Buying Rentals vs Paying Off Debt: What’s Better?

Maximize Your Real Estate Wealth by Understanding the Trade-offs

So, you have a little cash on the sidelines or monthly cash flow that you are not sure what to do with, and a common question that may be rattling around in your head is: “Should I focus on paying off my real estate debt, or use that money to buy more rentals?”

The answer, like most things in real estate, is that it depends. There’s no one-size-fits-all solution. However, there are several variables to consider to help you make the best decision for your situation. The right move ultimately depends on your financial goals, risk tolerance, and market conditions.

Let’s break it down.

Start with Your Goals

Before you run the numbers or chase another deal, take a step back. What are you trying to accomplish?

• Do you want to maximize cash flow now? Paying off debt may be the best decision as it has an immediate impact on monthly cash flow.
• Are you playing the long game and trying to maximize your wealth in the future? Acquiring more rentals could set you up for greater wealth down the road through appreciation and principal paydown.

Let’s explore some of the pros and cons of each decision to get your mind focused in the right direction to help with this challenging decision. 

Paying Off Debt

Pros:

• If you pay off the debt in full, you will enjoy an immediate cash flow boost from eliminated loan payments.
• There’s power in simplicity. Fewer loans mean less stress and more control.
• Lower risk in a downturn with fewer obligations.
• Psychological freedom from debt which appeals to many investors.
• Easier to weather vacancies, repairs, or sliding rents.

Cons:

• Opportunity cost. Cash used to pay down debt isn’t buying additional assets.
• Slower portfolio growth.
• Low-interest, tax-deductible debt is an important ingredient in wealth creation.
• Owning property free and clear is public information and shows the world you have assets, potentially making you a target for lawsuits.  

Buying More Rentals

Pros:

• Using leverage to buy rentals is how many investors grow wealth. If done wisely, it’s a path to significant long-term gains.
• More properties appreciating create larger overall gains.
• More rentals bring more tax benefits.
• This scales your cash flow over time, so when you are ready to pay off debt, you could have significantly higher cash flow with more properties.  

Cons:

• Increased debt load raises your risk.
• Tighter cash flow in the short term. It is difficult to find cash-flowing properties without significant down payments in today’s market.  Some assets may be great down the road, but hurt your current cash flow now.  Are the long-term gains worth the short-term sacrifices?
• More properties can create more management headaches and require more of your time.  

Other Factors to Consider

Interest Rates:
The rate you are paying on your loans matters.  If you refinanced during COVID, it is possible you have debt under 3%.  It would be difficult for me to pay off a loan with such a low rate, knowing I can invest in something like Pine for a much higher return and create far more cash flow.  The question is: if you did not pay off debt, what would you invest in? If it means leaving money in a savings account, it might be best to pay off the debt, but if you can invest for a higher return, it probably makes sense to leave low-rate debt alone.

Risk Tolerance:
Can you sleep at night with more leverage? Some investors thrive on aggressive growth. Others prefer peace of mind. Maybe you are somewhere in the middle.  In any case, there is certainly value in eliminating debt even if it does slow your long-term growth.

Liquidity Needs:
Paying off debt ties up capital. This might be the single biggest reason to consider not paying off debt.  Cash in the bank provides flexibility that free-and-clear properties cannot.  As I have said in the past, you cannot buy a beer with your home equity.

Tax Strategy:
Mortgage interest is often deductible, as are property depreciation and actual expenses on rental properties. More leveraged rentals create more tax-savings opportunities.

The Bottom Line:

When deciding between buying more rentals or paying off debt, the answer truly depends on your specific situation.  It depends on many factors, such as interest rates, risk tolerance, and your ultimate short- and long-term goals.  My recommendation would be to start by getting clear on your goals, evaluating your portfolio, and staying honest about your risk tolerance. Whether you’re building a portfolio or simplifying your life, this decision will help shape your financial future.