buy rental property or pay off debt?

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buy rental property or pay off debt?

Postby nzk » Thu May 09, 2013 1:52 pm

I have an opportunity to buy 2 homes at $200K each cash or pay down my mortgage $400K. Interest rate is 3% with $800K currently owed. Rental income will be $16K per home net per year. I know rental income would be good for long term cash flow, but paying down the mortgage will save me a lot of interest payments and give me some financial security. I do have time to manage the properties but would rather get a company to handle the headaches. I have never rented before and am eager learn, good or bad, from the experience. Which choice is boglehead worthy?

:?
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Re: buy rental property or pay off debt?

Postby OnFire » Thu May 09, 2013 2:18 pm

I have a rental house, and the mortgage on it is $130K, with a 20 year note. My primary residence has a 30 year note with a $160K note. I am only four years in on the rental, and one on the primary. My wife and I gross about $180-200K a year. Two young kids. We live in a very stable neighborhood and have very stable jobs. Me a firefighter, her, a dentist. The rental house is cash flow neutral.

How is your income? Are you maxing out your tax deferred space? Emergency fund up to snuff? Stable career(s)? Any experience as a landlord? Are you handy/can you fix things, but choose not to? How much will it cost to pay a management company? How in tune are you with the real estate market? What kind of neighborhood? Stable families? Or young, party area with lots of turnover? College town? Is there one factory in town that's about to close?

In absence of an other data, I would say pay off your mortgage. 800K is a big nut. Unless you're really sure that you can have near 100% occupancy, and the management costs are VERY low.
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Re: buy rental property or pay off debt?

Postby xGLORYx » Thu May 09, 2013 2:30 pm

www.biggerpockets.com <-- Real Estate forum dedicated to the REI

$16k on $400,000 isn't a good return, and when you say $16k Net, what is that? If you head over to the forum I posted above, you'll learn about the 50%/2% rule. BEFORE you jump in to any deal ~~ please make sure to do your full due diligence. I've seen WAYYY too many investors go belly up because they got way in over their heads.
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Re: buy rental property or pay off debt?

Postby abuss368 » Thu May 09, 2013 2:36 pm

Consider investing in REITs I stead. Dividend checks can be a great source of retirement income without the headaches.
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Re: buy rental property or pay off debt?

Postby TRC » Thu May 09, 2013 2:44 pm

Pay the mortgage down.
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Re: buy rental property or pay off debt?

Postby MindBogler » Thu May 09, 2013 2:47 pm

He actually said 32k/yr on 400k invested, not 16k.
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Re: buy rental property or pay off debt?

Postby willardx » Thu May 09, 2013 2:51 pm

xGLORYx wrote: $16k on $400,000 isn't a good return, and when you say $16k Net, what is that?


He said $16k per house, or $32k for $400K, or 8% ROI. But I agree, what is net, net depreciation?

As others have asked, your total financial picture is needed plus the other variables to know if it's a good move or not. Maybe a $800K mortgage is not a big deal, it is to me, though. I personally enjoy managing rental properties, despite the occasional calls for repairs. My feelings may change as I get older, but for now I like the cash flow and the potential for asset appreciation.
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Re: buy rental property or pay off debt?

Postby Honobob » Thu May 09, 2013 3:30 pm

nzk wrote:I have an opportunity to buy 2 homes at $200K each cash or pay down my mortgage $400K. Interest rate is 3% with $800K currently owed. Rental income will be $16K per home net per year. I know rental income would be good for long term cash flow, but paying down the mortgage will save me a lot of interest payments and give me some financial security. I do have time to manage the properties but would rather get a company to handle the headaches. I have never rented before and am eager learn, good or bad, from the experience. Which choice is boglehead worthy?

:?

The smart real estate investor would buy ten $200,000 homes. That way you are controlling $2,000,000 worth of rental properties and have 10 households paying you. Keep the 3% mortgage. What would you rekon those properties would appreciate each year?
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Re: buy rental property or pay off debt?

Postby nzk » Thu May 09, 2013 3:35 pm

Net meaning after expenses.

Neighborhood is moderate turnover located near a large medical center with many post grad schools.
Values are stable not going up but not going down. Demand is moderate. Management is $100/month per property. Job is stable and able to afford the mortgage. Retirement maxed out pretax. Good emergency fund.
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Re: buy rental property or pay off debt?

Postby Meg77 » Thu May 09, 2013 6:30 pm

I certainly wouldn't pay off your mortgage if the interest rate before taxes is fixed at 3.00%. If it's floating or if it's a short term loan then of course that needs to be addressed. But there are far better things to do with money than pay off debt that cheap and tax advantaged.

However buying two $200K rental homes in cash is almost certainly not your only other option. Leverage is one of the things that makes real estate such a good investment. If you pay cash your return is equal only to inflation (the average home price increase over time). Of course you'll have income, but rental income is nothing if not volatile and non-guaranteed. I have rentals so I understand the appeal and am not against that; I just wonder what this opportunity is and if it's a great one.

Make sure you're maxing out every retirement account you can and that you have 6-12 of expenses in cash before diving into a rental property. Not a bad time to buy real estate though, all things considered.
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Re: buy rental property or pay off debt?

Postby Clearly_Irrational » Thu May 09, 2013 7:08 pm

If you can't fully pay off your mortgage then paying it down is not a good plan.

If you've never owned a rental before then for heavens sake don't buy two at once, that's a pool you want to dip your toe into first before diving in.

My advice is find one rental that looks good on paper and purchase it using financing rather than all cash. (Leverage is actually a good thing in rentals since they're more like a business than a portfolio) Then the learning experience can begin. You'll do a bunch of things wrong, but after a couple of years you'll start to get the hang of it and you can decide whether to expand.
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Re: buy rental property or pay off debt?

Postby Clearly_Irrational » Thu May 09, 2013 7:29 pm

xGLORYx wrote:If you head over to the forum I posted above, you'll learn about the 50%/2% rule.


I had to look that one up. So first, I'd like to totally agree that many aspiring landlords totally space on costs other than the mortgage and that operating expenses are a big deal. Second, this rule looks totally bogus, at least for the two markets that I'm in: Portland, Oregon and Riverside, California. In both of those areas 50x one months rent wouldn't buy you a cardboard box, and let me tell you I'm a pretty tough shopper, I usually look at least 50 units before I find one that works. My rule is not to a buy a place unless it breaks even at 100% financing including a property management company, operating costs, taxes, vacancy rates, etc. etc. I use a spreadsheet to do all the modeling.
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Re: buy rental property or pay off debt?

Postby EmergDoc » Thu May 09, 2013 7:38 pm

nzk wrote:I have an opportunity to buy 2 homes at $200K each cash or pay down my mortgage $400K. Interest rate is 3% with $800K currently owed. Rental income will be $16K per home net per year. I know rental income would be good for long term cash flow, but paying down the mortgage will save me a lot of interest payments and give me some financial security. I do have time to manage the properties but would rather get a company to handle the headaches. I have never rented before and am eager learn, good or bad, from the experience. Which choice is boglehead worthy?

:?


They're both okay, but given that we're currently in a seller's market for real estate, and stocks and bonds seem pretty richly valued, I might lean toward paying down debt right now. 2-4 years ago.....buy the properties. You probably would have gotten them for $30K for both.

When you're not sure what to do, why not split the difference? Pay the mortgage down $200K and buy a property or two with the other $200K

One other thing to keep in mind is that interest rates are at an all time low. You might be able to pay down your mortgage to get below the jumbo limit and get a really sweet rate on a 15 year right now, like 2.5%. Otherwise it's pretty hard to get excited about paying off a 3% deductible loan especially at what I assume to be a pretty high bracket.

I'd read some of John T Reed's real estate books before purchasing rental property. If he can't talk you out of it, no one can. He's more sour on the experience than Bogleheads in general. (But at least you'll go in with eyes wide open.)
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