Pay Off Rental Home?

[kork13]

I'm fighting myself with a thought that's been on my mind for a while, and I'd appreciate your input in thinking through my decision making.

Background:
In 2012, I bought a home in Oklahoma City for $177k. Mortgage was ~25% down, 15-yr fixed at 2.75%, initially for $130k, $1200/mo PITI. I met & married DW in 2014, then in 2016 we moved to Alaska (we're both active duty military). We converted the home to a rental, and we have a property manager handling it for us. The home has been rented for the last 17 months at $1400/mo (lease is up next month, awaiting word on if they'll renew or move out), so basically covering our costs, but no real profit.

Fast forward to now, DW is facing potentially being medically retired/separated from the military. We don't know the exact timeline, but if that comes to pass, it would happen within the next 6-12 months (it's a very long, drawn out process). If she gets a medical retirement, she'll get a small disability income, but we don't expect it to be a whole lot (<$1k/mo). If she's medically separated, it would just be a one-time severance payment, $30k-$40k. We can easily make it on my income alone, but our savings rate would take a big hit (currently ~45% of gross income). If she's forced out, it'd be closer to 25%.

Anyway, what I'm looking at is whether to pull back from our current savings/investment plan in order to quickly pay off the rental. If I were to stop adding new money to our taxable investments, I could send an extra $3500/mo to the rental mortgage, and have it paid off within 18 months, or about 12 months if I also reduce our monthly cash savings & pull from other budget items. Alternately, we also have about $80k already in taxable investments (a few broad-market index funds), that I could theoretically cash out and pay off the rental mortgage tomorrow. They've earned 7.5% in the last year, 5-10% over the last 5 years. Third option of course is to split the difference, and do some of everything, but IMO that just means everything happens at a slow pace.

I know that by the numbers, holding the mortgage and just letting it ride makes the most financial sense. Emotionally, I hate having debts, and I like the idea of the rental providing pure income in the ~80% likelihood that DW is forced to leave the military. DW isn't big into finances, but I've discussed it with her, and she mostly prefers the idea of the fast (but not immediate) payoff. As I said, I'm very split.

So I'm just looking for your thoughts… What would you do in our situation? I can clarify/expand upon any questions if needed. Thanks!

[GoodSteward]

I was going to give a "smart" reply about numbers and such, but honestly, if you guys are facing a life-changing event I would just reduce the stress as much as you could. Technically you can run numbers and see the difference in interest lost by not investing and all that, but it sounds like your fine either way. Just do what will bring you the most peace during all this. Sometimes not having that debt staring at you has more value to your quality of life than trying to play with numbers. If we were talking about using all your cash vs payments, it'd be different.

That's just my opinion.

[Jluke]

random thoughts in no particular order...


* sell the rental property, unless you plan to move back to that location in the future.

* don't sell investments in taxable at gains, b/c then it will cost you even more money with taxes on the gains (assuming you are not eligible for 0% taxes on gains due to income level).

* knowing that you could payoff the rental if you absolutely had to should also be factored into the peace of mind you are seeking.

* are there tax write-offs on the rental mortgage interest?

* of the $1400/month rent, how much goes to the property management group and how much do you get?

* mortgage/HELOC rates are rising, why would you want to tie up even more of your net worth in an illiquid asset?

I think if I were in this situation with $3500/month extra cash I would want to keep more liquidity (safe places like money market, savings, cds, etc) than worry about paying off a rental property.

[TexasHusker]

I would sell the rental property. I'm not a big believer in holding residential rental property far from where you live. You're paying the property manager at least 10 points of the rent, and that drags down your yield to an unacceptable level. It's not a good investment once you've got a third party shaving off of it. Even without a property manager, the ROI on that thing sucks: You've spent $177K for something that is likely only yielding 8.5% before taxes, repairs, and insurance, and that's not counting any vacancy.

I'm guessing your actual yield with no mortgage on that rental house is 5% tops. Add 2 points for annual appreciation and it's still a dog.

Ditch it.

And don't screw with rentals unless your yield is a bare minimum of 10 points a year. It's not worth it until you reach double digit yields. You can put your hard-earned money to much better work for you someplace else.

[LivingAlmostLarge]

I would sell the rental property. I'm not a big believer in holding residential rental property far from where you live. You're paying the property manager at least 10 points of the rent, and that drags down your yield to an unacceptable level. It's not a good investment once you've got a third party shaving off of it. Even without a property manager, the ROI on that thing sucks: You've spent $177K for something that is likely only yielding 8.5% before taxes, repairs, and insurance, and that's not counting any vacancy.

I'm guessing your actual yield with no mortgage on that rental house is 5% tops. Add 2 points for annual appreciation and it's still a dog.

Ditch it.

And don't screw with rentals unless your yield is a bare minimum of 10 points a year. It's not worth it until you reach double digit yields. You can put your hard-earned money to much better work for you someplace else.

This is probably the best thing i've seen written about rentals. I rarely hear RE investors and I know you are TH write that you shouldn't be in it if it's not yeilding return. So many people say take the loss it'll appreciate. I hope people really listen so someone talking about yields and rentals.