Pay Off Rental Property?

Archived From: Finance
  • Go to page :
  • 1 2
  • Text Only
Voting History
rated:
After quite a bit of research on ways to build a passive income I still haven't found anything that tops owning rental properties. (That doesn't mean there's nothing better out there but for me, this seems like the least work for your money.) My long term financial goal is to acquire enough rental property to provide more than enough income for my wife and I to live comfortably without depending on our jobs.

We currently own two rentals.

Here's my strategy in a nutshell: Pay off my first rental property at the end of this year (this will generate $900 month income gross). Take the extra income from that and combine it with our normal monthly savings amount and use all of that to start paying off our other rental property (once paid off, this property will generate $600 mo gross). Next step will be to purchase a third rental, pay it off with the money from the other ones plus our normal monthly savings amount...repeat, repeat, until we have reached an income level that will support us.

Obviously paying off a house is not an easy thing and is probably what would keep most people from using this strategy. But we are finally getting very close to accomplishing this and I anticipate our first rental being paid off by the end of this year or early next year. Once one gets paid off, the next one should be easier and this pattern should continue as more properties get paid off.

My question is....does anyone see anything glaringly flawed in this strategy? Is there anything I'm missing?

I would greatly appreciate any input.

I realize that this process involves dumping alot of money in real estate, which over time has provided a lower return than the stock market; however, our goal is not to accumulate a large "nest egg" that we can withdraw funds from when we're 65 but rather to generate income that will be perpetual and not depend on going to work.

I'd appreciate any constructive criticism or other thoughts anybody has about this plan.


Thanks in advance!
Edit by Moderator: Thank you for participating in the forums. However, this topic has been covered in a recent post Here.

Member Summary
Most Recent Posts
Please point out where I made that claim. It just so happens that I do pocket about $265 on one of them and about $25 o... (more)

VoodooChild77 (Jul. 30, 2007 @ 10:42p) |

Next?

ScootyPuffSr (Jul. 30, 2007 @ 10:47p) |

That wasn't day one. I had an 80/20 loan on the property. (originally we lived there.)

The positive $265 cash flow only ... (more)

VoodooChild77 (Jul. 30, 2007 @ 10:49p) |

Quick Summary is created and edited by users like you... Add FAQ's, Links and other Relevant Information by clicking the edit button in the lower right hand corner of this message.
Thanks for visiting FatWallet.com. Join for free to remove this ad.

are there really places in the US where the CapRate is something worthwhile?

teplitsa said: are there really places in the US where the CapRate is something worthwhile?
Yes...fewer today than 10 years ago though...

my wife has an ex who bought a bunch of rentals in NYC when people's salaries were more than the RE selling prices. i know someone who wanted to buy a house as an investment last year and no matter how much i tried to explain basic math he didn't listen

VoodooChild77 said:
My question is....does anyone see anything glaringly flawed in this strategy? Is there anything I'm missing?



yes it's a perpetual machine if you are good at managing and maintaining your properties, i too paid off my rentals early based on your reasoning, but eventually i got tired dealing with tenants (late rent, sec.8 problems, etc.) and had to get out, when you think of it, money in the bank generates the same cash flow minus the headaches

I agree. I found out yesterday that my tenants BF may be selling drugs from my property. Working on an eviction notice today and dunno when I will find another tenant to pay $ 1800 in rent. So, really not worth in. I have a mutual fund, the entry point being $ 50,000, but has consistently returned 30% average over the last 3 years. Definitely beats my 3 rental properties in terms of ROI.

I would recommend putting all the money in the fund by borrowing against the properties. And if you have a long term tenant, great as it will pay the mortgage. When you start to wear out of it, sell the properties and pay off the mortgage. in the mean time, no opportunity cost as you invested your total equity in the fund etc.

my 2 cents.

gulshan12 said: I agree. I found out yesterday that my tenants BF may be selling drugs from my property. Working on an eviction notice today and dunno when I will find another tenant to pay $ 1800 in rent. So, really not worth in. I have a mutual fund, the entry point being $ 50,000, but has consistently returned 30% average over the last 3 years. Definitely beats my 3 rental properties in terms of ROI.

I would recommend putting all the money in the fund by borrowing against the properties. And if you have a long term tenant, great as it will pay the mortgage. When you start to wear out of it, sell the properties and pay off the mortgage. in the mean time, no opportunity cost as you invested your total equity in the fund etc.

my 2 cents.


Please do share the name of this mutual fund.

Just keep in mind that a paid off home is very vulnerable if you ever find yourself involved on the wrong side of a lawsuit. Liquid assets can be moved around fairly easily, but that isn't quite the same for a home.

Also, if there's some kind of natural disaster, most insurance will pay the cost to rebuild, but not necessarily the lost value from having an area decimated.

Are these good enough reasons to not payoff the rental? I'm not so sure.. but just giving you some things to think about...

VoodooChild77 said: After quite a bit of research on ways to build a passive income I still haven't found anything that tops owning rental properties. (That doesn't mean there's nothing better out there but for me, this seems like the least work for your money.) My long term financial goal is to acquire enough rental property to provide more than enough income for my wife and I to live comfortably without depending on our jobs.

We currently own two rentals.

Here's my strategy in a nutshell: Pay off my first rental property at the end of this year (this will generate $900 month income gross). Take the extra income from that and combine it with our normal monthly savings amount and use all of that to start paying off our other rental property (once paid off, this property will generate $600 mo gross). Next step will be to purchase a third rental, pay it off with the money from the other ones plus our normal monthly savings amount...repeat, repeat, until we have reached an income level that will support us.

Obviously paying off a house is not an easy thing and is probably what would keep most people from using this strategy. But we are finally getting very close to accomplishing this and I anticipate our first rental being paid off by the end of this year or early next year. Once one gets paid off, the next one should be easier and this pattern should continue as more properties get paid off.

My question is....does anyone see anything glaringly flawed in this strategy? Is there anything I'm missing?

I would greatly appreciate any input.

I realize that this process involves dumping alot of money in real estate, which over time has provided a lower return than the stock market; however, our goal is not to accumulate a large "nest egg" that we can withdraw funds from when we're 65 but rather to generate income that will be perpetual and not depend on going to work.

I'd appreciate any constructive criticism or other thoughts anybody has about this plan.


Thanks in advance!

kai2007 said: Please do share the name of this mutual fund.Please refrain from discussion of specific stocks or mutual funds. FWF is not the appropriate place for this.

It seems like you are paying everything off so quickly that you forgot about maintenance.

I would put a good amount of money in a liquid account each month and save it for when major repairs are necessary. That way you will have some leverage instead of having to take a home equity line out.

I agree with the hassles of renting. It is very difficult to get good renters and when you do get them they often times don't stay very long.

Good point, but here's my thinking on that...When a maintenance issue arises that is beyond my monthly extra/savings amount (and could just be paid for in that month) then I pay with a HELOC and work to immediately pay it off.

Also (for what it's worth), I'm not paying down these mortgages each month. I'm saving/investing each month until I have enough to pay off a given mortgage. So the only time I"m at $0 liquidity is immediately after paying off a mortgage. Once I pay one off I start building back up to pay off the next. I probably should have clarified that in my initial post.

Maybe I'm missing a point here, but why would you want to pay off a rental property early?

If you do, you'll start showing a profit on the property and rent will count as ordinary income. If you keep a mortgage on it, you can use the mortgage payments to offset the rent, reducing your taxible income. Rather than paying down the mortgage, put the additional $$$ into some sort of investment vehicle until you accumulate your next down payment.

I thought about this strategy but would rather diversify my savings/investments. A house is going to rent the same whether it has a mortgage or not, so you are really not doing anything except avoiding interest costs by paying down the mortgage, and right now your properties should be financed at pretty good rates, so you may be able to get a better return doing something else with that money.

For all the haters out there, I have one property that has rents 1.4 times more than my expenses for the year and the property is financed 100 percent. Yes, I have to deal with tenants, but I am lucky to have a very high demand niche position in my market and so far have found good tenants that pay on time and don't trash stuff. Who knows, maybe I will change my mind when some meth head trashes the place, but right now my two rentals are doing very well and I am watching declining markets looking to pick up more deals over the next couple years.

I notice a number of people have mentioned the hassles of renting and I agree that those certainly exist. I've only been doing rentals for 4 years but I've had my fair share of hassle.

However, what would be some lower hassle alterntives to generating a (relatively) passive income?

Piling up money in the stock market over a period of 20-30 years is certainly a tried and true way to retire after all those years of going to work. No argument there.

But what about those of us that are relatively good at saving and want to put our money to work at an early age to build a monthly income rather than a nest egg that depends on stock market performance?

I'm not dissing the stock market, my 401K that I contribute to each month is 100% in equities. I just want to get out of the rat race early or at least have the bulk of my monthly income come from sources outside my corporate job.

My reasoning is simple.

Let's take my first rental house as an example:

Monthly rent (income to me): $850
Mortgage payment: ($585)
Monthly Cash Flow = $265

Now the same equation with no mortgage payment:
Monthly rent : $850
Mortgage payment: $0
Monthly cash flow = $850


So it's one renter, one property to maintain and $850 a month in income versus having 10 properties with mortgages and making $50-$100 on each and dealing with 10 tenants and maintaining 10 properties to make roughly the same amount of income.

I'm going for the least amount of work for my money here.

I acknowledge my strategy here is very basic and not perfect which is exactly why I'm seeking the opinions of others.

I'd like to develop a "base" of paid off rentals and an income of $8000-$10000 a month and then possibly enter into some other business venture. This will be our bread and butter though.

I agree. The house rents the same either way, mortgage or not. But wouldn't it be nicer to collect rent that is not offset by a mortgage payment?? Then it's all gravy (less taxes,insurance, and maintenance...which can all be written off).

Because the rent can be written off!

Mortgage Income - Mortgage Interest - Expenses = Gross Income/Loss

If you pay off the mortgage early, mortgage interest goes down, resulting in less of a loss or net profit and that directly affects your taxable income.

You're also neglecting the opportunity cost of the equity in your paid off house. The investment income from that money could potentially be taxed at capital gains rates.

Never pay off a rental property!

Using that logic I guess a person should turn down their next raise at work because more income will mean you have to pay more in taxes.. (???)

I guess I see your point if your sole purpose for owning real estate is for the tax deductions but if you are wanting to build an income from rentals, the more the merrier right?

I understand that by paying off mortgages you are giving up the interest write off but the bottom line is that the biggest offsetting expense to my monthly rent is the mortgage payment (principal + interest). If I eliminate the mortgage payment then I get to keep the monthly rent instead of give 2/3s of it to the bank. Sure it's more income so I'll have to pay taxes but I'm thinking income is a good thing.

BobM73 said: You're also neglecting the opportunity cost of the equity in your paid off house. The investment income from that money could potentially be taxed at capital gains rates.

I'm sorry but I don't follow this statement at all.

My apologies if I got a little sarcastic in my last reply. I do appreciate the input.

VoodooChild77 said: Using that logic I guess a person should turn down their next raise at work because more income will mean you have to pay more in taxes.. (???)

I guess I see your point if your sole purpose for owning real estate is for the tax deductions but if you are wanting to build an income from rentals, the more the merrier right?

I understand that by paying off mortgages you are giving up the interest write off but the bottom line is that the biggest offsetting expense to my monthly rent is the mortgage payment (principal + interest). If I eliminate the mortgage payment then I get to keep the monthly rent instead of give 2/3s of it to the bank. Sure it's more income so I'll have to pay taxes but I'm thinking income is a good thing.


No, yet again, you're missing the point. If you've paid off the rental property, you've raided your other investments, which (should) be making you an "income" as well.

Your other investments would be long term investments, so if you're living off the interest, you'd be using money that's taxed at long term cap gains rates vs. ordinary income.

A rule of thumb in my area is that a rental property should return about 1% of its purchase price per month in rent. So, IF you keep the place rented, you're only making 12% per year BEFORE property taxes, income taxes, maintenance, etc.

In my own case, if my house was paid off, I"d pay 28% income tax on the rent, 3% of the home's value in property taxes and about 1% of the home's cost in maintenance. That nets out to a less that 5% return on my investment, not counting possible appreciation.

Personally, I'd rather have the house be cash flow neutral and invest the other money in a long term mutual fund hopefully averaging around 8%. After cap gains taxes, my money's making 6.4%. And I STILL have the appreciation of the rental property.

Although it would be more complex then this ultra-simple example, you spread your risk out a bit by owning more properties with mortgages than one or two with no mortgage. For example, if you had $200k to invest, you'd be better off to put 20% down on 10 different $100k properties then to buy 2 $100k properties outright. Lets say for sake of example they rent for $800 each. If one of your 2 properties is vacant, you lose 50% of your income. If 1 of 10 is vacant, you should be able to make debt service (which would be roughly $533 assuming $80k at 7% for 30 yrs on a $100k house with $20k down), so using $200k as example:

2 houses @ $800 rent = $1,600/month
10 houses @ $800 rent = $8,000 minus $5,330 debt service = $2,670
so more return with less exposure, so you could have as many as 3 homes vacant and still cash flow, but you will do more work and have more expenses of course.

Bob said: No, yet again, you're missing the point. If you've paid off the rental property, you've raided your other investments, which (should) be making you an "income" as well.


Ah...here's our disconnect. A "return" on a long term investment like a mutual fund is NOT the same as income. I don't feel comfortable living off returns that I hope I get from a mutual fund. Granted, over the long term you'll probably get 8 to 10 % in a mutual or index fund. But that rate of return depends on a very long time horizon (which is fine it that's your goal).

I'm 30 and I'm thinking I can build a passive income of $8000-$10000 over the next 8 years by following the steps in my original post. We live relatively cheaply and at that point working would be an option. Any time we want a raise, we can just buy/pay off another house. I realize I'm over simplifying but you get the idea.

I don't see how I can achieve the same thing by putting everything in the stock market and hoping for the best over the next 8-10 years.

VoodooChild77 said:
Ah...here's our disconnect. A "return" on a long term investment like a mutual fund is NOT the same as income. I don't feel comfortable living off returns that I hope I get from a mutual fund.

Unless you have guaranteed tenants, those returns are pretty much a hope too.
[am a landlord too]

In what part of the country do you have these cash flow positive rentals? Out in California, a house that sells for $600k will rent out in the low to mid $2000 range.



VoodooChild77 said: Bob said: No, yet again, you're missing the point. If you've paid off the rental property, you've raided your other investments, which (should) be making you an "income" as well.


Ah...here's our disconnect. A "return" on a long term investment like a mutual fund is NOT the same as income. I don't feel comfortable living off returns that I hope I get from a mutual fund. Granted, over the long term you'll probably get 8 to 10 % in a mutual or index fund. But that rate of return depends on a very long time horizon (which is fine it that's your goal).

I'm 30 and I'm thinking I can build a passive income of $8000-$10000 over the next 8 years by following the steps in my original post. We live relatively cheaply and at that point working would be an option. Any time we want a raise, we can just buy/pay off another house. I realize I'm over simplifying but you get the idea.

I don't see how I can achieve the same thing by putting everything in the stock market and hoping for the best over the next 8-10 years.

An interesting example, thank you. Definitely a new perspective for me there.
I think alot of this comes down to individual personality and how much of a headache and risk aversion a person has. For me, the thought of managing 10 properties, 10 tenants, and 10 mortgages makes my head spin. If 4 of those become vacant or 3 of them need a new air conditioner, etc. all at the same time; all of the sudden I am quite uncomfortable and my quality of life takes a hit.

I guess part of my reasoning with the "pay it off" method is the lower stress level involved. If it sits vacant for a couple of months it's not the end of the world.
When I got my first rental 4 1/2 years ago I only made about $33K a year. I had a condo sit vacant for two months right around Christmas and it was painful!! Definitely not the same now as I have come a long way but I think that experience made quite an impression on me.

VoodooChild77 said: Bob said: No, yet again, you're missing the point. If you've paid off the rental property, you've raided your other investments, which (should) be making you an "income" as well.


Ah...here's our disconnect. A "return" on a long term investment like a mutual fund is NOT the same as income. I don't feel comfortable living off returns that I hope I get from a mutual fund. Granted, over the long term you'll probably get 8 to 10 % in a mutual or index fund. But that rate of return depends on a very long time horizon (which is fine it that's your goal).

I'm 30 and I'm thinking I can build a passive income of $8000-$10000 over the next 8 years by following the steps in my original post. We live relatively cheaply and at that point working would be an option. Any time we want a raise, we can just buy/pay off another house. I realize I'm over simplifying but you get the idea.

I don't see how I can achieve the same thing by putting everything in the stock market and hoping for the best over the next 8-10 years.


If it were that easy, everyone would do it. Listen to what the people in this thread are telling you. They are giving you good advice.

So, where exactly do you hope to get the $800,000 in cash required to pay for the properties that will yield $8k a month in income?

If you have that much in cash, invest it in CD's, you'll still make 5% and be ahead of the game. Again, don't forget that you pay tax on the rental income, property taxes and maintenance. That 12% pre-expenses return drops pretty quickly.

I consider my rental property a long term investment. The money comes out of it when I sell it.

For the record, I'm 33 and have had my two family house for 6 years.

Agreed! But even if Bin-Laden decides to crash another plane into some buildings, people still need a place to live. And there is a certain socio-economic group of people who will always be renting. I'm relatively confident that I will always eventually be able to find a renter. (though I did have one sit vacant for a couple of months one time)

Bob said: <<So, where exactly do you hope to get the $800,000 in cash required to pay for the properties that will yield $8k a month in income?>>

Same place I got the $76K that I'm about to use to pay off my first one (working and living below my means) but now I'll have the additional income from the first paid of rental to contribute to paying off the next one. When that one is paid off I have the extra income from it so there's that much more to contribute to the next one. And on and on. Like dominoes. The first one is the hardest and then they should get progressively easier (to pay off) after that.

Bob said: <<If you have that much in cash, invest it in CD's, you'll still make 5% and be ahead of the game. Again, don't forget that you pay tax on the rental income, property taxes and maintenance. That 12% pre-expenses return drops pretty quickly.>>

I'd pay tax on cd income too. And I can always write off taxes,insurance, and maintenance. As for being "ahead of the game" with this method...my calculator comes up with much different results.

Bob said: <<I consider my rental property a long term investment. The money comes out of it when I sell it.>>

There's nothing wrong with that at all. It's just that I consider mine a long term investment but also a short-term income generator. In this regard, we just have different objectives.

Bob said: <<For the record, I'm 33 and have had my two family house for 6 years.>>

A commendable achievement indeed.

If it were that easy, everyone would do it. Listen to what the people in this thread are telling you. They are giving you good advice.

I agree and I appreciate all of the advice. However, there is nothing "easy" about paying off mortgages and that's why most people generally don't do it.

kai said: In what part of the country do you have these cash flow positive rentals? Out in California, a house that sells for $600k will rent out in the low to mid $2000 range.

I live and own property in the Dallas/Fort Worth metroplex.

No way I could do it in Cali.

VoodooChild77 said: I guess part of my reasoning with the "pay it off" method is the lower stress level involved. If it sits vacant for a couple of months it's not the end of the world...Except for the fact that you don't have any income coming in! Voodoo, you are putting all your eggs in one basket. If you tie up all your capital by paying off the properties, you lose a lot of flexibility. I'd rather have the loans outstanding and the cash in other investments. Diversification, liquidity and flexibility are then on your side.

dcwilbur said: <<Except for the fact that you don't have any income coming in!>>

Good point but I wouldn't even consider quitting my day job until I had at least 10-15 rentals paid for. I would certainly be gambling that I wouldn't have all of them vacant at one time but that seems like far less of a gamble than other things I could think of.

dcwilbur said: <<Voodoo, you are putting all your eggs in one basket. If you tie up all your capital by paying off the properties, you lose a lot of flexibility. I'd rather have the loans outstanding and the cash in other investments. Diversification, liquidity and flexibility are then on your side>>

Very true. But I do plan on continuing to contribute to my 401K (which is 100% stock market). I know that's money I can't touch for another 30+ years but would still keep me from being 100% in residential real estate.

kai2007 said: In what part of the country do you have these cash flow positive rentals? Out in California, a house that sells for $600k will rent out in the low to mid $2000 range.

I really don't get this. If this is the case, why is ANYONE in California renting property? Are all these people under some sort of collective delusion?

Auream said: kai2007 said: In what part of the country do you have these cash flow positive rentals? Out in California, a house that sells for $600k will rent out in the low to mid $2000 range.

I really don't get this. If this is the case, why is ANYONE in California renting property? Are all these people under some sort of collective delusion?
The fact that a house sells for $600K today doesn't mean much if the owner bought it for $200K 15 years ago.

If you can pay cash for your rentals, you should and other than the (in)capability of hiding these assets in a litigation I don't see any problem at all. But do not have your entire income depend on rentals. I will explain that:

Imagine a day when your entire income comes from 15 rentals and all your savings are there too. If there is a vacancy at a rental, your income goes down 6-7%. vacancy/ rent problems at 2 rentals and planned maintenances can really throw you in serious problems as far as your normal cash flow is concerned. These changes do not happen when one is employed so you can be caught by surprise when you disconnect the employment income.

So all networth/ income in rentals may not survive a hiccup. Or have a 30% buffer between your targeted income and income generation.

VoodooChild77 said: An interesting example, thank you. Definitely a new perspective for me there.
I think alot of this comes down to individual personality and how much of a headache and risk aversion a person has. For me, the thought of managing 10 properties, 10 tenants, and 10 mortgages makes my head spin. If 4 of those become vacant or 3 of them need a new air conditioner, etc. all at the same time; all of the sudden I am quite uncomfortable and my quality of life takes a hit.

I guess part of my reasoning with the "pay it off" method is the lower stress level involved. If it sits vacant for a couple of months it's not the end of the world.
When I got my first rental 4 1/2 years ago I only made about $33K a year. I had a condo sit vacant for two months right around Christmas and it was painful!! Definitely not the same now as I have come a long way but I think that experience made quite an impression on me.


As for risk aversion, I think the 10 property vs 2 example actually carries less risk. Using 10 with mortgages, instead of earning $1,600/month, you earn over $2,600, so you should set aside some reserves to ride out major repairs. For example, collect $1,800/month personal income and put $800/month aside in a reserve account for improvements, unexpected repairs, etc. You can further reduce your risk with proper lease expiration planning. For example, if you have 10 properties, schedule the leases to expire one per month except no expirations in November or December (as an example), this way you further reduce the risk of having several vacant at once, similar to CD laddering.

Also, you say your long term goal is to own more than the two you have now, so why not buy them now with mortgages, at todays prices rather than 10 years from now when they will probably cost more in the Dallas Metro. Also, 10 years from now your rents will probably be higher but the mortgages will be fixed, increasing your profits even more. They will also have 10 years of equity built up if you choose a standard mortgage.

BobM73 said: Maybe I'm missing a point here, but why would you want to pay off a rental property early?

If you do, you'll start showing a profit on the property and rent will count as ordinary income. If you keep a mortgage on it, you can use the mortgage payments to offset the rent, reducing your taxible income. Rather than paying down the mortgage, put the additional $$$ into some sort of investment vehicle until you accumulate your next down payment.


Why is reducing your taxable income by $100 a good way to save $36?

berlinsmommy said: <<Also, you say your long term goal is to own more than the two you have now, so why not buy them now with mortgages, at todays prices rather than 10 years from now when they will probably cost more in the Dallas Metro.>>

I like it. However, I do plan on doing this fairly quickly. One down at the end of this year. The next down a year and a half after that. And I think from there I can come close to getting one new house paid off every year (in the price range I'm looking at).

This is definitely something to think about. But I have to admit, having that many mortgages makes me a little nervous. It may just be a pyschological thing but my main objective is to break dependency on outside employement. That doesn't mean retiring at 38 and sitting on my rear end but by then I don't want my lifestyle to depend on a high salary derived from an outside employer. I'd like the ability to take any job I want without pay being so much of a factor. Maybe even just work part time and volunteer part time.
Thanks for the input.

Skipping 14 Messages...
Scooty said: Next?

That wasn't day one. I had an 80/20 loan on the property. (originally we lived there.)

The positive $265 cash flow only came when I paid off the first lein last summer.

When mortgages go away it's amazing how quickly the cash flow becomes positive.



Disclaimer: By providing links to other sites, FatWallet.com does not guarantee, approve or endorse the information or products available at these sites, nor does a link indicate any association with or endorsement by the linked site to FatWallet.com.

Thanks for visiting FatWallet.com. Join for free to remove this ad.

TRUSTe online privacy certification

While FatWallet makes every effort to post correct information, offers are subject to change without notice.
Some exclusions may apply based upon merchant policies.
© 1999-2014