash flow toward the principal and pay the properties off faster. For your first property, if you put your cash flow of $250 a month toward principal payments each month, you would pay off 16 years early without hindering your savings effort for more properties.