Pay off Property?

Question

Hello, I'm curious about the advantages and disadvantages of paying off my investment property.  I currently have enough savings to pay off one of my investments (which has a 15 year loan) completely.  On a monthly basis, I do not make a profit on the property, but do almost split even.  So, since I do not make a passive income from the property, I can't normally write off any of my expenses (rental losses, hoa, etc.) from that property on my taxes cause my household income is too high.  However, I am able to write off the interest and depreciation on my taxes.  I'd like to hear your thoughts on the advantages and disadvantages on paying off the property.  Thanks in advance.

Amy E. · Answer

Have you talked with a CPA about starting a business?  It seems like you would reap more tax benefits that way vs. trying to deduct stuff from your personal taxes, unless I've missed something.

I prefer to pay things off because my goal is a minimum net cashflow per month for as little effort as possible.  That said, I've run the numbers and it does make more sense from a purely dollar value standpoint (ROI, total net profits, CoCR, etc.) to leverage properties to buy more properties. But you've got to have a balance of this with your personal goals as well.  After all, most of us don't want to own a huge real estate company, we want X amount and when we get it we'll stop.

One thing that seems a bit off, though, you mention the property does not profit.  If that's the case, you should likely just sell it.  Sounds like it may just be a bad investment.  Paying off the debt may allow you to get some profit, but it won't make it any less of a bad investment and if you sold you could use the money to buy a more profitable property.

Joe Villeneuve · Answer

I never pay them off.  I never pay them.  My tenants do.  Basic math tells me not to.

Typical Example:   Property ARV                    $100,000Cost                                      90,000Cash in (20%)                       18,000Loan                                     72,000

Rent                                   $1000/moExpenses (T.I/etc...)               335CF w/No Loan                        665Loan Pmt                               365CF W/Loan                          $300/mo

Loan Payoff CF ($300/m = $3600/yr)Years to Payoff                       20  ($72,000 loan)Profit (CF) during Payoff           0Profit Lost during Payoff    $72,000  ($3,600/yr * 20 yrs)Years saved                            10      (120 mortgage pmts)Cash saved                        $48,800  (120 mortgage pmts)Net LOSS                           $28,200

Paying out of pocket (or from cash flow...same thing) on something that the tenant is already paying for makes no sense.  Worse, it makes not dollars.  The "higher cash flow" is an illusion.

Account Closed · Answer

Your rental* - I would sell it if it doesn't cash flow now. You may fare better selling it as a primary without a tenant inside. Then find a better rental 30 min further south from NOVA/DC.

I haven't paid off any 30 year low fixed rate mortgages. They all  cash flow well, but tenant's principal pay down is really slow. I can  rely on it now as I'm still young.

I have paid off short term loans used  for the down payments however as they can affect my ability to acquire  more. Helocs, 401k loan, OPM- not comfy borrowing long term etc.

Anthony Dooley · Answer

Paying it off will double your cash flow.

If it doesn't cash flow now, you probably over-paid for it.  Other ways to increase your cash flow is to shop for less expensive insurance, make sure you are at market rent, and self-manage the property.

If you over paid, I would probably sell the property and buy a better investment.

Steve Vaughan · Answer

I love paying off mortgages, but the riskier commercial kind. Not even I race to accelerate 3% fixed rate debt once I'm at 80% and don't have PMI.

Having a mortgage for the 'tax benefits" is absurd. Send me $10k, and I'll return $4k any day of the week.  Increase charitable giiving vs lining the pockets of the likes of Wells Fargo or Dimon.

High income earners need investment property with low land value. I have a couple apt bldgs at 3%. That means 97% depreciable. Have depreciatiion coming out of  my ears and could qualify for free school lunches on paper.  Can also look into condos for the same effect.

My mgt and consulting s-corp allows for contributions to a defined benefit retirememt plan up to like $35k/yr if it makes that much. That reduces income in the year earned dollar for dollar.  Lots of things we can do and that's the beauty of the business!

Zach Ward · Answer

are there no credit unions or small,home town, banks where you are? They love landlords. Open an LLC and use one of them to refinance your loan. Who cares if your APR goes up a little. It doesn't make a huge monthly cash difference. Also, who cares if you have a bunch of equity with no cash flow...you can't eat equity, cash is king. Renters are paying your interest not you. My preference, 20% cash on cash return and about 30% equity for  decent leverage. I want 200-250 monthly positive cash flow to play with or save.

Ashley Ben · Answer

If you're already 70% paid off, I think it's worth consulting a CPA on how to restructure so you're optimizing tax breaks.

John C. · Answer

This has definitely given me quite a bit to think about.

@Chris Tan - my current mortgage rate is 3.375%.  With regards to finding something that would give me a higher return on my money .. I am not sure.  The area I live in is fairly expensive and properties are pricey.

@Amy E - thanks for your suggestion, I will chat a bit more with my CPA about the LLC.  Last I spoke with my bank, they told me they would call the loan, so I had just paused there and thought I would create a LLC once the property was paid off.

With regards to the cash flow issue, this is definitely something I have been thinking about lately which is why I considered paying the property off early to create a cash flow and use the snowball effect to help me pay off other rental properties.  Would this be a good idea?  I will note, I have been thinking about buying a larger house for my personal use, so I am still weighing out the pros and cons of having less liquid capital for a larger down payment.  Welcome any insights.  Thanks!

Amy E. · Answer

An LLC is a business....I file a form 1065 with mine.  I am too high of an income to just claim a loss, but I can carry loss over and deduct it from the next year I have a positive income.  I also get loans in the name of my LLC (that I personally guarantee).  Talk to the bank and say that you want to transfer it for liability purposes and ask what the options are for lending to an LLC, I have better luck with small local banks for this.

My CPA said the easiest way to save money on your personal taxes is to start a business; because you are actually spending money on the business of owning a rental property, but right now you can't always claim the deductions whereas the business could.  Talk to a CPA, I get a lot of this stuff confused, which is why I hired one.

It sounds like you bought this property as a buy and hold.  Long term, you are going to pay much more in interest if you extend the loan term.  So, as a long term investment, you need to weigh your total life cycle costs that are going to increase if you refinance vs. the short term "cashflow" gain right now.  Extending the loan may bring more cashflow now, but at the price of a lower profit when you finally sell.  You need to look at the total lifecycle costs (purchase price, rehab, upkeep, interest, taxes, insurance, etc.) when you are doing a long term hold.

Its really hard for me to believe that a property that does not cashflow at a 15 year loan term is a worthy investment to keep.  Surely there are other properties in your area that will cashflow at a 15 year loan term and also appreciate?  But I do recognize each area is different, so maybe not.

Chris T. · Answer

@John C.

1 of the biggest reason investors set up LLC for rental houses is for liability reasons. Most banks would probably not call the loan even after you do a quit-claim deed under a LLC. Of course, there are some that could. Best talk to a CPA / asset protection attorney. It sounds like you have some significant assets so you want to structure it correctly.

What is your mortgage rate on the loan? Do you think you can get a higher return on your money else where? If you do, then you should refinance, take out most of that equity to buy more rental houses.

Or if you have a high mortgage interest rate and/or it gives you a piece of mind to pay off the properties, then pay it off asap.

It depends on your comfort zone and risk tolerance.

Pay off Property?

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