TBT: Ask Marco – Should I Pay Off My Rental Properties?

Lindsay, thanks for the question. These are good questions. You have a couple of them in here. So let me start off by saying that I don’t know your age. I don’t know your income goals, and I also don’t know your investment timeframe. So I need to make a few assumptions and generalize a little bit here. So that way it applies to you, but it’s applicable to everybody listening. The concepts and the principles are the same when it becomes very specific to you. It’s really all about what you have to work with. What’s your income, what’s your income goal? What are your debts? What’s your timeline, all that stuff. So these are variables that anyone listening to this needs to adjust for their own particular situation.

So having said that, I want to start off by just saying this. You got to look at your strategy. You always start off with your strategy. So this would be my question to you. If I was on the phone with you is, you know how old you are, not that I need to know specifically, but just, you know, where are you at in your life? Your inning. As some people call it, what inning are you in? And you know, what timeframe are you working with? Like in other words, if you have some income goals or some investment goals, you don’t need to be young or old to achieve them. The question is is how long do you want to take to achieve those goals? So you need to look at that. So age is certainly a variable because time is your biggest, biggest friend.

It is the most powerful resource that you have. And the more time you have, the more you can accomplish and time is that one thing that you can spend, but you can never get back. Everything else probably bends those rules, or it doesn’t apply, but the time you can spend it. You just can’t get it back. So time is on your side and the more you have of it, the better off you are. And that’s especially true with leverage or in other words, debt, which we’ll talk about here in a minute. So as part of your strategy, you have to consider age, secondly, as part of your strategy, you need to consider your cash flow and cashflow goals. In other words, what are your living expenses? But more importantly, what are your goals, and what are you trying to achieve from a financial perspective? And thirdly, part of your strategy is what is your equity growth?

So there’s probably a point in time where every investor is focused on growing their portfolio and maximizing how much equity they grow in their portfolio. The more, the better, the faster, the better, and the more equity you have in a shorter period of time. The more options you have to use that equity to increase your cash flow by increasing your investments. ie income-producing real estate. So age cashflow and equity. Now comment about your debt. You mentioned debt and you’re averse to that. You don’t like to have a lot of debt. Well, the question is what kind of debt I’ve talked about this many times on the show, you don’t want to have bad debt, consumer debt, debt that holds you down or takes money out of your pocket instead of actually putting money in your pocket. When you have good debt, which is in the form of mortgage financing to acquire income, producing assets, like income-producing real estate.

Now you have assets that are worth something grow in value over time and put money in your pocket. So it’s like triage. You have this debt where you have a dollar worth of debt, but it’s producing, let’s say a dollar 10 in income or a dollar 20 in income. So now you just pay off the dollar of debt from the dollar 10 or a dollar 20, and you’re left with, you know, 10 or 20 cents. Well, if you can do that with every dollar you invest or every dollar of debt that you have, well, guess what the question is, how much of it do you want? And the answer to that should be as much as I can get. So just think about that. All right. So debt is not a bad thing. It’s just how you use it. Now, the next question is how much passive income do you need?

So this is where your income goals come in. Now, keep in mind that there’s two ways to approach this, your passive income goals. And this really ties off of the question of debt. So there’s two scenarios here. Let’s just say you have a monthly income goal of $3,000 a month. You can have 10 properties or 10 units like you have with three plexes in the quadplex that are generating $300 a month in net passive income. Well, if you’ve got $300 a door times 10, you have $3,000 a month. This is on your levered units. You have mortgages in place. You’ve basically put down whatever down payment you’ve financed the rest using other people’s money, which is mortgage financing, but that’s still $3,000 a month. So if that was your goal, you’ve just hit your goal with 10 doors or 10 units. On the other side, you can do it with fewer units that are paid off.

For example, three units that are generating a thousand dollars a month in net, passive income, both scenarios are producing $3,000 a month in passive income. The differences is one scenario, the ladder you have three doors or three units or three properties, whatever it is in the first scenario, you have 10 units, 10 doors. Yeah. And you’re actually pretty close to that. You’ve got three, six, 10, you’re closing on another duplex. You’re going to have 12 units here shortly. So again, you know, this ties into your goal, but the thing is, is with leverage, with financing, you know, talking about that debt, you can get there faster because if you’ve got a hundred thousand dollars to invest or $500,000 to invest, if you can chop that up into smaller pieces, which are your down payments towards more units, then you can get there faster with debt financing.

So all else being equal. And I talked about this on some previous episodes, the same investment dollars will actually generate more income passively per month and per year by using leverage meaning 20%, 25% down, and then borrowing the other 75% or so then it would, if you purchased the properties from your investment capital, all cash. And so if you just sit down and do the math, you will see this, it should work out to be about 25% more per month in passive income using your investment capital to buy as many properties as you can. Now that could be more, it could be less, it just depends on where you’re buying and the price points, but you get the point. So that’s the road to passive income. Now, should you pay them off? Well, that’s a question of again, did you reach your income goal or are you not quite there yet?

Do you need to accelerate your path to get there? And if you do then my strategy, and this is not necessarily my advice to you because I don’t know enough about your situation, but what I would be doing. And especially if I have time on my side, I would focus on building my portfolio as large and as quickly as possible. Ideally in high growth areas where I still have positive cash flow, I don’t want to have negative cashflow in 99% of all situations, but I want to have a portfolio that’s going to appreciate quickly. And I’m not speculating here. I’m not chasing after appreciation, but I want to have the cash flow along with the equity growth and mostly through appreciation in this scenario, the equity through the amortization of the loan will come. It just happens. It’s built into the cake. That’s what amortized loans do is they just become less and less each and every month and every year.

But I’m looking for that faster and larger appreciation. That’s why the strong hot markets, if you will like the Florida markets and many others around the country, just talk to your team or my investment counselors here. But when you are focused on those equity gains for the next two, three years, five years, whatever it may be, then you can redeploy that equity, some of it into more property. And now you have more units in your portfolio and you have more units generating positive cashflow. Then the time will come. When you believe that you have enough units in your portfolio, enough properties, that you can now start to focus on paying down the mortgages quicker from the positive cash flow. If that’s what you even want. Some people just don’t do that. They just leave their properties. Mortgaged, let the tenants pay off the mortgage over time, regardless of how long that timeframe is because you know what your monthly cash flow is.

And that will likely go up over the years because rents will go up and your mortgage payments are fixed. So your mortgage payment doesn’t go up, but your rents will go up. So your cash flows will naturally go up over time, but you just leave the mortgages in place and you don’t even bother paying them down. You just leave them in place. And you just collect your $300 a month plus or minus on your unit times. However many UNC have. So these are just different strategies, but some people will choose to pay off their mortgages. Now, one of the ways to do that is to use the snowball effect. You just pick one property that you could pay off the fastest and pay that down using the cash flows, or maybe the extra capital you have. And you mentioned having money in the stock market.

So maybe pay that down. Now you have a larger chunk of cash coming off that one property. And if you’re not trying to grow your portfolio at this stage of the game, then what you do is you take that extra cash flow that you don’t actually need to live off of. It’s just investible capital, and you can apply that to the next property. The second one that is the fastest to pay down and you keep doing that. And just one after another, you don’t try and pay them all down at the same time, because that’s the slower way to go. It’s faster to actually pay down the first one, get that larger chunk of cash started applying that to the next quickest one to pay down. And then the next one and the next one. And you’ll see that that just starts to snowball. And then you get to a point where you have them all paid off.

So there are no mortgages to pay. And the cash flow is basically your gross rent minus your carrying expenses, your operating expenses. And that’s a fast way to get there too. But again, it depends on whether you are in growth mode, trying to grow your passive income portfolio, or you are in a cashflow mode where you are trying to maximize the cash flows from your existing properties. So I hope that made sense. I kind of went through that pretty quick. And then just in wrapping up here regarding the stock market, as you know, I’m not a big fan of the stock market. It has its time and place. And yeah, I have some stock. I don’t always have stock in the stock market, but the whole concept of diversification, some people refer to it as diverse or thy worse of occasion. And often the reason people diversify is really because they have lack of control or no control or no understanding of what they’re actually invested in. So they’re really just spreading their chips into different places. And the other reason that people supposedly diversify is to hedge their bets. They just don’t have control or know what the future holds for a particular stock or a particular investment. And so they don’t know if we’re going to have more inflation or less inflation or deflation. So they’re hedging their bets with other investments, be it stocks or precious metals or whatever it may be.

So you really need to understand the investment. It’s more important that you understand what you’re investing in and that controls your risk. So that’s more important than trying to diversify just for the sake of diversification. So I don’t buy into the diversification, but of course, geographic diversification with real estate is something I do subscribe to. It’s one of my rules for successful real estate investing. I think it’s number six. So that diversification makes sense. But at the end of the day, figure out what your goals are, look what you have and what you need to accomplish or gain in order to get there, but do the math. Because what you’re trying to do is maximize your returns, finding the best returns to get you to your goals as quickly as possible. And if you haven’t listened to the episode, go back and listen to the episode I did a couple of months ago called The Real Rates of Return in Real Estate. I believe that’s the title where I break it down in more detail and show you the three main ways you make money or gain returns in real estate. And it’s the cash flow, obviously the cash on cash return, but it’s also the amortization of the loan. And thirdly, it’s the equity growth that you have over time.

On average, those three things add up and they’re not necessarily the same and depending on where you invest in, what you’re investing in, will skew those numbers up and down relative to each other. So I think it’s a good episode to listen to. All right, Lindsay, I hope that helps. 

I hope you enjoyed this week’s throwback Thursday episode. If you haven’t already, remember to subscribe so you don’t miss out on a single episode. If you have a question about real estate investing or finance, simply go to passiverealestateinvesting.com and click the Ask Marco button. . I read all of them, I reply to many of them, and sometimes I cover them on the show, and I’m gonna try and do more of that. So, I am going to encourage you to go to passiverealestateinvesting.com and submit your question for Ask Marco.  Lastly, help us share the show with other like-minded people that you know who can benefit from it as well. Just visit us on your platform. Most of you are on iTunes and leave us a rating and review. I would greatly appreciate it. I read them all and I will thank you in advance. And that is it for today. Thanks for listening. I will see you on our next episode.

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