Strategies for Allocating Cash Flow

[Eric D.]

I am seeking financial advice about what to do with my cash flow which is $1k each for two multi-families -- invest it in the market or pay off the mortgages more quickly? Or something else?

Basic info: within the past year, I purchased two multi-family rental properties in north NJ in the $400k-$500k range, putting down 25% and obtaining 30 year mortgages (4.7% and 5.25%). I owe a little over $300k on each.

After paying my mortgage/tax/insurance, I cash flow about $1k per month for each.

I hear that paying off extra on your mortgage within the first 5 years can really shorten the life of the loan. And it is like making an investment with a guaranteed 5% return in my case.

OTH, by paying off the mortgage with the cash flow, I feel like I would be too heavily invested in my properties and should diversify. Further, I feel like over time the home value and rents will increase so that it is not really necessary to allocate money I could use now into the mortgage.

What would you do?

[Evan Kirkpatrick]

My #1 question whenever someone asks me this sort of question is this - what are you trying to achieve by owning real estate?

If you're just looking to invest cash somewhere, paying down mortgages isn't the worst.  It's a guaranteed rate of return equal to the interest rate.  It's not super liquid, but for a risk-free investment it's not that bad.  Also, under 2018 tax rules, if you're paying down the mortgage on your primary residence you may not even be costing yourself the mortgage interest deduction, since a lot of people aren't going to be itemizing anymore anyway.

However, using your cash this way is very conservative. Most people get into real estate with grander goals than that. If you ever want to use real estate to do more than just supplement your income, then you need scale. To scale, you need capital - for down payments, operational costs, what have you. You can get this by involving other investors, but if you're trying to maintain 100% ownership of all your properties, you have to have some money to bring to the table to start the BRRRR cycle or whatever other mechanism you are using to make profit and cash flow in real estate. If you're looking to scale, then you need to hold on to cash flow and use it to build up the war chest to do more deals.

So, that's the choice - if you're not trying to expand, paying down mortgages can be okay.  If you're going to do more deals, then that's not what you want to do.