Payoff investment property?

Question

I have an investment property (thats rented out) that I am paying monthly mortgage on. I still have ~60% loan left the property. I now got cash that could payoff 20% off the loan. Is it wise to close the loan or use the cash to invest on another property?

Joe Villeneuve · Answer

NO.  You don't have 60% of the loan to pay off...your tenant does...and if you have positive cash flow, they're doing a great job.

The only thing you pay for a property is what comes out of your pocket.  In this case, it should have only been the down payment.  When you add out of pocket to the mortgage, it doesn't help you...it hurts you.  The more YOU pay on it, the more money you have to recover before you start making a profit.

Steve Vaughan · Answer

Personally, I only accelerate higher risk and/or higher rate loans and I have quite a few free and clears.

High risk loans = commercial, portfolio, blanket, seller--financed, adjustable, callable or with a balloon.

Higher rate = 6.125% and up.

Paying a loan down 20% doesn't really help ya other than shortening the term.  The payment stays the same, but now your cash is illiquid.  Good to consider options, though.

Theresa Harris · Answer

@Saravanan Varadan  There are a few posts on this and it depends on your goals and how you feel about debt.  As you want to buy another property, I'd use it as a down payment for another property.  This is assuming your income to debt ratio is okay and the bank will loan you more money.

Mike Krieg · Answer

@Saravanan Varadan I'd definitely be in acquisition mode. The Fed and Congress have almost guaranteed a long and steady devaluation of the dollar through QE. What was once unusual has now become the norm in terms of monetary policy. Get assets and borrow.

Tyler Gibson · Answer

@Saravanan Varadan I would put it to another unit. Even if you are worried about property values dropping, the reality is that we buy and hold investors should be investing for Cashflow and long term growth. People will always need a place to live so I worry little about a correction to home values. Because in 30 years the property will likely be worth more than I pay today and if it cashflows I am not really paying for it. In 20 or 30 years you should have plenty of equity to make it solid investment regardless of what the value is at that time. Putting the money into the existing mortgage will not increase the value of the property or increase cash flow.

Jim Cummings · Answer

@Saravanan Varadan. I'm not smart enough to talk about Quantitative easing & tightening, flow charts, etc. I'm in envy of the folks that understand all that and can translate it to the audience.

When faced with a similar issue - I ran the numbers. If I paid off my rental property - my Cash Flow went up by about $200. By using the money for down payment on a new property - I was able to gain about $400 in Cash Flow. Easy decision!

George Gammon · Answer

@Saravanan Varadan I really like the way you're weighing the macro environment in your decision making process.  But with all due respect, I think you know just enough about macro to be dangerous.  Which is nothing to be ashamed of, I was right there with you when I started my macro/REI journey in 2012.  Keep thinking about it and keep learning, it'll serve you very well in your investment career.

That said, let's dive into your question.  Should you take the money and pay down the debt on your cash flowing prop or reinvest it into another prop?

Short answer is reinvest.  Here's why and how...

First I want to get your macro bearings straight.  The Fed has been reducing the size of it's balance sheet (QT or quantitative tightening) since 2017.  In other words the Fed has not only been reducing the size of QE, buying bonds, it's been doing the opposite, it's been selling bonds.  See chart of Fed balance sheet.

I think this chart is especially interesting because it shows the S&P, which is now near all time highs.  But compare the direction of S&P with the direction of the Feds balance sheet.  Not an exact correlation.

I'm by no means saying they aren't connected.  I think the S&P would be much higher without QT but that's another topic.

Now let's look at a chart of home prices and compare them to the same time frame as the Fed reducing the size of it's balance sheet.

You can see there's no correlation between QT and housing prices.  One could argue home prices would be higher w/o QT, but QT definitely didn't cause the housing market or the S&P to tank.

Having said all that, we know the Fed will most likely start lowering rates.  Another poster rightly pointed out, what was "extraordinary" measures (QE) is now part of the Fed's normal tool kit.  And they'll use this tool to do their best to create inflation.

It's likely we'll see QE4 sometime.

The government is 23 trillion in debt, and it's headed one direction...up.  So they desperately need inflation, and I think the Fed will do their best to accommodate.

The Fed knows the economy is built on 3 things... 1. Debt  2. Asset prices 3. Confidence.  Without increasing asset prices (nominal), or worse yet, decreasing asset prices, the house of cards comes crashing down.

This is why I suggest owning the only asset denominated in US dollars that's currently cheap, 30 year fixed rate mortgages.  In an inflationary environment theres a transfer of wealth from creditors (banks) to debtors (real estate investors.)  As long as you're buying SF starter homes in linear markets (like midwest and south), under the cost of construction, your downside is limited but your upside (when you consider inflation) is huge.

It's the exact asymmetry you want.  Small downside, big upside.

So if you pay down your debt you reduce the amount of wealth transfer from banks to you.  If you increase your exposure, wisely (prudent LTV's, always cash flow positive) to 30 year fixed rate debt, you'll increase the wealth transfer.

There are several other reasons to invest in more props, but they've been covered well on this thread.  I wanted to give you a different way of looking at the same question, even if my final answer to the question is the same.

Good luck,

George

Account Closed · Answer

San Jose market price has declined last 12 months already, in a declining market, I would not purchase additional property during to the high risk of the property value will sink more in the near future. Instead, I would reduce the debt, like what you said, pay down the mortgage to save interest.

Brian Garlington · Answer

@Saravanan Varadan    In your scenario...debt is your friend.

Mike Krieg · Answer

@Saravanan Varadan Yes, it is certainly true that certain markets are susceptible to this pull back. I'd be careful buying properties where the price to median income is disproportionate. If you stick to affordable housing within the range of what is affordable to a median income, buy right with a healthy down payment, you can mitigate that risk. Even in RE there are no guarantees. We are risk managers as well as capital managers.

Payoff investment property?

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