Pay Off Mortgage or Invest New?

Question

Hi All,

In 2013 I purchased a 153k personal residence in Menomonee Falls, WI: A SFH with 20% down and designs to stay. Instead, I was offered a better job and relocated to Chicago only a year later.

I decided to rent it out to a family member and now have roughly 114k remaining on the 4.125% mortgage. FMV for the house currently is about 170k.

The house is currently renting for $900 to that family member but I am told that come July I should be able to rent for $1300+.

In June, I will have the ability to pay off nearly the entire mortgage or take that same sum (roughly 90k) and invest that in what I would like to be a multi-family or commercial type property here in Chicago.

Any advice on what to consider with this decision? I am looking at neighborhoods like Logan Square if I go solo or perhaps joining up with a few others to enter into a nicer neighborhood or bigger opportunity.

Ultimately my goal is to generate cash flow of 60k annually within the next 3 years.

Can't wait to learn from everyone and eventually contribute!

Best,

Nick

Brie Schmidt · Answer

@Nick Klomstad - The cost of keeping your loan is 4.125% (your mortgage rate) so if you can get a better return than it makes sense to do it.

If I can borrow at 4% and get a 8% return it is a no brainier

If buying in Chicago you need to factor in water, about $500 per unit per year, snow is $800 / yr, gas/electric will depend on the property and how it is metered and what the heat source it is.

Brie Schmidt · Answer

I you can invest in Chicago and get better than a 4.125% of your return than it makes sense to do that

Michael Facchini · Answer

I personally feel the next two to three years will be a healthy market.  This past month of January (which is usually quiet) perfectly illustrated it.  The day after new years break we returned to many calls and emails requesting preapprovals, and by mid to late Jan people were making offers and getting into contract.  This isn't just my clients, but all of my loan officers' clients.  This never happens.  Usually it starts to heat up in Feb.  Point is, there are lots of buyers looking to buy their first home while rates remain low.  The demand remains high, and supply remains short.  Millenials are hitting the marketplace in droves and will continue to do so.  New construction and conversions will start to feed that demand, but the waiting line remains long for the lower price points.  Thus, the market remains active as a result....but also, not all buyers will be able to land a home in their target price range.  That means they will need to rent.  My rents have increased notably over the last few years and have tenants fighting over my apartments.  As inflation, cost of living, and wages increase, leasing will continue to hold steady.  When mortgage rates are at 6 or 7% again (not to mention higher)....and yes, it WILL happen at some point...the rush to purchase will slow down and more people will HAVE to rent.  If you're sitting on investments that are fixed in the 4's or so, those investments begin to pay further dividends as rates, inflation, cost of living, etc. continue to increase in the future.  So, we're buying in now for the long-play.  Only the pros should be playing the short-game.  Rookies made a lot of money in the short game early/mid 2000's, and then some feasted on the scraps after the 2008 disaster....but now those easy plays aren't sitting around.  Need to focus on the long-game :-)

Hope that helps and happy to talk further live as it's easier to share my 2 cents.

Thomas S. · Answer

The property you have is barley marginal as is due to the value of the property is too high based on a $1300 rent. You will eventually end up with negative cash flow if you hold. On a SFH with rent at $1300 after expenses you only have $650 to cover the mortgage and pay the return on equity.  here is how I see your investment:

Rent $1300

Expenses $650

Return on equity $466 ($56K @ 10%)

Debt repayment  $845

End result  ($661) negative cash flow /month.

If you pay down the mortgage ($90,000)  you will increase your cash flow to ($566) negative cash flow.

I would sell.

Michael Facchini · Answer

I personally feel the better move is to leverage (intelligently) and parlay that capital into another real estate investment.  There are lots of great multi-unit investments in Humboldt, Avondale, Pilsen, and other areas...some need some TLC and will result in greater ROI, and some are ready to go as-is.  Cash is king (for those looking to invest), and will be even more so as rates, inflation, and cost of living rise.  As a mortgage lender and investor, I am constantly looking at opportunities for myself as I feel now is a good time.  That said, competition can be fierce in markets such as this spring market (which is stacking up quickly), so you might have to look outside the box a little.

Tom ONeil · Answer

@Nick Klomstad It sounds like you will have a good cash flowing property come July (depending on your insurance and taxes) and you have a low interest rate.  If you have a renter who will cover all of your expenses while increasing your equity in the home, I personally would not pay it off.  Using leverage to invest in additional properties will create a greater future return.  Also, more doors = more stability (If your one tenant moves out, no cash coming in.  If you have multiple units, one vacancy does not eliminate all cash flow.).

There are a couple ways to look at it, but personally I like to keep that money leveraged at a low interest rate and allow a tenant to pay down the mortgage and build your equity.

Nick Klomstad · Answer

Thomas S.

Does this analysis look correct and if so, does it change any of your opinion(s) on how I should proceed? 1% CoC doesn't seem worthwhile based on what I see below? This has been such a great learning opportunity for me - many thanks!

SFH Rental Analysis

Purchase Price

153,000

Projected Expenses

5,155

Down-Payment

30,600

Vacancy

810

Loan Balance

114,500

Property Management

2,295

FMV

169,900

Insurance

480

Annual Debt Service   (P&I/Taxes)

10,260

Maintenance

720

Current Estimated Equity

55,400

Tax Accountant

250

Cash in Deal

55,400

Legal

400

Projected Monthly Rent

1,350

Supplies

200

Projected Annual Rent

16,200

Projected Annual Expense

5,155

NOI

11,045

Annual Cash Flow

785

Cash on Cash

1%

Rent/Cost

0.0088

Debt Service Ratio

1.0765

Cap Rate

0.0722

Nick Klomstad · Answer

Thomas S. - Does it matter at all that the expenses I've incurred over the term of the rental have a monthly average far less than $650? I've read that it's best to look at that number as long term in the event that something significant happens.

For example thus far, being self-managed I am averaging only $60/month in expenses...which changes the projected cash flow significantly. Is it unwise to use that math?

Thanks for pointing that out...hadn't thought to use that rationale.

Michael Lee · Answer

Hello and welcome to BP!  Why did you not ask a question about the BRRRR deal?  All that I saw was your opinion and thoughts of what is going on in your area.  Never did you ask for an answer to anything.  Real estate has cycles and the prices tend to be high now and until then we will continue to see high prices and rents.  No one can tell what the future contains.  You can only do what presently happening. Making any moves can be risky regarding any purchases.  Most seller's today are asking for retail prices and even more.  Do not buy unless you can buy at a large discount so you will not be caught by lower values of 20% or more from current values.

Shawn Ackerman · Answer

@Nick Klomstad man you threw the whole kit and caboodle into this deal.  Legal and supplies....Go for it my friend.  Keep pushing my friend.  Persist and you will WIN!!!

Pay Off Mortgage or Invest New?

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