Converting real estate to stocks/bonds: pay off mortgages in the meantime or invest?

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billthecat
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Converting real estate to stocks/bonds: pay off mortgages in the meantime or invest?

Post by billthecat » Fri Jun 15, 2018 2:02 pm

I'm in the process of liquidating rental properties, which will happen over the next 12 months. What I'm wondering is whether I should pay off the mortgages in the meantime, or invest in stocks/bonds and continue to hold the loans.

My asset allocation for financial assets is 60/40. About $1M. Plus another $275K in cash. The mortgages are ARMs, one is currently at 5% and won't adjust again before I sell, and the other will adjust in October probably to 5.125% and won't adjust again before I sell. But the interest is tax deductible, so 5% effectively becomes 3.3%. I could pay them off outright. My real estate equity (including my home) represents about 50% of my total assets, so I feel too heavily weighted toward real estate.

I already max out all tax deferred accounts (HSA, backdoor Roth IRA, 401K, mega backdoor Roth 401K), have an emergency fund, etc. It's really about the excess cash.

Since it's only a question of what to do for the next 12 months, maybe it doesn't matter.
Last edited by billthecat on Fri Jun 15, 2018 2:13 pm, edited 1 time in total.

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Pajamas
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Re: Converting real estate to stocks/bonds: pay off mortgages in the meantime or invest?

Post by Pajamas » Fri Jun 15, 2018 2:09 pm

If you are in the process of selling them, you are right that it probably doesn't matter that much. Just depends on if you prefer the guaranteed return of not having to pay mortgage interest vs. potential gains or losses from investing.

Also if you are already too heavily weighted to real estate you might not want to increase that weight even until the properties are sold.

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grabiner
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Re: Converting real estate to stocks/bonds: pay off mortgages in the meantime or invest?

Post by grabiner » Fri Jun 15, 2018 10:04 pm

Paying down the mortgage on a 5% loan which you will liquidate in one year is equivalent to buying a one-year CD with a 5% yield. Therefore, you should do this instead of bond investments, as long as it doesn't cause liquidity problems.

Note that you are not increasing your weight in real estate by doing this. If you have a $500K home with a $400K mortgage, and real-estate prices drop by 20%, you lose your $100K equity when you sell. If you pay down the mortgage to $200K, and real-estate prices drop by 20%, you get $200K instead of the $300K you were expecting when you sell, so you haven't changed your risk. (And unlike a loan on your residence, if you wind up underwater on the mortgage, you will probably need to make up the deficiency when you sell, so you aren't protected against a housing crash by having a large mortgage.)
Wiki David Grabiner

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