Hold or fold?

Question

An older friend (close to 70) owns a rental that makes a small positive cash flow. 
There is an existing mortgage of about $15K which he could pay, but has been saving that $15K (and more) for down payment when he finds another house to buy--which would also be a rental. He had been hoping to buy after prices fall even more. (2 rentals plus his home)
With the economy being what it is, he is concerned about banks failing and losing half or more of his money to runs on the banks, a recession/depression, and possibly losing that house unless it IS paid off, so is thinking of paying the mortgage off. Then he wouldn't have enough money for a downpayment on almost anything. Paying the mortgage would increase the cash flow of course, but not enough the spent money could be replaced anytime soon.

His personal income is enough to live frugally since he owns his house.  No, he's not interested in or able to sell either place right now. 
What advice would you give him? Pay the mortgage off, keep the full amount and wait for prices to come down, what?

Account Closed · Answer

Sorry to be so dense, what is cross collateralize, and how does one do it?

Account Closed · Answer

It's been a long-time dream of his to own three houses. (The next 4-5 houses come after that, lol!) His mortgage is a bit less than $15K at 5.5% fixed. As I said previously, it generates a tiny positive cash flow. If he does not pay the mortgage, he will have about $25K for a down payment. If he pays it, he won't have enough now for the down, and the income from the rental would be too small to replace that money quickly OR get him a loan of the size he'd then need to purchase that third house. 
His hope is to purchase and rent at +cash flow, and use that extra to first pay off the existing mortgage, then the new one. 
But he has become concerned about the economy and in particular, a bank run and losing the savings he has. Hence the question of what to do.

Jon Holdman · Answer

$13,000 in vacancies seems pretty reasonable, actually.  If they rent for $500 a unit, total scheduled rent for a year is $6000/unit or $240,000 for the whole year.  $13,000 is 5.4%.  Now, if rents are $200/unit, that's pretty high.  If rents average $1000/unit, that's really excellent work.

The problem with expecting 5% appreciation going forward is that we've just been through a period where its been MUCH, MUCH higher.  So, at best, prices are going to be flat until the long term trend catches up to the current prices.  More likely, prices will decline in many places, especially anywhere that's seen massive runups.

Look at Shiller's analysis in the latest version of "Irrational Exhuberance".   While prices have gone up and down, the historical trend has been inflation.  Take out inflation, house prices are flat for the last 100 years.  Except a period from the great depression until the end of WWII when they were depresses below that trend.  And, except for the last few year.

Jon

Lynn Z · Answer

Good input from everyone.  My family has 40 rental units from the 70's and they just added up $13000 in vacancies this year (and they do this full time themselves) which could really make life better had that expense not occurred.

Today on the TV I heard that the average appreciation for housing in the US has been 5% traditionally.  Minus inflation that's not much for the risks we take.  Rents haven't risen proportionally with property taxes and insurance so if you don't have cash flow........?????

Real estate ought to return 12-15% according to Dave Ramsey who did go under in Nashville in the 80's investing in real estate.  It sure seems it should be higher than 5%.

Mary-Beth Morgan ccl · Answer

I know I am new here but just thought I would throw this in here. 
What does your 70 year old friend want to leave behind and to whom? I know that sounds awful but it is time for him to be realistic. Is he trying to just have income for himself or set up some children and or grandchildren for a better life for years to come? If setting up his family member for success is not his intention, why pay all of his money into one or two places to only leave it the family to sell and have all the cash to play with? If his goal is to have an income and enjoy his life, I say do not pay off the mortgage. I say invest the funds into other income producing investments with as little cash in as possible (and still see a monthly income of course) and use those tax benefits as much as possible now. Let the family worry about selling the properties years down the road. Of course he doesn't want to leave the family debt so he should have a fund set up in an estate with at least 6 months if not more of payments to allot time for the property to be sold. 
Just a suggestion from this little corner. :)

Lynn Z · Answer

Of course, I agree that at 70 too many eggs in the real estate basket isn't a great idea right now.  Here's what he could do.   Pay off the low interest rental house mortgage and keep his $15,000 go to a commercial lender and cross collateralize the down payment with the clear rental.  We borrow 15-20 year 5 year balloons and cross collateralize all of the time.  .5 pt. close and little paperwork.  If he needs fix up money for the acquisition he needs to ask for that.  We get interest only payments for 6 month to a year for the fix up months.

Then he can go out any time he wants and get a long term loan.  The rate on the commercial runs about 7.25-7.75% this year.  I'd select the  20year amortization.

He may have enough equity in one of the other houses to cross collateralize the down from one of those.  I've done that too.  Encourage him to really study the rental market in the area he's buying.  It's been difficult here this year except for 4 bedroom 2 bath houses rented to students.

Lynn Z · Answer

Try getting a job at 70 despite AGE discrimation laws.  Or why limit the number of mortgages from most lenders  to an investor at 10?  Makes no sense to me.  It doesn't matter what their ability to repay is. It all has to do with perception of risk and what Fannie Mae says.   I"m sure my CPA sees people trying to get loans and having difficulty because of age.  If the ability to repay is relevant (one wonders) than why would you lend to someone 70 a 30 or 40 year mortgage?  Doesn't seem practical.

Yeh, DR for $100.  Good buy.  Lots of people with assets in my class  but no spending control.  Lots of common concern across the spectrum. The wealthiest person in the room bottoml ine was the trailer park investor and he was highly leveraged.  Go figure.

Jon Holdman · Answer

Once upon a time, many mortgages were callable by the bank.  If the bank got into trouble, they could call in loans to generate cash.  That's not the case anymore.  So, there is zero risk of a bank run resulting the your friend's mortgage getting called.  Now, subject to deals are another story...

Might things get really bad, and the value of dollars plummet?  Yeah, that's possible. Might there be a massive run like there almost was on Northern Rock in England?  Yep, could happen.  I consider those things pretty unlikely.  Not impossible, but not likely, either.

I think its even less likely that money your friend has in the bank will up and disappear.  Its insured, and the US government is not going to let that just go away.

If things really get that bad you better have a place to hide out and lots of ammunition and food.

I do think a significant bump in inflation is a real possibility.  The Fed is going to pump money into the system and keep rates low in a (IMHO futile) attempt to prevent a recession.  At some point that will backfire, and inflation will kick in with a vengeance.  Its going to be just like Wile E. Coyote running off the cliff.  Having investments in real assets, like houses and gold, will be very lucrative in that environment.

That said, I believe in diversification.  Having all his assets in real estate is not a good plan, in my opinion.

Jon

Lynn Z · Answer

My CPA said it gets harder to borrow money the older you get.  If that is true, it's not just the issue of having $15000 down. $15,000 represents 20% of the buy.  Many of us kick in on a 15 year mortgage to pay principle and interest off early but not when I'm 70.   Besides he needs a 6 month emergency fund for himself and 6 months for each rental property.  If he goes to a DR course at the church for $100 he'll hear wealthy people talk about what a bind they're in.  He'll feel lucky.

As an oldie, you no longer get to do what feels good at the moment.

Eric Foster · Answer

Borrowing is based on income, credit, and debts...  not age! So if his income allows him to borrow at 18, 35, 55, or 103... Nothing changes... I once did a 30 year mortgage for a 96 year old… (or some age like that) Believe me… I was doing the math…

As far as DR? Are you meaning Dave Ramsey? If you are, that is the first time I have heard him mentioned here... Good for you.

Yes, you are correct... sounds like he is in not that bad of condition financially. He should do what makes him happy, and feel comfortable.