Payoff a rental property when I am renting a place myself??

Question

Hi there!

I am very new to the concept of investing and I have a few questions. I have done enough research to know that it may be wise to invest money that gets a higher rate of return than my mortgage interest paid, but that's the extent of my knowledge at this point. I left CA and moved to CO in 2016. When I left CA, I rented my house out and subsequently rented a place in Denver while I figured out the lay of the land & decided where I'd like to buy. I owe $185,000 on my house in CA @ 4.375% interest and I have enough cash to pay it off. Or, I could use all or some of that cash as a down payment on a place here in CO, but I worry that the market here is increasing at rate that it cannot maintain. I am seeing houses that sold for $230,000 in 2015 on the market for $440,000, etc. Buying right now in this market feels too much like CA in 2008 when everything was overvalued & came crashing down. Investing the money in a rental property would make sense if I owned the place I'm living in, but I don't. My initial choice was to buy here in CO using the cash as 30-40% down payment, but then I got nervous I'd be buying too high. Then I thought I'd just pay off my house in CA and pocket the rent as profit every month. The rent collected would offset the rent I pay in CO, giving me time to wait until the market softens here before I buy. After talking with a few people, and reading some forums, I feel there may be a better way to do it, but I need some advice to help me get some clarity. Paying off my house in CA has minimal risk, whereas putting a large chunk down in an overpriced market is a big risk. Does it make financial sense to buy a duplex or 4plex in an affordable market as an investment property when I am currently renting myself? If so, will that hurt me in terms of getting a mortgage down the road when I find a place to buy here in CO? Common sense tells me that getting approved for 3rd mortgage when I want to buy a place for myself will be difficult, but maybe investment properties are viewed differently?  If any of you have some advice, I could really use it. Everything is as clear as mud on my end.

Thanks

Bill S. · Answer

@Andrew McManus so from a supply and demand standpoint, the Denver market still has lots of legs. Also one item not mentioned in previous discussion is interest rates. Interest rates are going up. Waiting has incredible interest rate risk. Not sure what increased interest rates will do to demand. I do know this, rent rates are not keeping up with property costs. At some point, those two will need to come back together. At the end of the day, if you are investing in real estate, it must pay for itself. Now from a 30,000 ft level, in 30-40 years we will laugh at how cheap the properties were today. Timing the market is a fools game.

Jared Bouzek · Answer

@Andrew McManus In my mind, paying down your mortgage in CA would be the worst thing you could do. Then the only way you could get the cash back out of it to invest later would be a HELOC which is subject to the rapidly rising interest rates or a c/o refi at a much higher rate than you have now. Having the rate you have currently on an investment property, I wouldn't mess with that mortgage. Also as mentioned above, your effective return on a paid-off property is not the best use of that dead equity.

Ultimately I think this comes down to your time horizon. If you're a short-term 5-7 year investor then maybe you do struggle with the thought of investing right now. Denver is not unique in that our market has intense pressure on it due to lack of supply and pent up demand. There are many cities like this across America, and as @Matt M. mentioned, those economic factors don't turn on a dime barring major political/economic events. My personal biased opinion is that over the long-term picture of 20-30 years, Denver will be an excellent market to hold real estate in. Attempting to time the real estate market will be about as successful as attempting to time the stock market.

You would be better off investing your money into a new property locally and allowing the long-term effect of real estate appreciation build your wealth over time. House hacking would be an excellent way to get started on that path, and if you have that much cash saved, you probably have the ability to house hack and even invest further if you choose. As far as your question on continuing to purchase more properties, if you're buying good properties that make sense from an investment perspective, your rent should net out most of your mortgage payment and help keep your DTI under control.

Andrew McManus · Answer

I really appreciate the perspectives from all of you. Definitely some more food for thought. Given all of the advice and some more thought, I may just bite the bullet and buy in CO.

Thomas S. · Answer

Paying down a rental property mortgage is not investing, it is parking money that you have no further use for. It is money you place no value on. No investor worth their salt would be happy with a 4% return on their investment. Dead equity is hoarding not investing.

My advice would be to sell the property in CA and move your cash to where you now want to invest.

Matt M. · Answer

For the past 4-5 years, I've been hearing people say the market is going to soften or crash, etc in this town. And it hasn't nor will it for the next few years. I've got a few clients that waited on the sidelines and finally bought something a year later for 20-30% more.

We have had around a month of supply for a while now. There are too many people looking to buy. Supply has gotten worse in the past few years and is floating at a new low. It won't shoot up overnight or even in 1 year. Barring something catastrophic, our prices will continue upward.

With the amount you'd be putting down, you should be able to weather a storm as long as you ride it out.

I'm buying my 3rd place this year in two weeks and looking for more.

Samuel Pawlitzki · Answer

@Andrew McManus Have you thought about paying some of it down and refinancing to get a really low payment but still hanging on to some of the cash so you can pull the trigger on a deal in CO when it presents itself?

Matt M. · Answer

I never said it would go up forever. Most of us on this site went through the 2008ish market. I personally was front and center to what was happening here in Denver.  Right now I'm in the trenches in our market in investment and retail and completely disagree that we are in a bubble.

Andrew McManus · Answer

@Matt M. no real estate market just keeps going up forever. Sooner or later, inventory will catch up with demand or other economic factors will level it off. Real estate markets that have home prices doubling in less than 5 years are not sustainable. I lived through this type of thing already. I bought my CA house in 2002 for $144k. By 2007, it was appraised at $460,000. Only to drop to $190k by the end of 2008. Now, it's around $325k, right where it should be.  The thought at that time in CA was that it would continue forever too, but it didn't. It was bubble, just like Denver is now. The bubble may still be getting larger, but it's still a bubble.

Andrew McManus · Answer

@Samuel Pawlitzki  I have also considered that as an option.  It is just that none of the options that I have considered our jumping out at me as definitively the right decision.  Refinancing the existing mortgage in California instead of paying it off sounds like a way to kind of land somewhere in the middle.  I will have a much lower payment for the mortgage, while retaining some cash for a down payment here in Colorado.  This may be the direction I choose unless I can find a strong argument otherwise.

Payoff a rental property when I am renting a place myself??

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