If you are an experienced investor with an existing portfolio of rental properties, you have probably wondered whether you should continue to acquire new properties or focus your attention on paying down the mortgages on the properties that you currently own.
While there is no simple way to answer this question, the reality is that the only logical way you can make this decision is by analyzing the numbers for each scenario and letting the potential financial returns be your guide.
Pros of Paying Down Your Mortgage
The main benefit to paying down your mortgage is that you will have more equity stored in your property and will shorten the time frame for which you can own the property “free and clear” without any debt obligations.
The long-term advantage to this strategy is that once the mortgage is paid off, you will see a significant increase in your cash flow, as you will no longer have to make a monthly mortgage payment. This is great for those who are investing in real estate in order to fund their retirement, as this strategy will result in having a debt-free, income producing properties that will provide a great lifestyle in your golden years.
While the benefits of paying down the mortgages on your investment properties are a long-term play, there are many short-term advantages as well. Paying down your mortgages and lowering the amount of debt you owe on your properties, will enable you to have more flexibility when selling and offer more protection if there is ever a turn in the marketplace.
Cons of Paying Down Your Mortgage
The negative aspect of paying down the mortgages on your investment properties, as opposed to acquiring new assets, is that you won’t see a change in your monthly cash flow unless you can refinance the property. In essence, you have simply given your money to the bank, which is probably not the best use of your investment capital.
The long-term disadvantage of this strategy is that if you are unable to refinance the property at the lower principal, then you will be unable to reap the benefits of generating higher yields from your monthly cash flow. Your investment capital will be “trapped” within the property and you will only be able to reap higher gains once the property is paid off or sold.
Paying down your mortgages is a long-term play and may not be the most advantageous strategy for investors looking to maximize their investment yield. You always need to ensure that your capital is working hard to generate consistent returns for you and paying down debt without lowering your monthly payment obligation is rarely a good idea.
Pros of Acquiring More Rental Properties
Leveraging your existing capital to acquire new properties can have many advantages both short-term and long, depending on your investment strategy and your personal goals. One benefit to purchasing more rental properties is that as you acquire more properties for your portfolio, you have the potential for greater portfolio appreciation over time.
If you have three properties valued at $100,000 each, your total portfolio value is $300,000. Assuming that the market appreciates on average 5% per year, your portfolio would gain $15,000 in equity every year, because 5 percent of $300,000 is $15,000. Subsequently, if you had five properties with a total portfolio value of $500,000, your portfolio would be gaining $25,000 in equity every year at the same rate of appreciation, as 5 percent of $500,000 is $25,000.
Over the course of 10 years, the decision to acquire more rental properties could have a tremendous effect on your portfolio value and your net worth as a whole. A portfolio consisting of only 3 properties would have appreciated $150,000, while the portfolio of 5 properties would have appreciated $250,000. This also does not take into account the increase in rental yields, as you will also generate more monthly income by owning more properties.
Cons of Acquiring More Rental Properties
The down side to acquiring more rental properties, as opposed to paying down the mortgages on your existing properties is that you are exposed to more potential liabilities. As you acquire more properties, you also acquire more tenants and all of the issues that come with managing and maintaining properties. You will have more maintenance costs to consider and over the long term, you will have an increase in your capital expenditures, as you will need to fix and upgrade more properties. Increased vacancies across your numerous properties could also be detrimental to your cash flow and your long-term investment returns.
Having a large portfolio of rental properties is great when everything is going as planned, however, highly leveraged properties offer less protection in the event of a downturn in the real estate market. A steep decline in real estate prices could leave you with a portfolio of homes that is worth less than the amount of debt that is owed on them, making the possibility of selling them at a profit a faint reality.
As with any investment opportunity, you should always weigh the advantages and disadvantages to determine if the opportunity fits your investment objectives and time horizon. Determining whether to acquire more property or pay down the mortgages of your existing properties will ultimately depend on your current market and its long term future outlook.