Jun 11 2008
Another Real Estate Model
We’ve all heard about debt problems people have. Common advice to people with multiple credit cards: pay extra on one card until the balance is paid off. Then use that money to pay off and double up payments on the next credit card. So on and so forth until all the credit cards are paid off.
What if that same idea was applied to real estate?
An investor I know, along with several partners, buy out of state properties. Each property produces positive cashflows. With the cash coming in, what they have elected to do is work on paying off the mortgage of the smallest property. Once that mortgage is paid off then move onto the next property. In addition, all the partners chip in an extra $1,000 per month to help the mortgage go away.
With each property being between $75,000 and $200,000 you can see the mortgages on these properties would quickly melt away.
His objective: have all the properties paid off within five years. When all is said and done, their monthly cashflow per partner will be $10,000.
I know this flies against Kiyosaki’s cashflow game. You exit the rat race when the monthly cashflow exceeds monthly expenses. Pay the minimum on debt, such as mortgages. It’s better to have cash on hand then to sink every penny into debt and have no cash. That’s his model.
But what would be wrong in sinking every penny of positive cashflow into paying down a mortgage, especially if you don’t need the money? In this case, these investors don’t need to have the $500/month in positive cashflow so why not pump it into the mortgage?
I can’t see a downside to this. Of course I just got here and I know I’m not the smartest person in the room.
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I can think of two issues:
1. It’s a low rate of return at typical interest rates in the US currently, especially in after tax terms. But it’s a certain rate of return.
2. In the current credit crunch banks might not want to lend you back the money against your property if you need it….
mooms last blog post..Australian Stock MArket Update
When the market is moving up rapidly, interest rates favor borrowing, and you are in an asset accumulation phase, borrow to finance acquisitions and/or to improve cash flow. When the market is stalled or dropping, interest rates and/or loan terms are unappetizing, alternative investment yields are weak, or you just don’t want another pesky rental, pay off debt.
Debt equals risk. Manage your risk wisely, and you will survive and prosper.
First time poster, long time lurker.
I agree with the previous poster that debt = risk. It a two edged sword and cuts both ways. By risk I mean, any bumps in the road could derail your rentals.
The other thing is opportunities. If you didn’t have debt on your rentals, you could more easily fund future acquisition as they presented themselves.
Right now, you are tapped. You can’t borrow any more of new purchases. You are losing out on opportunities.
But the main reason I would pay off mortgages would be to reduce by risk.
My 2 cents. Good luck.
@Merch: Thanks for stopping by! This isn’t me doing the investing but someone else. Their investing model is different from mine and different from most others I had heard of. My intent was just to share a different idea with the class.
His reason for doing this is so he can retire before he’s 40.