Free and clear vs leveraged

[Tim Moore]

Hey guys, so I keep flip flopping on how I want to structure my real estate business plan in the future. We always talk about "good debt" on BP and I understand that you can use the properties you have to leverage into more properties, but wouldn't your cash flow be much higher if you had it entirely payed off? Part of me wants to pay everything off as quickly as possible because I don't have dreams of being a billionaire or anything. I want enough passive income to supplement mine and my wife's W2 jobs so we can focus on what we love. Does paying off your mortgage not change the cash flow as much as I'm assuming it would or what? Help me out here and let me know what you think about free and clear vs leveraging your properties to get more. Thanks BP!

[Larry Turowski]

@Tim Moore This discussion has been had so many times.  Yes, your cash flow would be higher if you owned a property free and clear.  But you can leverage to increase your net worth faster.  Consider this totally made up scenario (I'm leaving out some details, like closing costs to keep it simpler):

You have $100K to invest.

Scenario 1: You could buy a $100K property outright that rents for $1,300/mo.  Let's say your total expenses including taxes, insurance, maintenance, vacancy, management, and amortized capital expenditures (those things that are expensive, rare events, like a new roof or furnace) add up to $700/mo.  You are cash flowing $600/mo.  And likewise your net worth is growing by that $600/mo (assuming you save it).

Scenario 2: You buy four $100K properties identical in every way to Scenario 1, except with $25K down each.  You carry a $75K 20yr mortgage on each at 5% interest.  This works out to payment of roughly $500/mo with roughly $200 going to principal and $300 to interest (to begin with).  You have the same $700/mo expense on each.  Plus you have a $500/mo mortgage payment on each.  That is $1,200 outflow total.  You cash flow $100/mo per house, for $400/mo total.  Less than what you would cash flow in Scenario 1.  BUT, you are also paying $200/mo toward principal on each, $800/mo total.  So while your cash flow is only $400/mo.  Your net worth is growing by that PLUS your principal paydown (equity capture) of $800/mo, for a total of $1,200/mo.

So the question is, would you rather cash flow $600/mo and have your net worth grow by $600/mo (Scenario 1), or cash flow $400/mo and have your net worth grow by $1,200/mo?

Where people get confused is comparing the same HOUSE leveraged vs non-leveraged.  What you should be comparing is the same MONEY INVESTED leveraged vs non-leveraged.

There may be reasons to opt for Scenario 1 over Scenario 2.  But Scenario 2 will grow your net worth faster than Scenario 1.