First Duplex Rental Investment: What to do with cash flow?

Question

Soo... I did it! I’ve officially made my first real estate investment and closed on Friday; A duplex in an awesome area next to a new Cerner w/ a long term tenant in one unit and another long term tenant coming soon following my background check. I’ve run the numbers like a madman and everything seems to check out with a CF of about 650/mo.

But now what?

I’ve seen lots of articles about strategies with buy and hold in regards to duplexes. I can pocket cash flow in an effort to build capital for my next investment, life hack (I’m not doing this), or I could put every dollar the property generates and make double payments on my mortgage.

I’m teetering between pocketing the cash flow and investing the cash flow back into the property. The difference between the two “seem” to be the following;

-Pocket CF

PRO’s: regaining of down payment, self-generated on-hand cash reserve for emergency repairs

CON’s: TAXES!!!!!!!!!!#!@@!1!@321#1#$!!

- Put CF into mortgage payoff

PRO’s: Safe haven to protect from taxes (?), quicker payoff (possible 8/9 yrs.)

CON’s: ehhh... take longer to build for next investment?

I suck at explaining myself in some regard, but I feel my question is straight forward. What pros and cons of each could I be overlooking? What strategy should I follow to get the best benefit from this investment? What tax benefits should I be aware of, strategies that can help solidify the next investment, or other cool stuff that those of wisdom may provide?

Let me know if I left out pertinent details.

Joe Scaparra · Answer

@Leaven Phillips Congratulations, You my friend are doing it exactly as I started 15 years ago. I love my duplexes, keep it going. Here are a few tips: Regardless of what you decide to do with the extra cash flow do THIS FIRST!1. Set up a separate bank account for all monies going into and out for your rental property only! Don't mix and match income from your job, or living cost.....Period!!2. Take all cash flow first year and keep it in your duplex account for maintenance reserve. With $650/mo positive at the end of 12 months you will have $7800 plus the first month of owning you have no mortgage payment so all rent goes into maintenance reserve 1st month estimated at $1600 (800 per side, you never stated what your rents are) and lastly you have deposits estimated at one months rent $1600. So at the end of one year, barring no maintenance you will have 7800 + 1600 (1st months rent), + 1600 deposits for a total of $11,000 maintenance reserve after 12-13 months. 3. With maintenance reserve secure, now comes your big decision. Do I pay down the loan or use the money to acquire more property. IT DEPENDS...what is your goal, how old are you, what is your monthly cash flow for living, excluding your rental property. You will have 13 months to think about this before you have to even make this decision. I was a bit conservative when I started and I had excess cash flow from my job. So after the first year, I started paying down debt, at the same time acquiring more property due to excess cash flow from my job. As I acquired more property, I took profits from all properties and paid down on note. First property paid off in 8 years due to this strategy. I am now 62 and getting ready to enter retirement with all properties paid off. However, if I was younger when I started and my goal was to get 50 or more doors etc then you might not pay down notes but use it to buy more properties. 4. You will also need to improve your landlord skills. I avoid buying two story duplexes.....my future renters are baby boomers on SS that can't walk up stairs...BTW they will be your best renters. Don't replace carpet with carpet! Enforce late fees from day one your job will become easier! Don't let a renter get behind more than two weeks without at least giving a vacate order. I give the vacate order just to preserve my options quickly but rarely do I have to follow through with the eviction process. Always make your rentals the best looking and best kept up in the neighborhood and you will have no problem finding quality tenants.5. Lastly, I go by this motto: I use my money to secure the loan (20%), I then forbid myself to use my own money on the property. I use tenant's money for all the rest. Exception to the rule is if I buy a property that I will rehab in the process of buying then I usually will use my own money to do the initial rehab. Essentially your buying property 20 cents on the dollar and it should be paid off between 10 and 12 years.

John Underwood · Answer

@Leaven PhillipsIf it were me I would not make extra payments on the mortgage. Leverage is what can help you build your real estate empire. If you have a 6% loan then you are only making 6% on the money you are paying down your principal with.You can make a much better return on your money with other real estate investments.Put that money back for emergency repairs and for the down payment on your next investment property. Buy another duplex or a quadplex as soon as you can get the down payment.Once you have equity build up refinance and get some cash back to buy more properties.Also owing a high percentage of the value of your properties to the bank is a form of asset protection. It is less likely that someone would sue you over a property that you have very little equity in.

Mark B. · Answer

I agree with what @Joe Scaparra said. Once you have the separate bank accounts set up, I would just let the money sit there for a year and see where you end up. I bought a 4 unit back in December and was worried about what I would do with all the money I had at the end of the first year. 7 months later and I'm worried if I'll have any at all lol.Once you do set up your reserves, I would look at the situation you in and what your goals are. For me, I want to keep the money separated and use it towards my next down payment. If i was not in a growth phase, i would probably use the CF to start paying down my mortgages to get the big CF sooner

Thomas S. · Answer

Save for reinvesting. Based on your stage in investing you have no true idea what your cash flow is so you would be best to ride things out for a while. Do not put any money on the mortgage. It becomes dead equity and will only hurt your cash flow as John suggests. Paying down a mortgage on a income property reduces your cash flow and amounts to money hoarding. Interest payments are deductible, you do not want to pay money to lose money. This is the most expensive possible way to buy artificial cash flow. It is a home owners mentality not a investor wishing to expand.Leverage generates cash flow, equity kills it.

Daniel Dietz · Answer

I will let more qualified people explain the details, but paying down the loan does NOT change your tax situation at all. The 'profit' is the same, you would just be choosing where to put the dollars which is not an 'expense'.I save save it up for future down payments and it could also be there in the mean time for emergencies if needed.Dan Dietz