Should I pay off land or buy a rental house?

[wade5628]

I bought some land awhile back but have saved enough money to pay it off (paying 6.25% interest). I am earning next to nothing in interest by keeping it in a savings account. Or I could use it as a down payment to buy a rental house (and get positive cash flow from the get go). Prices are low and interest rates are down (which won't last forever) and I was thinking that this would be a good time. What would you do in this situation?

[wolf]

OP:

I don't want to appear rude. But time is short.

You should first get an education in investing, landlording, and money management!

1. For most people, buying raw land is a major mistake. Raw land does not generate income.

Paying 6% on an investment (land) is foolish. Unless the land is inflating in value. Even raw land has expenses, property tax, insurance, etc....

Calculate how much it is really costing you to "own" raw land. (which is why you need more financial courses).

2. Paying off the land does not make any sense. In realty, you probalbly would be better selling the land.

3. You said you could buy rental property and have positive cash flow.

Again, this shows your naive thinking, (again, don't take this personal, just trying to help you).

You need to look at your "net return". Figure out your capital cost, figure out your true net return and look at the percentage.

If your net return on your investment is 2 or 3 %, lousy investment. You could earn this in a CD with no work.

Another example, I could buy a house for 100% cash. It would have positve cash flow. But still be a terrible investment. (hope this makes sense to you).

Do you have any landlording experience, are you a handyman type person,can you deal with people, do you have basic contract experience, (leases, tenants rights, etc)....

well, good luck, but from your post, you need to look beyond, your orginal question, of whether it's better to pay off the land or buy rental property.

again, just my 2 cents....

[haha]

Quote:

Originally Posted by wolf OP: I don't want to appear rude. But time is short. 3. You said you could buy rental property and have positive cash flow. Again, this shows your naive thinking, (again, don't take this personal, just trying to help you). You need to look at your "net return". Figure out your capital cost, figure out your true net return and look at the percentage. If your net return on your investment is 2 or 3 %, lousy investment. You could earn this in a CD with no work. Another example, I could buy a house for 100% cash. It would have positve cash flow. But still be a terrible investment. (hope this makes sense to you). Do you have any landlording experience, are you a handyman type person,can you deal with people, do you have basic contract experience, (leases, tenants rights, etc)....

One thing to consider is that the 2-3% will tend to be a real return, whereas the same rate from a CD will be nominal.

Buying rental houses in most places and most markets is usually a bet on inflation, which was a pretty good bet for almost 100 years. With our all-powerful government now vowing to create inflation, it may again be a very good bet.

Ha

[jimnjana]

I'd pay off the land, then save to buy the rental. It's not like there appears a recovery in the housing market anytime soon. If you feel compelled to buy a rental, betcha can get a better rate than what you are paying on the land.

[CoopersBeach]

Quote:

Originally Posted by wade5628 I bought some land awhile back but have saved enough money to pay it off (paying 6.25% interest). I am earning next to nothing in interest by keeping it in a savings account. Or I could use it as a down payment to buy a rental house (and get positive cash flow from the get go). Prices are low and interest rates are down (which won't last forever) and I was thinking that this would be a good time. What would you do in this situation?

Some questions:

How much do you owe on the land? How much does it cost you for maintenance and property taxes? Does the land generate any income? What kind of raw land it is (e.g. farm, ranch, improved lot, unimproved lot, etc.)? Do you engage in any ag activities that get you ag exemptions and reduced property taxes? How big is it? How close/far is it from "civilization"? What's happening to the neighboring properties?

Land banking is a high risk and potentially very high reward investment. Yes it is possible to hit pay dirt and make lots of $$$, but the payoff is usually years away, and in the meantime, it is illiquid, can expose you to all sorts of liabilities (e.g. endangered species found on property; pollution from prior use that you have to clean up), and usually has a negative cash flow. It is unsuitable for most people, especially if you're retired and don't have significant means.

I would say don't put any more money into the land. That money can be better utilized elsewhere, such as the rental property. If you can afford the yearly maintenance and property taxes, and don't need access to money already tied up in the land, then keep it. If not, you should sell it.

[wade5628]

Quote:

Originally Posted by wolf I don't want to appear rude. But time is short. You should first get an education in investing, landlording, and money management!

The land was purchased before I studied investing and money management. I wish I also would have studied these areas before the big 401K a couple years ago, but what's done is done.

Quote:

1. For most people, buying raw land is a major mistake. Raw land does not generate income. Paying 6% on an investment (land) is foolish. Unless the land is inflating in value. Even raw land has expenses, property tax, insurance, etc.... Calculate how much it is really costing you to "own" raw land. (which is why you need more financial courses). 2. Paying off the land does not make any sense. In realty, you probalbly would be better selling the land. 3. You said you could buy rental property and have positive cash flow.

Agreed and I realize there's no easy option. It's a horrible time to sell. Paying it off might not seem like the greatest move but like you wrote, paying 6% interest seems foolish also. What I'm trying to figure out is what would be the lesser of two evils: pay it off or keep paying on it. I'm paying over $100 per month in interest.

Quote:

Another example, I could buy a house for 100% cash. It would have positve cash flow. But still be a terrible investment. (hope this makes sense to you).

What about passive income?

Quote:

Do you have any landlording experience, are you a handyman type person,can you deal with people, do you have basic contract experience, (leases, tenants rights, etc)....

I'm not a handyman...is this enough of a reason to be a showstopper?

[wade5628]

Quote:

I'd pay off the land, then save to buy the rental. It's not like there appears a recovery in the housing market anytime soon. If you feel compelled to buy a rental, betcha can get a better rate than what you are paying on the land

Do you see any signs of interest rates going up anytime soon?

[wade5628]

Quote:

Originally Posted by CoopersBeach Some questions: How much do you owe on the land? How much does it cost you for maintenance and property taxes? Does the land generate any income? What kind of raw land it is (e.g. farm, ranch, improved lot, unimproved lot, etc.)? Do you engage in any ag activities that get you ag exemptions and reduced property taxes? How big is it? How close/far is it from "civilization"? What's happening to the neighboring properties?

I owe about 20K. Taxes = $300-400 per year, no income

Quote:

I would say don't put any more money into the land. That money can be better utilized elsewhere, such as the rental property. If you can afford the yearly maintenance and property taxes, and don't need access to money already tied up in the land, then keep it. If not, you should sell it.

I'd rather not sell it unless I needed access to the money. So it's either pay it off, or keeping paying the interest on it and find another investment. Finding another investment that pays over 6% might be a challenge.

[cardude]

I think I would pay it off, IF you already have enough money set aside for emergencies. If you are using emergency fund money to pay it off then I would not do it. You would need to find about an 8.3% pre tax return investment (if your tax rate is 25%) just to break even on paying off the land "investment". Where else can you get a guaranteed, no risk return of 8.3% for just sitting on your a**?

You can find rentals that will return more than that (I have some small duplexes that return 25%+ with no leverage, but I bought them really cheap years ago), but if you have to contract out for all repairs then it will be harder to get much more than a 10% return, and that's if it's fully rented. Renting a house for a return is a pain IMO, and I would not put up with only a 10% return for all the hassle. I always shoot for 20% plus to make it worthwhile.

So again, if you have plenty of liquidity, pay it off.........Just my opinion of course.

[Hobo]

In my real estate course years ago, land is always considered the most risky investment with the most profit potential. In my personal experience, I have made a lot more money in raw land than rental houses. But, you must look at the circumstances.

Are you in the path of future development? Is something going to happen that makes the land double in value in the next 5 years? If the answer is yes, then I would pay off the land and get those interest payments off your back. Sounds like you've got some other good sources of income, so you can save for another investment pretty quickly.

If the answer is no, the land is not going to appreciate faster than inflation + interest, then you bought a real DOG! That is called a "sunk situation" - where you spent your money and there is nothing you can do to salvage the money spent. If you can't sell it, then there is nothing you can do to make things better.

As I explain below, the rental house doesn't sound great either, so I guess I would pay off the land just to get it off my back as a liability.

I think if you are not a handyman, and can't find someone to do that kind of stuff, then a rental house is a real pain. I have had rental houses too. But I had a partner - and wives. Together we could go in, repair, clean, and re-rent pretty easy. But I was young then.

Make sure you know how to calculate rate of return on your positive cash flow. You've got income tax advantages, as well as hidden costs. Make sure this rental house will spin off an honest 10% earnings. Otherwise you can use your money to lend money on second trust deeds that will pay a nominal 12% a year, usually for a 3-5 year period. (Talk to a Realtor how to do this)

I really doubt you are going to see any significant appreciation in the value of house for quite some time. We may even see an "anti-bubble" in housing prices where they don't go up for 5-7 years. People will be afraid to buy houses for quite some time. Then finally prices will pop up quickly when people really start buying again.

I've made a lot of money in real estate, and lost some too. I feel comfortable in real estate vs. the stock market. But honestly, right now, I would be sitting on the sidelines and wait until we start to see some positive movement and trends again. If you get any more money, park it somewhere safe. The time for making money in real estate will return - it always does. But, you can't force it.

PS. Look for a partner who is a handyman and will work for "sweat equity", that is, you pay more cash, he does the dirty work. Partners are good in the real estate business, IMO.

[wolf]

OP:

One last bit of advice.

Follow the advice of the posters who have "real estate experience". I think you can tell by their explanations.

If the "raw land", is a dog, sell and cut your losses. Paying it off makes no sense. Just ties up your resources. Opportunity costs.

Not being a "handyman", in the early years of owning rental property, is a path to destruction. Hiring someone to paint, make repairs, is very expensive.

One last bit of advice, try and find an old guy to "mentor" you. Be sure the person you find is successful.

[Hobo]

Paying off the land and saving the 6.25% interest is equivalent to earning 6.25% on your money. That ain't great, but better than keeping it in a savings account.

As I said before, if you are going to be in real estate, don't over-look making private 2nd trust deeds to people who can't quite qualify at their bank. Banks are stupid when it comes to lending. Lots of really reliable people need an extra $10k to buy a house. In my life I have made a lot of private second trust deeds at 12% interest only, payable in 3 years. I never once had one go bad on me. Of course you want to be selective about who you are lending the money to. Plus, I always wanted the monthly paid to me in "green cash" money - the kind that doesn't leave any tracks in the snow.

[wolf]

Hobo:

Sorry to disagree with you, but in "this case", paying off the land is not the equivalent of earning 6.25%.

If you treat the land as an investment, what is the "net return" on the land? That percentage is your true earning.

Assume the land is paid for, what is the net appreciation per year?

Using your logic, if I had a terrible loan, say 25 %, and I paid off the loan, my land would not yield a 25 % return.

Maybe, one of the more experienced investors can explain this more clearly.

Also, I don't think the OP should even consider 2nd deed of trusts. OP is a novice.

[haha]

Quote:

Originally Posted by wolf Hobo: Sorry to disagree with you, but in "this case", paying off the land is not the equivalent of earning 6.25%. If you treat the land as an investment, what is the "net return" on the land? That percentage is your true earning. Assume the land is paid for, what is the net appreciation per year? Using your logic, if I had a terrible loan, say 25 %, and I paid off the loan, my land would not yield a 25 % return. Maybe, one of the more experienced investors can explain this more clearly. Also, I don't think the OP should even consider 2nd deed of trusts. OP is a novice.

That really is not what he is saying. He is saying that given that you do not plan on selling the land, paying off the note will be an approximate improvement of 6.25% pa in your cash flow from this property.

Kind of hard to argue with this.

Ha

[Hobo]

Quote:

Originally Posted by wolf Hobo: Sorry to disagree with you, but in "this case", paying off the land is not the equivalent of earning 6.25%. If you treat the land as an investment, what is the "net return" on the land? That percentage is your true earning. Assume the land is paid for, what is the net appreciation per year? Using your logic, if I had a terrible loan, say 25 %, and I paid off the loan, my land would not yield a 25 % return. Maybe, one of the more experienced investors can explain this more clearly. Also, I don't think the OP should even consider 2nd deed of trusts. OP is a novice.

Using a simplistic economic analysis, consider of two alternatives:

Alternative one is to keep the cash he has in his pocket, continue to keep the debt and continue to pay 6.25% interest.

Alternative two is to use the cash, pay off the debt and avoid paying 6.25% interest.

The present value of both of those two alternative are exactly equal. Avoiding paying 6.25% interest is the same thing as earning 6.25% interest.

Maybe you don't like the term "earning". Would you prefer the term "keeping"?

[wolf]

OK:

I see both your points. I've heard this same argument used when a person says, should I pay of my "home" mortgage. And I tend to agree.

If a person's home mortgage is 6 %, and they pay it off, it like getting a 6 % return.

However, in OP's case, I guess I'm looking at the big picture. He is losing money on raw land. He said himself, it's a bad time to sell. Maybe, he should sell at a loss, take a capital loss on his tax return, and look for a better investment.

Reminds me of people who buy stock, the stock falls, and they cannot sell until it comes back. Human nature. Then they just wait, and miss out on better opportunities.

Oh, well, again, just my 2 cents.

[Hobo]

Quote:

Originally Posted by wolf OK: I see both your points. I've heard this same argument used when a person says, should I pay of my "home" mortgage. And I tend to agree. If a person's home mortgage is 6 %, and they pay it off, it like getting a 6 % return. However, in OP's case, I guess I'm looking at the big picture. He is losing money on raw land. He said himself, it's a bad time to sell. Maybe, he should sell at a loss, take a capital loss on his tax return, and look for a better investment. Reminds me of people who buy stock, the stock falls, and they cannot sell until it comes back. Human nature. Then they just wait, and miss out on better opportunities. Oh, well, again, just my 2 cents.

Yes, good points. Even a rigorous economic analysis can't make decisions for you. Income tax consequences were not included, neither were property tax costs, and maintenance costs. Intangibles such as possible property price increases or decreases, and opportunity costs are largely judgment calls.

Personally, I would hate to sell any property in this market - this is the worst of times. Surely this is a buyers market and anyone interested would be a tough negotiator. On the other hand OP must have had some feeling that this land was desirable, so maybe it isn't so bad if he is willing to wait.

The bottom line is this: you can do all the all the analyzes in the world, but in the end, you are the one who must make the decision. Even putting it in the "too hard to decide" filing basket is a conscious decision.

I hate to think back at all the stupid decisions that I made in real estate.
But hindsight will never make anybody richer!

[innova]

I haven't read anything yet about income the land could produce.

1) Tillable acres?
2) Timber?

What is the nature of the land?

[Meadbh]

Any minerals or oil underneath?
By the seashore?
View?
Agricultural value?

Obviously in the current economic climate, rampant development is unlikely in the next few years.

[keegs]

Wade,

Lots of good advice here to you. I don't have much to add. You already know what you're into and paying it off seems to make sense over all to me, assuming you can do it without risk.

I don't recall anyone asking whether the land had any pleasure value to you...e.g. do you use it for hunting, fishing, camping...etc.

Is there other value to you in this property other than what you may find on a balance sheet?