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Rental Property: Monthly Cash Flow vs. Principal Pay Down
Old 11-03-2015, 05:15 PM   #1
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Rental Property: Monthly Cash Flow vs. Principal Pay Down

When looking at future cash flows in retirement, it seems fairly straightforward when accounting for monthly positive cash flow from a rental property - it basically offsets monthly spending, thus reducing the monthly total needed from other income sources (e.g., pensions, annuities, investment principal draw down, part-time job, etc.). However, if I will still be carrying a mortgage on the rental property into retirement, how should I view the mortgage principal pay down that is occurring monthly? I don't think this is cash flow, per se, because I can't buy groceries with it. That said, how should I be thinking about this monthly $ amount in my retirement projections since it certainly will be increasing my net worth? Thanks!

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Old 11-03-2015, 05:38 PM   #2
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The principal pay down is increasing your Net Worth.

Net Worth = Assets minus Liabilities.

Your equity in the property is an Asset. Your mortgage is a Liability. When the mortgage is paid off you will have an Asset equal to the value of the property, with no Liability.

Coincidentally, when you pay off the mortgage, your monthly cash flow will improve by the amount of the mortgage payment.
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Old 11-03-2015, 05:39 PM   #3
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I don't know much about real estate but could you account for it like you would an annuity.

will there be any extra after the mortgage is paid? My sister in law has a 2 family rental, family A pays the mortgage, family B is profit that she can add into her monthly income
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Old 11-03-2015, 06:02 PM   #4
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I make sure to allocate 10% of rents to maintenance, 7% for management and 5% to vacancy. Then I pay all expenses.

Then I pay the mortgage. Then, what is left, is cash flow. If you do not set aside the above amounts, you are doing it in a risky fashion.

The principle paid is money you MAY get back, but you should also account for depreciation recapture (25% tax), commissions and other selling expenses, and capital gains.

I personally do not count the monthly principle amount, only the equity at some point, heavily discounted.
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Old 11-03-2015, 06:09 PM   #5
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Quote:
Originally Posted by Downtown View Post
.... how should I be thinking about this monthly $ amount in my retirement projections since it certainly will be increasing my net worth? Thanks!

Downtown
I have a mortgage in retirement. I view my mortgage payments as being part of my necessary withdrawals and essentially like an expense in my retirement budget even though I understand that a portion of these cash outflows effectively increase my equity and net worth, nonetheless the cash has to go out the door and come from my portfolio.
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Old 11-04-2015, 08:34 AM   #6
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Emphasis added...

Quote:
Originally Posted by Downtown View Post
When looking at future cash flows in retirement, it seems fairly straightforward when accounting for monthly positive cash flow from a rental property - it basically offsets monthly spending, thus reducing the monthly total needed from other income sources (e.g., pensions, annuities, investment principal draw down, part-time job, etc.). However, if I will still be carrying a mortgage on the rental property into retirement, how should I view the mortgage principal pay down that is occurring monthly? I don't think this is cash flow, per se, because I can't buy groceries with it. That said, how should I be thinking about this monthly $ amount in my retirement projections since it certainly will be increasing my net worth?...
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The principal pay down is increasing your Net Worth...
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Originally Posted by pb4uski View Post
...I view my mortgage payments as being part of my necessary withdrawals and essentially like an expense in my retirement budget even though I understand that a portion of these cash outflows effectively increase my equity and net worth, nonetheless the cash has to go out the door and come from my portfolio.
Principal pay-down does not increase net worth. It is neutral to net worth. Each principal payment decreases assets (i.e., cash) and liabilities by an equal amount, which has no effect on net worth. Net worth will only change as the market value of the property changes.

From a technical accounting perspective, only the interest portion of each payment is an "expense." But as a practical matter of planning for retirement, the principal pay-down is a very tangible cashflow obligation that must come from somewhere, same as interest.

Like pb4uski suggests, just think of the whole mortgage payment as cash-out-the-door that has to come from your portfolio or other income sources. The good news is: unlike other expenses, there's a specific date when the cashflow obligation ends. And better yet, you have the ability to control that timing.
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Old 11-04-2015, 08:54 AM   #7
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Thanks for everyone's comments. I think I'm clear on it now. Very helpful.

This is a great community!
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Old 11-04-2015, 09:22 AM   #8
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...Principal pay-down does not increase net worth. It is neutral to net worth. Each principal payment decreases assets (i.e., cash) and liabilities by an equal amount, which has no effect on net worth. ...
You are correct... while it increases equity (in the property because the debt is lower) it is neutral to net worth because the reduction in debt is offset by a corresponding reduction in cash.
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Old 11-04-2015, 04:49 PM   #9
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The principal pay down is increasing your Net Worth.

Net Worth = Assets minus Liabilities.

Your equity in the property is an Asset. Your mortgage is a Liability. When the mortgage is paid off you will have an Asset equal to the value of the property, with no Liability.

Coincidentally, when you pay off the mortgage, your monthly cash flow will improve by the amount of the mortgage payment.
+1. My wife and I agreed on paying off a rental property asap we own as it increases our cash flow.
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Old 11-04-2015, 05:37 PM   #10
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My spreadsheets, when I had a mortgage, showed the monthly principal pay down as reducing the liability column every month. The asset value, however, was measured by the market value of the property per Zillow.


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Old 11-04-2015, 08:34 PM   #11
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You are correct... while it increases equity (in the property because the debt is lower) it is neutral to net worth because the reduction in debt is offset by a corresponding reduction in cash.
Very true, if the property value remains the same throughout the life of the mortgage.
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