Best use of cash - pay down debt or buy new property?

[Kris Biz]

Hi fellow investors,

I am trying to decide between paying down debt on my existing rental property or acquiring new rental property with the cash I have. Conventional wisdom says it is better to use leverage and acquire new property, and I have read articles on bigger pockets as well as heard this on podcast episodes. However, when I do the math, paying down debt looks quite appealing in my case. Here are the details.

Option 1 - pay down $211,000 debt on my rental property. At 3.875% rate, my monthly P+I is $1192. If I pay it off, I would save $14,304 per year. That is 6.77% cash on cash return!

Optio 2 - use this as a down payment (30%) on a new home purchase worth around 704k. Unfortunately, in my area (San Diego), even with 30% down you are barely cash flow neutral so there is no cash on cash return. If you consider principal reduction due to mortgage payments, you would get about 8k per year assuming 4.5% rate. This is an indirect cash on cash return of 3.8%.

Considering the higher cash on cash return, option 1 seems more appealing, so why would anyone choose to go with option 2? If I put down more for the purchase, I can improve the return on option 2 somewhat, but it still is lower than option 1. But you get less leverage by putting down more. 

Am I missing something? I am fairly new to real estate investment, so hoping experienced investors can share their insights. Thanks!

[Thomas S.]

In your area it is 6 to 1, 1/2 dozen to the other. For most investors paying down a 3.8% mortgage would be crazy. Cash easily earns a 10% or greater return when invested in a good market there for paying down a 3.8% loan is losing 6.2% return.

If throwing cash at a rental is the only way to make money it isn't really investing.

Having equity in a rental kills cash flow but if you have no cash flow to begin with there is very little reason to even own the property. It is not investing it is simply speculating on appreciation. You might as well be playing the stock market.