Should You Pay Off A Commercial Mortgage or Invest

Suppose you have a $500,000 mortgage on a commercial property, costing you 5% interest a year. You have just received a $500,000 after-tax gain from selling a different property. Should you pay off the mortgage or invest the proceeds?

Let’s assume you own the properties personally. I’m not an accountant, so please check with one before you do anything, but here is my work on the question.

1. The $25,000 I pay in interest is deducted from the income from that property. After I deduct that, I am paying $18,000 in interest. The other $7,000 is not required to be paid due to the deduction.

2. If I pay off the mortgage, my $500,000 will save me $18,000. Thus, I am earning $18,000 in cash flow by paying off that mortgage.

3. If I leave the mortgage and invest the funds in a dividend-paying stock like a major Canadian Bank, I’ll earn 6.5% in dividends on the $500,000. There are no taxes owing on the $32,500. So, by taking the $500,000 and investing it in Laurentian Bank, I am earning $14,500 more than if I had paid off the mortgage.

4. If I were a public company owning property, and I paid off all of my mortgages, my shareholders would fire me. I would not be managing the assets properly.

5. It gets more lucrative when you add inflation. Inflation is currently 4%. On the $500,000 mortgage, the value of that money is decreasing by 4% per year. That is a gain for me. If we add that to the gain of keeping the mortgage, we are at $52,500 in income by not paying off the mortgage compared to the $18,000 if I do pay it off. The gain on inflation is not taxable.

6. If inflation decreases the value of the mortgage, it also increases the value of the building. Based on a 5% inflation rate, we could add $20,000 to the gain in the asset's value. Keeping this mortgage would mean an increase of $72,500 a year. This $20,000 is also earned if I pay off the mortgage.

There is a risk that mortgage rates will increase, removing many of the advantages listed. However, with each mortgage, it’s important to do the math and understand the risks and implications of using this strategy. So, if given the chance, I won’t be paying off a mortgage. If I did that commonly recommended action, I would be an irresponsible asset manager.

Debt can be good.