Focus Investing

June 24, 2013/ 8 Comments

Suppose that you own 10 buildings in your portfolio and you have 10 mortgages of $80,000 each for a total mortgage debt of $800,000. Further, suppose your portfolio generates a total of $3,000/month of cash flow. If you decide that it’s time to start paying off your mortgages by reinvesting $2,000/month of your cash flow, would it be better to put $200/month toward the principal on each mortgage, or would it make more sense to throw the entire $2,000/month toward one of these mortgages? Let’s consider this…

Paying on 10 Mortgages Equally

If you had $2,000 per month to reinvest, you could contribute a total of $200 per month toward each mortgage. All things being equal, this would lead you after 60 months to recapture roughly $12,000 of principal on each of your mortgages, for total equity in your portfolio of $120,000. Not bad…

Paying Toward 1 Mortgage

By contributing the entire $2,000 per month toward one of the $80,000 mortgages, you will pay off that mortgage in about 40 months. In doing so, and this is the very important point, you will not only free up laveragable equity, but you eliminate the payment associated with the paid off mortgage. If we assume an interest payment at 6%, this will free up $400/month.

At this point, and this is where it gets fun, you can either chose to pay off another one of your mortgages, but instead of throwing $2,000 toward the principal you will now be able to pay an additional $2,400 per month. This means that in only about 34 months you will pay the second mortgage down to $0, and free up yet another payment associated with it. And on, and on, and on…

Also, instead of moving to the second mortgage, you could chose to re-leverage the paid-off property and bridge the equity into acquisition of additional assets.

Conclusion

The problem with the first approach is two-fold. While you do recover equity, the amount is not sufficient to be able to bridge. And also, since nothing gets paid-off, you do not recover cash flow – your payment does not drop-off.

Investing is about having options and by utilizing the second method you create options for yourself!

Thoughts anyone?

8 Comments

Seth @ REtipster July 2, 2013 at 10:03 pm Reply
I agree with your assessment Ben. Even psychologically speaking, I’d really appreciate just getting one of those monkeys off my back, with one less payment to worry about each month. There’s something to be said a for having a little bit more peace of mind.

Ben July 2, 2013 at 10:11 pm Reply
Hey Seth – thanks so much for your comment,
I am glad that you agree, but I have to confess – the above article is only part of the story 🙂 Here is the deal – it is what I do:
If I have balloons or arms that need to be cashed out or paid-down, I do exactly what I described. However, once things are in a comfortable place – I releverage. Several reasons:
1. It’s not a good idea to own equity from liability stand-point – attracts bad attention, if you understand what I am saying.
2. Equity needs to work, more specifically it needs to be traded in for Cash Flow.
In the end, this cycle just repeats and I come out with a much larger assets base and income statement.
What do you think Seth?

Seth @ REtipster.com July 3, 2013 at 8:31 am Reply
Hi Ben – so if I’m hearing you right, you just don’t like to have a lot of equity in any ONE particular property (i.e. – too many of your eggs in one basket – from a liability standpoint), correct? This makes sense to me and I have to admit, I had never really thought about your 2nd point – but that totally makes sense. If you have too much equity in any one property, you may have a healthier global balance sheet, but you’re also passing up the opportunity to generate a stronger global cash flow.
These are all great things to think about!

Ben July 3, 2013 at 8:52 am Reply
Yes Seth,
I plain don’t like a lot of equity. It’s useless. It does not pay for bread or medical – Cash Flow does all that. And yes, we have to be cognizant of the society that we live in. As to lawyers, they don’t like to work for free. I have to believe, and I know this to be true, that the first thing they check is how much they can earn, which is a function if equity.
Some people practice equity stripping (financing equity out and spending it in the Caribbean). I don’t do that! I bridge equity into acquisition of Cash Flow. Now, the techniques and tools that I use for that is an whole another conversation for which this is neither the time or the place.
I know that this perspective is different from the main-stream thinking Seth – but it has worked well for me equally at the top of the bubble and in the past 4 years.

Junior S July 5, 2013 at 2:02 pm Reply
Great point brought up Ben. I’m still new to the investing world, but things like this really open up my eyes up in terms of figuring out ways to free up money and equity. I agree with you alot in the sense that equity doesn’t entice me as much as cash flows.

Ben July 5, 2013 at 2:10 pm Reply
Hey Junior – nice to see you here!
What can I say – I get hungry once in a while, and equity does very little to put food in my mouth. That’s a job for Cash Flow 🙂
Thanks so much for reading and commenting Junior!

Starla July 10, 2013 at 5:18 pm Reply
Ben, I agree with you in theory. But do you ever worry that by over-leveraging, you are creating a “house of cards” that could collapse? Or that you will take on more properties than you can properly manage? I’m just wondering, as I often worry about this with our own rental properties.

Ben July 10, 2013 at 5:35 pm Reply
Hey Starla – it’s nice to see you here!
No and No and Yes and Yes – let me explain…
I am always concerned that everyone is properly collateralized – my good name and reputation is riding on it. However, there is a big difference between leveraging 100% of the purchase price verses 100% of the value. For instance – let’s say I buying a property out of the Chapter 11 forced liquidation fire sale. The property is worth $275,000 but I am paying $200,000. Furthermore, with effective management, this property is going to capitalize at $325,000 in under 2 years. Besides, my capacity to perform is a function of Cash Flow and has nothing to do with the equity. So, am I worried about leveraging 100% of the purchase price? I am prudent, but No – I am not; I know I’ll get out for what I have in it if need-be. By the way, this is not a hypothetical example; this is a 6-plex I bought last fall 🙂
As far as management – there is a learning curve with every acquisition; this is to be expected. Having said that, we are out there building systems – right? If your management process does not involve you building systems, then you are managing yourself – you will hit a dead end soon. We should be building systems – plugging people into those systems – and managing the systems. This is the only way to proficiently manage a portfolio of RE.
Thanks so much for your comment Starla…

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