Buy and Hold Investor Opinions: Pay down debt, or acquire more?

Question

I'm really curious to get opinions from other buy and hold investors with numerous financed properties in their portfolios. Currently, I'm in a healthy financial position, and I have 6 rentals that are all cash flowing, appreciating and under control. These are single family residences, and 4 of the properties have Conventional mortgages. Based on where we are at in the current economic cycle, I'm interested to hear what other buy and hold investors are doing or would recommend? I'm debating on whether I should be targeting additional investments currently, or (due to the stage of the economic cycle) shift my focus towards paying off mortgages. Another thought I had, but am less inclined towards, is stockpiling cash for a shift to be able to capitalize on more opportunities if there is a shift. I'd love to hear thoughts and opinions.

David Greene, Scott Trench, Brandon Turner, I would love to hear any feedback you might have.

Joe Villeneuve · Answer

I'll second this.  The equity you are buying isn't really doing anything other than move your cash in a liquid form (in the bank) to dead equity (in the floorboards of the house).

If you have $100k to use, and you buy one property that gets you $10k in CF per year, vs. buying that same house with only 20% down ($20k), you are much better off only using $20k.  Why?  Here's a series of steps, following the money (cash), to show why:

1 - Profit comes only AFTER you recover all the cash you put into a property.

2 - If you get $10k in CF/year, but have to spend $100k to get it, it will take you 10 years to break even...all things being perfect during those 1- years (unlikely).

3 - If you get $5k/year, but only have to spend $20k to get it, it will only take you 4 years to break even...and, both properties are appreciating exactly the same.

4 - If you want that same $10k/year, you only need to buy 2 properties, at $20k/ea, which still would only take 4 years to break even on both properties....and you have two properties appreciating, getting you twice as much appreciation... and you still have $60k in cash unused.

5 - Now, spend all $100k on $20k properties, and you now have 5 properties getting $5k/ea per year (and all 5 break even in 4 years),...for $25k/year in CF...and, 5 properties appreciating instead of just one.

Steve Vaughan · Answer

If your existing mortgages are long-term, fixed in the 4s or even 5% I'd probably leave them alone. You can always pile up a massive opportunity fund.  When it gets large enough to pay one off, evaluate and buy more or pay down.  No harm in that.

I paid off a bunch but the lowest rate was 6%+ and they were seller-financed or commercial,  representing more pain and risk than what you most likely have.

Last consideration is if you have a small balance loan but are running into conventional loan limits of 4 or 10.  I paid a couple smalls off to make room for a larger deal at great terms.

Thomas S. · Answer

Paying down a mortgage is stockpiling cash, actually closer to hoarding cash.  If you do not wish to stockpile then you have your answer already.

I personally do not allow dead equity to accumulate in real-estate, too risky. If you do not want to continue to invest in additional properties pull the equity and invest it in income funds where you can more easily access it. Putting your cash in a fund is as secure as paying down a mortgage with the benefit of a higher return.

Dan Moore · Answer

You are basically asking if you should time the market. Timing the market it TOUGH. Some investors are moving to cash to do exactly what you are doing. Some are still leveraging as hard and fast as they can go. The more leverage the better. It seems the majority of the opinions here are similar to Joes, and the math works in their favor. But that math doesn't take into account your risk tolerance in a down turn. Will your properties cash flow when they go vacant for 6 months? Or when rental rates drop 20% due to oversupply or a desperate competitor? Do you have the cash reserves to weather a storm? Based on your question, it sounds like you aren't running scared, but are looking to capitalize when things turn South.

In a down turn, the world goes on sale. Everything (that we are interested in) gets cheaper. So do you pause and prepare for your estimated 14 months, miss the years appreciation and opportunities, and then pounce when the market turns? I think that is your question.

A down turn typically lasts about 4 years. We are indeed due for one but there is no guarantee of when or how it will happen. So let's go with your assumption of 14 months.

House A is currently $200,000. Call it a normal distressed buy. Call it a retail price. Call it a broker price. Whatever method you would buy this house normally during todays market.

Because the market is strong, in 14 months, house A will have appreciated to $207,000 (3.5% appreciation)

The housing market, by all expectations I've seen, isn't expected to have another correction like it did in 2008. So at the bottom of the down turn, house A is now $186,300. A 10% reduction from the 207k price. 2008 saw about a 20% reduction so we'll assume the smart folks are correct and we'll only have a normal downturn. (Remember this is an apples to apples comparison, not a grandma cannot pay her mortgage payment screaming deal). You save $13,700 by waiting. (The current price today, when you passed on the house of 200,000 minus 186,300)

You don't swoop in and buy at the start of the down turn. That is when prices are falling. No sense getting caught on the elevator ride down. So you wait till things stabilize. That would be about 3 years into the four year down turn. So your wait time is roughly four years (3 years of down turn, plus the original 14 months)

You also loose the cash flow of this property during the time period. Call it $100 per door or $1200 per year. ($5000 - 50 months x $100 per month) Yes your cash flow may not be as strong during the down turn. Rates could decrease, vacancies could go up. I'm just making the math simple, make your own adjustments.

So you saved $13,700 by waiting, minus the $5000 in cash flow, so $8,700 is what you saved.

So the question is, are you good enough at timing the market to make the $8,700 saved worth it. In reality, you aren't REALLY having to time the market. Once the down turn starts, you'll have plenty to keep you busy while the market falls. Lending will be much harder. Tenants will be tougher to keep happy (too many good places to rent for less down the street). There is plenty to keep you occupied during a down turn.

Interest rates may jack back up to their normal levels with a market correction and these current rates will be a thing of a nostalgic past. I remember when the rate on our floor plan was 14% and that was borrowing at favorable rates.Your 200k house at 5% has total interest of about $167k over a typical 30 year note. Move the rate up to what in my lifetime has been a normal rate of 8% and the total interest paid is $295k, or  $128k more over the note. That certainly blows your $8700 savings from a down market out of the water.

"But Dan, my tenant is paying the interest, what do I care?" You won't be getting the rental rate you want when your payment is $1300 per month, and all the other houses are out there at rates with payments of $900 per month for P&I. It takes time for rates to move up. If you currently have houses with interest rates of 3.0% then you know how smart you were to buy then. The same will be true if rates move higher again.

All of this disregards the house you buy for 50% of value because the buyer is distressed due to the economy, and all the other amazing deals that will be on the street. But if you are in a long term game, low rates and time (and payments) already behind you are two of the best things that you can have going for you. Even buying your 200k house at 50% off would be wiped away by just going back to normal interest rates during that same time period.

Just my .02.

Personally I'm buying with cash to find deals in todays market. Holding for the long term and financing with a 50% LTV once the property is rehabbed and rented. That makes me liquid enough to cash flow whatever comes, but allows me to double my purchasing power over straight cash. If rates go up, I'll be sitting pretty with a low interest rate. If rates go down I'll refi and pull cash out. If rates stay the same, I'll keep buying 4-5 properties per year. I say this so you know what kind of moron is offering you advice. This is the internet, after all.

John Underwood · Answer

@Seth M. Jones Your properties are cash flowing therefore your tenants are paying off the mortgages.  Let them keep paying for your properties, meanwhile be buying more.

Jay Hinrichs · Answer

your in the lending field in a down market how does lending work ??? last big down market it froze like the artic.. there were no loans for investors..  all the big players pulled out.   So it was the cash buyers who cleaned up .. I was buying foreclosures in Ft myers Le high and Coral for 25 to 50k a house .. those were selling 4 years earlier for 200k.. no financing you need the bucks.

in my mind all of you folks that like rentals.. as long as your tenants are doing well and your well positioned vis a vi your local economy then keep the train running if that's what you want to do.. Obviously right now its not like it was 10 years ago.. and who knows even in a down cycle that could mean just no more appreciation and prices settle to a mild re treat on valuations. But unless we have another mortgage crisis with millions of vacant foreclosed homes your not going to see a repeat of those buying opportunities 7 to 10 years ago.

At least I don't know any one who currently owns real estate that is wishing their properties drop in value drastically. I get it does not matter you have cash flow but you then have negative equity and no liquidity.

Seth M. Jones · Answer

Great points Thomas S., I haven't been looking at it that way, but what you say definitely makes sense. Joe Villeneuve thank you for your added perspective... Thanks everyone. My primary question revolves around strategy in regards to the market cycle... however it sounds I'm definitely hearing a strong consensus that the money shouldn't go towards paying off the mortgage.

I generally am of the same mindset as that. I spend a lot of time studying the markets, especially in Central Florida, and I've developed the opinion that we are about 14 months out from a buyers market. With that thought, I've been thinking about paying off a couple mortgages in order to free up my ability to really go all out in the next buyers market, utilizing a lot of leverage. Does anyone have any input regarding the original question as it relates to where we are in the current market cycle?

Johann Jells · Answer

I don't see how this is relevant, since any investment during the same period deals with the same inflation number.

I feel some of the perspectives here are skewed. I don't see equity as cash, it's simply license to borrow at prevailing rates. So keeping cash rather than paying down a mortgage isn't free, it's costing you that rate. Borrowing from equity to purchase isn't really paying cash, it's simply timeshifting your borrowing to create a purchasing advantage against someone who would need a loan dependent contract, all the while paying interest between the time you borrowed and when you buy. Short term investments that pay more than your mortgage rate have inherent risks.

Your opportunities are in the difference between that refi rate and your return on another property.  So if you borrow a 25% downpayment for a 15 note at 5% on a property with zero cashflow after ALL expenses, at the end of the loan you've made only about 4.5%. So you lose some of the biggest leverage advantages of RE investing. Opportunities for higher cashflow and appreciation vary greatly regionally, and that's where this game is played.

Personally, I'm sitting on equity and cash, this market is way too high to buy, the GRMs in my area are astronomic.

John Morgan · Answer

@Seth M. Jones

I’m in your same position. I have 6 SFRs and two are paid off. My four mortgages have fairly low interest rates (3.25-3.75%) on 15 year loans. These properties all cash flow and I’m not going to bother paying them off early. If they were at higher interest rates like over 6% then I’d try and pay them off. I would keep saving up cash with the intent to pounce on a deal that comes your way in the next few years. I’m doing that and will have patience for something enticing to come along if there is a downturn in the next several years. But cash is king if something comes up on a moments notice. I’m pretty sure something will come up and I’d like to be prepared to jump on it with a low competitive offer. Ten rentals will probably be my max. Keeping track of all the paperwork work on more than ten doesn’t excite me at all. Haha

Larry Turowski · Answer

@Seth M. Jones as regards the current market cycle, paying down mortgages will not have any impact whether things get better, worse, or stay the same. It’ll save you a bit of interest but make you much less liquid.

On the other hand, it’ll help prevent you from buying more properties. And maybe that is your question. Should you stand until the market supposedly down cycles?  But not having cash will also prevent you from seizing opportunities when they arise. (Yeah you could try no money down strategies if you are set up for that but cash is nice.)

Everyone has their own sensibilities: feelings about the market; feelings about different types of debt; feelings about partnerships; etc.

I love liquidity. It allows me to jump on opportunities.  But I don’t like money just piling up not being productive. So besides rentals I also do flips. My liquidity is impacted for the duration of the flip but that is not very long and I’m always ready to jump on the next rental or flip opportunity.

Buy and Hold Investor Opinions: Pay down debt, or acquire more?

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