Many rental property owners are debating between two choices:
Should they focus on paying down the handful of properties that they already own? Or should they buy more properties?
In this article, we'll discuss two questions that you should ask yourself in order to arrive at the answer.
I'd like to give two caveats before discussing this problem.
First, the term "handful" (when used to describe the number of houses that you own) relates to your personal experience and debt tolerance. Some people think a "handful" of properties is one or two units; other people think it's 15 or 20 units.
Almost every investor will start to seriously contemplate this question once they've accumulated a number of properties – though that number differs wildly. And that's totally OK. Personal finance ispersonal.
Secondly, this article focuses on what an investor should do as opposed to what an investor cando. I'm not going to focus on whether or not an investor CAN buy more properties (i.e. qualifying for loans). I'm going to focus on how to make the decision as to whether or not you WANT to buy more.
The "buy more or pay down?" question relates to your debt tolerance and the goals that you set for your life. Let's look at these two factors.
Risk tolerance—and its corollary, debt tolerance—lays on a spectrum. On one end of the spectrum, you'll find people who aren't even reading Bigger Pockets because they would never foray into real estate investing in the first place. They are comfortable keeping their money in bonds, cash, and bank CDs.
On the other side of the spectrum, you'll find people who enthusiastically use margins to leverage their penny-stock purchases and who take out massive loans to fund all types of businesses.
These are extreme examples. The majority of us lay somewhere in the middle.
On Bigger Pockets, you'll find investors who represent every side of this issue. Some investors believe you should never put your own money into an investment, while others only buy properties with cash.
"Debt tolerance" may be a more accurate description of this question than "risk tolerance."
Why? Some investors think that using their own cash is riskier than using other people's (lenders) money. But other investors, who are exclusively cash buyers, disagree. The rest of us lay somewhere in the middle.
So if you're deciding whether to pay down your properties or accumulate more, the first question you should ask yourself is: What's my debt tolerance? How close am I to "maxing out" my comfort level?
The second issue is a question of your life goals. What are your goals for your real estate business? How well do your investments align with these goals?
We don't create profit in a vacuum. We do it for a higher purpose. What is your purpose? Is your goal to have a lot of money when you're in your 60's, or is it to have decent cash flow when you're in your 30's?
Joe is 30. He owns four single-family homes as rental properties. Each house collects a gross rental income of $2,000 per month. After paying the mortgage, repairs, management, vacancies, and all other expenses, Joe collects $800 a month in passive cash. His goal is to have his rental properties provide him with a nice fat retirement when he is in his 60's.
Based on this goal, he chooses not to pay down his houses. Instead he makes the minimum mortgage payments on his properties, and he focuses on accumulating even more houses. This will allow him to enjoy a heftier cash flow when he's in his 60's.
Jill is also 30 years old. She also owns four single-family homes as rental properties, each of which have a gross rent of $2,000 per month and a current passive cash flow of $200 each ($800 total). In other words, her current situation is identical to Joe's.
However, her goal is to enjoy passive income and financial freedom when she is in her 30′s. This will allow her to spend her youth focusing on other endeavors, such as moving to Europe, launching a different business, joining the Peace Corps or raising a family. Rather than focusing on accumulating more properties, she focuses on paying down the rentals that she owns.
When all four houses are paid-in-full, she'll gross $8,000 per month. Assuming that roughly half of her gross income will get spent on non-mortgage related operating expenses, she will collect $4,000 per month in passive income. And if she aggressively pays those houses down, she can enjoy that money in her 30′s.
The Best Option
Which of these two options is correct? The best course of action depends on your personal goals. Joe wants to have more money in his 60's; Jill wants to have immediate cash flow in her 30's. Both of these are valid options, and they underscore how your decisions need to align with your life goals.
We don't make profits in a vacuum; we make them to support the lifestyle that we want to enjoy.
Should you buy more rental properties or focus on paying down the ones that you own? That's not the question you should be asking yourself. The real questions are: What do I want out of life? And how much debt am I willing to accept in order to reach those goals?
Once you answer those two questions, the "buy-more versus pay-down?" question will be easier to solve.
This article Should You Buy More Rental Properties Or Pay Down the Ones You Have? originally appeared on The Bigger Pockets Blog.