Equity in multi-family dwellings

[Tim B.]

Morning,

I've got a question with regards to equity in rental properties. Would one be better off to pay a rental unit off with the income he/she receives from it or reinvest in another rental? It seems to me that paying it off would be a good deal considering it's a lot lower risk and you get more income with it being paid off. I don't know that I would feel comfortable owning 4 or 5 rental units all with loans and the possibility of them being vacant.

My initial thoughts are to get my house paid off (within the next 1.5 years) and purchase a multi-family home 2-4 unit to start. I was thinking that I could pay that off between my current job and the income I receive from it and move on to another once it's paid off. I figure I can pay a $150k loan over about 3-5 years depending on the income I receive from said unit in addition to my current job. I know this would take a bit longer to get more properties, but it'd be safer to start. I suppose I could have more units or loans once I had a few properties under my belt and a bigger safety net. My goal is to get enough rental properties to have enough cash flow to quit my job and do real estate full-time. I'll probably try to buy said properties on the low end, rent, and sell in the distant future once I'm sick of being a landlord.

Regards,

Tim

[Michael Seeker]

Originally posted by @Tim B.:

That makes sense and I figured that was about the response I'd get. I just don't want to get in a situation where I have more loans than what I could pay should I have multiple units vacant. Perhaps I'm being too pessimistic? That being said, do you guys simply save your cash flow for down payments on the next property?

The quickest way to determine if a loan makes sense is by looking at the CAP rate of the property vs the interest rate you can get on the loan. If you have a 10% CAP rate and can get a loan at 5%, then it's to your advantage to do so. If you're buying at 5% CAP rate and interest rates are at 10%, then you're much better buying all cash or paying down the loan as quickly as possible.

I'm also in growth mode, so I'd vote for leveraging to buy more properties regardless. But it all boils down to the numbers and your risk tolerance. If you invest in an area with high vacancy, you should keep a lot more in reserves to handle a scenario where your tenants don't cover the mortgage for you. Paying down the mortgage faster doesn't lower your risk until the note is completely paid off.