Tenants Paying My Mortgage

by Mr. Cheap

Some time ago Mike and his wife exchanged comments about having tenants pay off your mortgage.  My mother takes the same position as Mrs. Pillars does:  tenants paying off your mortgage is a good thing.  With respect to both frighteningly intelligent women, I’m suspicious this is a poor way to think about the investment.

Say you buy a rental property in Pleasantville.  This is a delightful small town, where few people move to but few people leave (’cause it’s so pleasant).  Because of this property prices are very stable, increasing at the rate of inflation.  Say you buy a property for $100K with a 100% interest-only mortgage and you manage to rent it out for exactly the same rental fee as your mortgage payment (so every month you take the rent check, hand it to the bank and you’re even with them).  Is this a good investment?

I don’t think so.  First off, you aren’t making much (in cash flow or appreciation, beyond the increases due to inflation).  While your mortgage is being covered, you’ll still have to pay the maintenance, vacancies (maybe), utilities and taxes yourself. You’ll also have to put in time dealing with tenant complaints or problems. If appreciation equals inflation, this may (or may not) exceed your costs, making this a pretty volatile investment.

Say as an alternative, I invest in ultra-safe GICs and get the 3% rate being offered by PC Financial. This will probably work out to be a little bit above inflation. Is this better or worse than investing in Pleasantville? With an unknown future (and all my made up numbers), it’s impossible to say, but I find it pretty tough to view the real estate investment as the clear winner. There’s FAR more volatility, and the returns don’t seem to compensating for this.

Some might say “Don’t invest in Pleasantville, invest in the hot markets!”. The subprime fallout in Florida, Arizona and throughout California paints a bleak portrait of one possible outcome of that choice.

Richard Thaler coined the term “Mental Accounting” in 1980.  A Washington Post article illustrated this difference with the example “Would you rather lose a $10 ticket, and have to buy another one to replace it, or lose a $10 bill on your way to the event?” Surprisingly, in spite of these being virtually identical situations (from a purely monetary perspective), most people would prefer to lose the $10 bill. Similarly, there’s something irresistibly enticing about matching up a tenant’s rent check with the mortgage payment that I don’t think is entirely rational.

My point ISN’T to debunk real estate investing. I just think that it would be very easy to have tenants paying the mortgage and it being a TERRIBLE investment. Having tenants covering the mortgage may be a small part of the reasoning about whether a deal make sense or not, but that CERTAINLY shouldn’t be the end of the consideration (if that’s all the investor is getting out of it, I think she’d do much better in an couch potato style portfolio or a even a high interest savings account or GIC).

What are your feelings about having tenants pay the mortgage?

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