Cash flow or equity paydown!

[LAndersen]

I am just looking to seek others thoughts. Is it better to take any positive cash flow and let it build over time or is it better to on a say quarterly basis use this extra cash to pay down the principal more? Both ideas have their pros and cons and it probably depends on the situation. Other thoughts???

 

[Thomas Beyer]

keep a healthy cash reserve, say 6 months mortgage payments to allow for (un)expected repairs and (un)expected vacancies !



roofs, boilers, hot water tanks, windows, kitchens, bathrooms, showerheads, toilets, carpets, front entry doors, drywall, paint, lights... all need replacement once in a while or get damaged/break ! Budget for that, depending on age and condition of home.

 

[LAndersen]

Thanks for your thoughts. I have single family and suited properties and am just trying to get others thoughts looking long term.

 

[SpecialEd]

Thomas,



What do you think is an appropriate cash reserve for say a one bedroom condominium unit?



There are less major things that can go wrong (roofs, boilers, hotwater tanks, windows etc.), but certainly a lot of other things that may need fixing and always have to account for vacancies. My thinking was to have a 3 month reserve and then use the cashflow after that to pay down principal etc.

 

[Thomas Beyer]

[quote user=SpecialEd]What do you think is an appropriate cash reserve for say a one bedroom condominium unit?


3-6 months is a good rule of thumb .. depending on age of property, your other income and vacancy potential of city.



Mortgage paydown or more property purchase also depends on your goals. Is it "wealth creation" or "wealth preservation + live off cash-flow" ?



If you chose mortgage paydown, you make 3% to 4%, i.e. the interest you save. Usually you can do FAR BETTER owning more real estate, as with a 70-75% mortgage and no cash-flow and an average 3% value appreciation you can make about 14-15%/year without big risk !



[Math: 30% down with a 70% mortgage, and no cash-flow, mortgage paydown is about 10% of the mortgage in 5 years .. add 15% to this 7% and you have 22% equity over a 30% downpayment i.e. 70% ROI in 5 years in a very normal low risk average real estate investment .. and if you buy in faster growing regions and have a bit of cash-flow you can do far better]





Cash or access to cash (via a LOC, for example) is always useful to

a) sleep better at night i.e. for (un)expected vacancies/(un)expected expenses,

b) buy more properties

c) enjoy life to buy "stuff" (vacations, kids education, new car, fancier hotel room, donations, etc. ..)

d) upgrade existing property for higher rents or higher values down the road !



If goal is cash-flow for retirement then mortgage paydown MAY make sense, or likely not. It MAY make more sense to buy more properties that cash-flow, or to keep the cash for a) to d)



I always have erred on the side of keeping more cash for a) to d) .. as I find a 3% ROI just a tad too low !!

 

[Lucy]

Whether you pay down the mortgage or choose a longer amortization period to stay more cash flow positive, these monies are still taxable.
I guess it all depends on whether you believe that real estate will continue to appreciate indefinitely from these all time highs, with rates at emergency situation, all time lows.

 

[Thomas Beyer]

[quote user=Lucy]Whether you pay down the mortgage or choose a longer amortization period to stay more cash flow positive, these monies are still taxable.
I guess it all depends on whether you believe that real estate will continue to appreciate indefinitely from these all time highs, with rates at emergency situation, all time lows.


I think it matters not what one believes .. the FACTS matter ! If I believe the earth is flat it doesn't really matter, for example ! Believes have to be grounded in facts or science ! Facts are, on average, over a longer period of time real estate prices APPRECIATE in a healthy economy. (see related reinpost with a 120 year view here) For example, not knowing Libya, prices are probably lower now than 6 months ago .. but will be higher 2 years from now. Ditto Edmonton where real estate prices have shot up a lot to 2007 .. and have corrected downwards a bit for 2 years and are now starting to rise. Even in California, after a 50% drop prices are still higher than in 2000 !



Does anyone honestly believe that prices in 10 or 20 or 30 years will be lower .. be it cars, houses, oil, peanut butter or socks ?



Also: taxes are payable only on TAXABLE INCOME .. and taxable income is rent collected minus operating expenses (like property taxes, mgmt fees, utilities, repairs, insurance, condo fees, ..) minus interest paid on the mortgage or LOC .. MINUS depreciation (which is 4% of house value). Due to depreciation (also called CCA, capital cost allowance) with a 50%+ mortgage usually no taxes are payable until one sells the property !!

 

[jonathanb]

Thomas, i heard the price of socks is supposed to plummet, so im selling all mine now!



Short term prices/values matter most to short term investers.



jon

 

[Thomas Beyer]

[quote user=jonathanb]i heard the price of socks is supposed to plummet, so im selling all mine now!


True for stocks too !!

 

[bizaro86]

[quote user=jonathanb]Thomas, i heard the price of socks is supposed to plummet, so im selling all mine now!





Is the person who told you this already a multi-billionaire? If so, why not? Anyone who can predict the short-term direction of the stock market should be very, very wealthy, as it would be very easy to make a killing with that information. I would consider this a situation where you need to look behind the curtain, and see what motivation the person who said this has. (And it might just be that doom and gloom is good for ratings!)



Michael

 

[jonathanb]

Michael



Please note i said "socks" not "stocks" as i was joking around about Thomas' earlier post about everything eventually costing more over time- be it real estate, gas, food, socks etc.



jon

 

[bizaro86]

[quote user=jonathanb]Michael



Please note i said "socks" not "stocks" as i was joking around about Thomas' earlier post about everything eventually costing more over time- be it real estate, gas, food, socks etc.



jon



Ok, you got me



It would be much harder to make a fortune speculating on the price of socks, even if you did know the markets movements in advance.



A lesson for me to read more carefully. Reminds me of this, for those who haven't seen it: http://www.anvari.org/log/20030916.1803_first-and-last-letter-research.html



Michael

 

[jonathanb]

Haha... very true.



jon

 

[RedlineBrett]

to help answer the OP's question in my opinion you should structure your investment to yield the highest cash flow possible. If you have no better options than to pay down mortgage debt you have the option to do so. The 'cash in hand' that comes from better cash flow might serve you well in times of operational emergencies, vacancies or profit taking. Essentially when you have cash flow you have options.... one of which is to pay down principal!

 

[Lucy]

I would think, "the greatest cash flow" comes from paying off your mortgage on your investments rather than managing multiple properties in hopes that this 15 consecutive year run up in prices will continue forever.

What I should have added in my earlier post is that it depends on how old you are. If you are 20 to 40 years old for example, you may want to leverage yourself to the maximum I hopes that there will be continued appreciation in prices for the next 20 years.

If you are pushing 50 or 60, I hope you are smart enough to realize you are not going to live forever and having a passive income of $200,000 or more by owning one or two quality income properties paid for is a nice place to be at that age.

 

[bizaro86]

[quote user=Lucy] I would think, "the greatest cash flow" comes from paying off your mortgage on your investments rather than managing multiple properties in hopes that this 15 consecutive year run up in prices will continue forever. What I should have added in my earlier post is that it depends on how old you are. If you are 20 to 40 years old for example, you may want to leverage yourself to the maximum I hopes that there will be continued appreciation in prices for the next 20 years. If you are pushing 50 or 60, I hope you are smart enough to realize you are not going to live forever and having a passive income of $200,000 or more by owning one or two quality income properties paid for is a nice place to be at that age.



I would be very happy indeed to have passive income of 200,000 or more by owning one or two quality properties. They would have to be multifamily as well as of good quality to generate that sort of income, I would think. 200,000/12 =16,666 per month. If you figure only 40% for expenses (as they'd be paid off in your example), that would require $27,777 per month of gross rent, or approximately 23 doors at $1200 per month.



So I think (as with so many things) that the right answer for a person depends on their situation (as you mentioned) as well as their current portfolio and their goals. If 200,000 per year was required for someone's Belize, and their current portfolio was 5 doors, then additional buying will be acquired, and Brett's suggestion of maximizing cash flow makes the most sense. If on the other hand, enough properties to meet your goals have already been required, then paying them off as expeditiously as possible makes lots of sense.



Of course, Brett's point that you can always choose to pay down your mortgages with cash-in-hand is still a great one. Cash gives you the most options, and if you have it in hand there's nothing stopping you from paying down your mortgages. (assuming 15% per year pre-payments or whatever you have doesn't limit you)



Regards,



Michael

 

[Thomas Beyer]

real estate assets comes with THREE profit centers:

a) cash-flow from renting

b) mortgage pay-down (if mortgaged)

c) value appreciation through continued small or large improvements and inflation [& possibly repositioning/condo conversion]



So, indeed, depending on your age and cash availability the mix of all 3 is different .. so in early years (tax free/deferred) equity creation and mortgage paydown is usually key aka wealth creation and as you get older cash-flow and wealth preservation is usually the focus !



10 years ago I have done really well with teh former in buildings in a fast rising Edmonton market .. today it is more a combination of both, i.e. less levered .. and perhaps in 10 years there will be some free and clear asset .. although I think that cash-flow alone is an insufficient reason for real estate in most circumstances !

 

[Lucy]

I have been investing in real estate for 30 years. The last peak was in 1990. What is going on in the Gta market is alarming. I imagine the Vancouver market is even more pronounced. Prices are now rising at 10 % per year for the last couple of years for most desirable properties. It's a freight train waiting to derail. These types of appreciations are not healthy or sustainable. The overall stats lump many types of homes together in many different areas showing a smaller annual increase however when you look specifically at the more desirable properties, in the desirable areas, these are where the frenzies are happening. Buyers are paying $200,000 lot premiums on $800,000 homes in the suburbs. Jumping at the $200,000 premium without consideration simply because last year this same type of premium was only $150,000 and "we should have bought last year, look how much money we would have made."

I was at a mastermind meeting last Friday where I voiced my concerns and I was scolded for thinking like a "loser" by newbies investing for only the last 6 to 12 years.

We are definitely approaching another peak sometime in the near future. Of course no one knows exactly when but these types of appreciations cannot be sustained forever.

If the last peak occurred 20 years ago and one is in their later years, say 50 to 60 and the next peak may occur 10 -20 years from now, I would work real hard to pay down your base choice properties and enjoy your cashflow as much as possible. They don't have to be residential types investments. I am especially fond of quality commercial and prestige buildings as they are NET leases.

I may think like a "loser" but this is the way I see it at my age. I don't have much confidence in this type of appreciation for much longer. At these rates of appreciation my kids will need to pay $1,000,000 for a semi detached home in the suburbs of Toronto in 6 or 7 years.

I don't think so.

 

[markl]

Do you have a principal residence? If so you should use the cash flow from your properties to pay this mortgage off first as it is not tax deductable plus you can get the re-advancable kind of mortgage where you can then have your equity accessable to invest with monies that the interest rate is tax deductable.



If you own your own home free and clear then the answer is it depends on your current situation have you been investing for 10 years and enjoyed enough paydown and appreciation where you want to head off into your twilight years? Or are you still agressively growing your portfolio? Therefore using the monies to re invest in new properties?

 

[bizaro86]

[quote user=Lucy]I was at a mastermind meeting last Friday where I voiced my concerns and I was scolded for thinking like a "loser" by newbies investing for only the last 6 to 12 years.



This is not very nice. Two thinking people can disagree on something without the discussion degenerating into personal attacks. Ad hominem arguments have no place in a real estate discussion. Obviously you should have been treated with more respect.



[quote user=Lucy]one is in their later years, say 50 to 60



I think this is the crux of the matter. I'm 25, and own 4 residential rental properties. I could pay them all off, and the income wouldn't replace what I'm making now from my job, not to mention my wife's employment income. That strategy doesn't make sense for me at this stage in my life, so I keep my amortizations long, mainly to improve my TDS so I can qualify for additional funding. The extra cashflow helps when saving for additional downpayments as well, although it's not significant at this point compared to employment savings.



[quote user=Lucy]I am especially fond of quality commercial and prestige buildings as they are NET leases.



I would love to be able to play in this sandbox, since the leases are net and the tenants are businesspeople, so I think feelings are less likely to enter the situation. If I had the money to purchase these types of properties, I would.



http://www.einnews.com/pr-news/372250-riocan-real-estate-investment-trust-provides-update-on-recent-acquisition-activities-



I read this press release with interest. The properties listed under "Other Canadian Acquisitions" seem like they could reasonably have been purchased by an individual investor, and would probably make good investments when mixed with a reasonable amount of leverage and then paid down.



Regards,



Michael