We’ve got real estate tycoons and we’ve got stock market tycoons. We’ve even got wealthy bond investors such as Bill Gross who pulls in over $100 million a year. Now that the markets have recovered from the financial downturn, I’d like to have an open discussion on which asset class provides the the most amount of wealth over the long run.
It’s important to realize there are no renter or cash tycoons. The return on rent is always -100% every single month. Meanwhile, the return on cash averages a paltry 0.1% nationwide, even after the Fed rate hike. You can certainly be a wealthy renter with tons of cash in the bank. But your wealth was accumulated through other means so don’t get confused. Having a money strength grade of F- is no way to go.
In this article I’ll explain why I have a preference for real estate over stocks (equities). Both have proven worthy of building great wealth over time.
REASONS WHY REAL ESTATE IS BETTER THAN STOCKS
1) You are more in control. Every physical real estate investment you make puts you in charge as CEO. As CEO, you are able to make improvements, cut costs (refinance your mortgage now that rates are back down post now that Trump is disappointing on some of his main promises), raise rents, find better tenants, and market accordingly. Of course you are still at the mercy of the economic cycle, but overall you have much more leeway in making wealth optimizing decisions. When you invest in a public or private company, you are a minority investor who puts his or her faith in management. Sometimes managers commit fraud or blow their companies to smithereens through unwise acquisitions. Nobody cares more about your investment than you.
2) Leverage with other people’s money. Leverage in a rising market is a wonderful thing. Even if real estate only tracks inflation over the long run, a 3% increase on a property where you put 20% down is a 15% cash-on-cash return. In five years you will have more than doubled your equity at this rate. Stocks, on the other hand, generate roughly 7% – 9% a year including dividends. Leverage also kills on the way down, so remember to always run the worst case numbers before purchase.
3) Tax advantageous. Not only can you deduct the interest on up to $1 million in mortgage indebtedness on your primary home, you can also sell your primary home for tax free profits up to $250,000 for singles and $500,000 for married couples if you live in the home for the last two of a five year period. If you are in the 28% or higher tax bracket, it behooves you to own property. All expenses associated with managing your rental properties are also deductible towards your income. Income limits do apply however, so make sure you don’t make much more than ~$166,000 a year total.
4) Tangible asset. Real estate is something you can see, feel, and utilize. Life is about living, and real estate can provide a higher quality of life. Stocks aren’t event pieces of paper anymore, but ticker symbols and numbers. When the world comes to an end, you can seek shelter in your property. Real estate is one of the three pillars for survival, the other two being food and shelter.
5) Easier to analyze and quantify If you can calculate realistic expenses and rental income that’s all you really need when it comes down to valuing a piece of property. If you can borrow at 3% and rent out for a 6%+ yield, you’ve likely found yourself a winner. Real estate is immediately exploitable if you have the financial means to invest. There’s not only the cash flow component but the underlying equity component that helps investors build wealth. Stocks require you to trust what the company reports. There are countless ways for companies to massage their numbers to make things look better than they really are e.g. adjusting accounts receivables, adding one off gains, and using various amortization or depreciation strategies to name a few. Take a look at Zillow for the latest estimates, comparables, and sales history. It’s so easy to do research on real estate compared with researching stocks.
6) Less visible volatility. Your house value could be tanking and you would never know it since there isn’t a daily ticker symbol. During bad times, the utility of your home really helps soften the blow as you enjoy your home and create great memories. During the 2008-2009 downturn, I still got to enjoy my vacation property in Lake Tahoe 15-20 days a year even though its value was plunging. Meanwhile, looking at the TV or computer screen just made me mad. When your investment is less volatile, it’s much easier to stay the course and not sell at the bottom.
7) A source of pride. Making money for money’s sake is a pretty empty feeling after a while. Every time I drive by my rental properties I feel proud to have made the purchases years ago. I know that my money is working as hard as possible so I don’t have to. Real estate is a constant reminder that taking calculated risks over time pays off. There is an indescribable feeling nobody tells you once you’ve closed on your property. Even though the bank probably owns most of it in the beginning, you literally feel like the King or Queen of your castle. When you die, you can pass on your pride to your children or closest companions to let them create their own memories. Further, there is a “step-up” function where your heirs inherit the property based on the value of the property at the time of passing so that the cost basis is higher, which helps lower tax liability if the property is ever sold.
8) More insulated. Real estate is local. If you’ve made a good decision to buy in an economically strong region, you will be more insulated from the national economy or the global economy. Spain blowing up is likely not going to affect the rent you can charge. Brexit actually helped drive mortgage rates lower as foreign investors bought safe US Treasury bonds. Look at prices in superstar cities such as NYC, Hong Kong, Singapore, London, Paris, and San Francisco. They fall the least, recover the soonest and gain the most. Of course, industries in your area could suddenly disappear and leave you broken as well. Of course, it’s also a good idea to diversify into lower cost regions of the country for higher yields. I do this through real estate crowdfunding and focus on real estate projects in Texas, Nebraska, Utah, and Tennessee.
9) The government is on your side. Not only do you get generous mortgage interest tax deductions and tax free profits, you get bailouts if you can’t pay your mortgage. The government also aggressively went after banks to force them to extend loan modifications to bad and good creditors. I even got a free loan mod recently to my surprise. Programs such as HARP 1.0 and HARP 2.0 are allowing folks without hefty downpayments to get in on the action. There are plenty of non-recourse states such as California and Nevada which don’t go after your other assets if you decide to stop paying your mortgage and squat for months. When was the last time the government bailed individual investors out of their stock investments?
Home prices will probably start slowing down in 2018 and beyond
REASONS WHY STOCKS ARE BETTER THAN REAL ESTATE
1) Higher rate of return. Stocks have historically returned ~7-9% a year compared to 2-4% for real estate over the past 60 years. You can also go on margin to boost your returns, however, I don’t recommend this strategy given your brokerage account will force you to liquidate holdings to come up with cash when things go the other way. Your bank can’t force you to come up with cash or move out so long as you are paying your mortgage.
2) Much more liquid. If you don’t like a stock or need immediate cash, you can easily sell your stock holdings. If you need to cash out of real estate you could potentially take out a home equity line of credit, but it’s costly and takes at least a month.
3) Lower transaction costs. Online transaction costs are under $10 a trade no matter how much you have to buy or sell. The real estate industry is still an oligopoly which still fixes commissions at a ridiculously high level of 5-6%. You would think the invention of Zillow would lower transaction costs, but unfortunately they’ve done very little to help lower expenses. They are in cahoots with the National Association of Realtors because they are their source of advertising revenue.
4) Less work. Real estate takes constant managing due to maintenance, conflicts with neighbors, and tenant rotation. Stocks can literally be left alone forever and pay out dividends to investors. Without maintenance you’re able to focus your attention elsewhere such as spending time with family, your business, or traveling the world. You can easily pay a mutual fund manager 0.5% a year to pick stocks for you or hire a financial advisor at 1% a year. Or you can just manage your portfolio yourself due to so many free financial tools online.
5) More variety. Unless you are super rich, you can’t own properties in Honolulu, San Francisco, Rio, Amsterdam and all the other great cities of the world. With stocks you can not only invest in different countries, you can also invest in various sectors. A well diversified stock portfolio could very well be less volatile than a property portfolio.
6) Invest in what you use. One of the most fun aspects about the stock market is that you can invest in what you use. Let’s say you are a huge fan of Apple products, McDonald’s cheeseburgers, and Lululemon yoga pants. You can simply buy AAPL, MCD, and LULU. It’s a great feeling to not only use the products you invest in, but make money off your investments.
7) Tax benefits. Long term capital gains and dividend income are taxed at lower rates (15% and 20%) than the top four W2 income rates (28%, 33%, 35%, 39.6%). If you can build your financial nut large enough so that the majority of your income comes from dividends, you could lower your marginal tax rate by as much as 20% or so, depending on the current legislation.
8) Hedging is easier. You can protect your real estate investments through insurance. If disaster strikes, it’s often a pain to get your insurance company to pay for damages because the burden is on you to prove your claim. With stocks, you can easily short stocks or buy inverse ETFs to protect your portfolio from downside risk.
9) Potentially less ongoing taxes and fees. Holding property requires paying property taxes usually equal to 1-2% of the value of the property each year. Then there’s maintenance costs, insurance costs, and property management costs. You can build your own portfolio of individual stocks and bonds for just $5 a trade. Or you can have a digital wealth advisor like Wealthfront build and maintain your investment portfolio for just 0.25% a year in assets under management after the first $15,000. They use their research and algorithms based off modern portfolio theory to best manage your money based off your inputted risk tolerance.
CHARACTERISTICS MOST SUITABLE FOR REAL ESTATE AND STOCKS
Real Estate
* Believe wealth is made up of real assets not paper.
* Know where you want to live for at least five years.
* Do not do well in volatile environments.
* Easily spooked by downturns.
* Tend to buy and sell too often. High transaction costs ironically keep you from trading too often.
* Enjoy interacting with people.
* Takes pride in ownership.
* Likes to feel more in control.
Stocks
* Happy to give up control to those who should know better.
* Can stomach volatility.
* Have tremendous discipline not to chase rallies and sell when things are imploding.
* Likes to trade.
* Enjoy studying economics, politics, and researching stocks.
* Don’t want to be tied down.
* Have a limited amount of capital to invest.
NO BAD CHOICES IN A BULL MARKET
The choice between investing in real estate or stocks is like choosing between eating a chocolate cake or a hot fudge sundae. Both are good provided that you don’t go overboard. When you are younger, investing in stocks is easier and makes more sense since you have less money and are more mobile. As you get older you probably want to set some roots so owning at least your primary residence is beneficial.
With stocks, it’s terrific to see portfolios go up. But after a while, it becomes unsatisfying to see more money accumulate in your brokerage account. Money needs to be spent on something, otherwise, what’s the point of saving and investing?
Whatever you do, don’t own nothing. Inflation will rob you of your financial happiness when you are older and less willing or able to work. Own assets that rise with inflation such as stocks and real estate. Let’s just pray the bear market doesn’t return, but it sure seems like things are slowing.
Recommendations
* Look into real estate crowdsourcing opportunities: If you don’t have the downpayment to buy a property or don’t want to tie up your liquidity in physical real estate, take a look at RealtyShares, one of the largest real estate crowdsourcing companies today. Real estate is a key component of a diversified portfolio. If you study the asset allocation mix of college endowment funds and high net worth individuals, you’ll see real estate weightings of anywhere between 10% -25%. Real estate crowdsourcing also allows you to be more flexible in your real estate investments by investing beyond just where you live for the best returns possible. For example, cap rates are around 4% – 5% in San Francisco, but over 10% in the Midwest and South if you’re looking for strictly investing income returns.
Realtyshares pre-vetting funnel to highlight only the best opportunities on their platform
* Shop around for a mortgage: Mortgage rates have come down again after an initial rise post presidential election. Check the latest mortgage rates online through LendingTree. They’ve got one of the largest networks of lenders that compete for your business. Your goal should be to get as many written offers as possible and then use the offers as leverage to get the lowest interest rate possible. This is exactly what I did to lock in a 2.375% 5/1 ARM for my latest refinance. For those looking to purchase property, the same thing is in order. If you’ve found a good deal, can afford the payments, and plan to own the property for 10+ years, I’d get neutral inflation and take advantage of the low rates.
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About the Author: Sam began investing his own money ever since he opened an online brokerage account online in 1995. Sam loved investing so much that he decided to make a career out of investing by spending the next 13 years after college working at Goldman Sachs and Credit Suisse Group. During this time, Sam received his MBA from UC Berkeley with a focus on finance and real estate. He also became Series 7 and Series 63 registered. In 2012, Sam was able to retire at the age of 34 largely due to his investments that now generate roughly $175,000 a year in passive income. He spends time playing tennis, hanging out with family, consulting for leading fintech companies, and writing online to help others achieve financial freedom.
Updated for 2018 and beyond.
Personally, I prefer real estate to stocks – mainly because it is a tangible asset and I understand it better. However, like you, I think that they are both great investments. I think the best investment for somebody to make is one that they can both understand and make them bucket loads of money.
There’s something alluring about making money off an asset which you can enjoy using during the ownership period. It’s like a piece of fine art hanging on your living room wall. Imagine it increasing in value by 100% over a 10 year time period all the while getting to enjoy it’s beauty. Can’t do that with stocks.
That is a great analogy, and I couldn’t agree more.
It would be nice if the art is protected. The sun, cats, crazy little kid, made that impossible for us. We just have to hide the fine art in the closet…
As my art dealer tells me, “Put the Monet away.”
We like whatever’s the most mis-priced in our favor at the time. A few years ago, that was real estate in our area, so we scooped up as much as we could at the time. Now real estate isn’t mis-priced, so we’re focusing on paying that off and making sure we’re maxing out all of our free money via tax preferred and employee matching on stock market accounts. We’re not really picky over the long haul.
Good investor mindset! I wonder if the folks who sold to you guys are kicking themselves now.
I’m not sure if banks can kick themselves. All of our properties were bought out of foreclosure as banks needed to get RE assets off their books at the time to satisfy regulators.
Gotcha. Good call buying foreclosures!
That makes a lot of sense. What do you think is most mis-priced now?
I don’t know. We’ve been playing with some numbers on different types of RE in our area – we looked at the numbers for a commercial building (restaurant) that’s in foreclosure, and condos in a higher end area but nothing’s screaming “buy”. As for stocks, I am definitely not an expert and don’t devote time to value investing the way I’d like to eventually, so we’re just going the way of index funds in long term tax preferred accounts with employer matching. That and paying off the RE to deleverage that.
What do you think is mis-priced at the moment?
How about Apple? PE in the single digits, and it you strip out their cash, it’s PE is below 7?
There’s a pretty good case to be made that the market is in a bubble where its strength has been derived from government activity instead of business fundamentals. Real estate prices are still artificially high, but probably not as artificially high as the market.
When market wealth evaporates, people will still need a place to live. If I had a lot of cash laying around right now, I’d be buying properties. That’s my vote!
You mean like the Washington DC area and the sequestration that is now in effect?
I don’t see real estate as artificially high when rental yields are much higher than borrowing costs.
The stock market is what could turn on a DIME.
I think we’re agreeing then, unless I’ve misread.
Yep, we agree.
I agree with you about 90% of the way on this one & my goal too is to have my asset allocation in similar amounts. Although it is not a popular choice, my opinion is if you buy rental property with cash you are a lot better off in the long run. I know there are a million people out there will disagree, but it is hard to lose a property to foreclosure when there is no mortgage. Yep, you lose out on the leverage aspect, but you’ll make better decisions about what you choose, who you allow to be a tennant when you happen to lose one, and you will sleep easier at night. A bear real estate market is actually what you wait and hope for, that is when you make your money. Everybody looks smart when times are good. Slow and steady wins the game everytime, leverage is what has caused empires to crumble.
A bear market or actually a super hot market bode well for cash buyers. I think you mentioned you bought your property with all cash? I think that’s great if you’ve got a lot more cash and cash flow behind.
I just like taking full advantage of government subsidies up to a $1 million primary home mortgage while I’m in a high income tax bracket and invest the money elsewhere.
Yep I paid cash for an awesome home at the absolute bottom of the market that I was able to do because I was in a cash position. I hear you on taking advantage of the system the government has created, you cannot argue that the math is definitely on your side of the arguement…I guess I am just an old fashioned 42 year old that is o.k. with not being crazy weathly. If you pay cash it makes you think a little more about if it is a good decision, the ramifications are greater & the grass feels different on your toes when the property is paid for & I absolutely sleep easier at night vs. having a $1 million mortgage hanging over my head. Funny thing I actually talked my finacial advisor into paying off his home vs. carrying a mortgage…
If someone paid cash for a house, why would they need “a lot more cash and cash flow behind”?
After all, it’s a LOT easier to get work (or simply offset) utilities and property taxes than it is to add in the mortgage in addition to the utilities and property taxes.
Although if one has a large enough stash of cash, the perspective can be skewed I’d imagine.
There in lies the issue…how much is enough? The goal of buying a “home” should be to actually own it. It enriches your life and is an expense, not a profit center…buy something you love and can afford. Your “cash” piles back up in a hurry when you are paying yourself instead of the bank. I see way to many people (my friends and family included) that put a minimum amount down & have the maximum home possible, over 50% of these people the dream has not quite worked out…they are upside down, house poor, and miss out on life experiences because the anchor that is weighing them down. But the “math” definitely says borrow as much as you can at 2.85% I get that and don’t knock anybody for doing it, hell young people who don’t have a ton of cash abosulety should jump in now…it is more about piece of mind for me knowing the next crash has no impact.
Here’s the thing though. Let’s say you have $1 million home that declines by 50%.
Scenario 1: You pay $1 million cash, so your asset is worth $500,000.
Scenario 2: You put $200,000 down and now have negative $300,000 equity, but you have $800,000 cash in the bank. Still end up with net $500,000, BUT you can walk away from your house, jockey for a bailout or whatever and still keep your $800,000 cash. Not saying people should or would, but having that $800,000 cash provides more optionality.
Real estate has a strong “heads I win, tails you lose” component to it.
But again Sam,
Reduction by 50%.
Scenario 1: You pay $1M cash and your asset is worth $500,000. You still don’t have to move.
Scenario 2: You have $800,000 cash, and because of the negative equity you decide it’s better to not sit still because the area is degrading quickly, so you now choose to move someplace else and rinse/repeat.
Like you and nbsdmp both know, there’s a rub either way.
In another 10-15 years I believe that rates will go up, but not to the point of doubling unless you have a 2%-2.5% rate. There is a cycle, although for mortgage rates, the cycle just happens to be measure in decades than in a single year.
I consider a house a place to live so that when I retire some day, I don’t have any extra bills outside of utilities and property taxes, and still have $0.5M-$1M that I can easily live off of, thanks to people like yourself that cause some of us to “get a grip” on personal finance. :-)
Because once you tie up a big nut that you’ve become accustomed to being liquid, you start to fret about no longer having that liquidity position. But you’re right. Paying cash for the house should require less cash flow due to no mortgage payments.
The psychology all depends on where one is in life. If you are in the later stages and don’t have the hunt to invest in new things nor do you plan to live for another 40 years, then liquidity isn’t as important.
For someone in their 20-40s, I think it’s better to not have everything tied up in a house.
Great conversation guys! A couple of notes/comments that I would like to make. I paid cash for my home but it at no point represented more than 20% of my net worth. I would also not suggest having a HUGE chunck of your net worth tied up in a single asset being your home. I’m fortunate and have a nice income, savings, and paid for income producing assets that I let accumulate overtime prior to buying. (delayed gratification) I would say that 30% would be the maximum of your net worth I would suggest being tied up in a home if you were young…skewing lower as you get older. (geographic exceptions do occur I understand)
Sam, I do not agree though on your calculation of putting $200k down, the market goes down 50% and you have an actual loss of $200K, but that other $800k you have you put that to work in other assets such as the market, well that goes down as well with the market so you are out $400k. That’s a total loss of $600k. People need to put on their big boy pants and fulfill the commitments they sign up to, yes you can walk out on your commitment that you made to the mortgage company. Another way to think about this is would you go take a loan for $800,000 at 3% to go put it in the stock market to try and get 8% return? And be willing to lose your $200k equity and have all the stress associated with it.
FS, another great post. I do like your emphasis on the fact that real estate and stocks are really the only ways to build wealth. You see things as they are, not the way you (and many others including myself) would like things to be. Bonds, CDs, commodities are all just ways to manage risk and tread water until another path becomes clear for investment.
Also, enjoyed your point about the non-monetary benefit of making great experiences and memories with your vacation property. Not everything is measured in dollars. And also that is a great picture of a beautiful Victorian home; your pics are always a nice complement to the posts!
Yep, once you build a sizeable financial nut, it really is about risk control. I fear a correction in the markets this summer, which is another reason why I’m just waiting to deploy some money.
The non-monetary benefits of RE really are the BEST benefits. Live to live. Money is just a tool.
LOL~! Yes!! And that nut is to be protected like SPARTA!
btw, I pulled the trigger. Still working on the details, but the biggest item for my consideration has been met in my favor; my separation is a ‘layoff’ in every definition. And your book, “How To Engineer Your Layoff” was amazingly helpful. Thank you so much for writing the book and sharing your experience, it was a great benefit to me. More to come…
Great news Jay! I wish you good luck in the next step of your life. Perhaps you will share another post to readers about your success story! If you ever come to SF I’ll have to buy you a drink to congratulate you!
What about Cash? You mentioned 65%, 30%, 5% for net worth allocations – shouldn’t you have a percentage in cash that is available to take advantage of opportunities that arise without having to sell stock positions or being trapped in CDs?
Good question. I hate cash. I try and have as close to $0 cash as possible due to the pathetic returns.
At any given time, my 35% stock exposure has some cash to invest. I can always sell positions to buy new opportunities as well. I am cash flow positive every month, so whatever disposable income I have goes towards investments.
Good post & comparison Sam! I think both have their benefits and think it’s great when you can be in both to be further diversified. I generally prefer being in stocks because stocks I know, am comfortable with and can do from anywhere. While we would like to get into real estate at some point in the future, we just do not have the time right now.
Kind of like running an online business. Can operate from anywhere. At some point I will probably hire a property manager to deal with ALL issues related to property for me.
There’s one income stream that’s even better than RE and cash, but I’ll wait until the Fall to talk about it :)
I second this and the thought in #4. With fears of the world ending or a crash coming, I like owning things that are tangible. A rising # that you can view on the Internet doesn’t provide the most security.
I would say that both are great investments right now, primarily because our government loves them both. The Fed loves rising home and stock values.
Long live the Fed!
I prefer stocks because they don’t come with expenses (debt service, maintenance). While I like the idea of real estate in theory, I don’t like the work involved and the possibility of having stretches of time with no renters.
Having said that, I like dividend paying stocks because they act like rental real estate (value of stock = value of the house; dividend payments = rental income). But I’m conservative. So far I’ve only ventured into the Dividend Aristocrats.
Great post!
Good points. If you don’t want to do any work at all, RE is not for you.
Real estate, Hmmmmmmm. My income comes from a pension. I have investment accounts. My house is paid off. I am single with one claimable dependent. Because of all this, I found that my newly retired situation doesn’t leave much in the way of tax breaks. I have been contemplating real estate for the tax benefits as well as diversification. In Vegas, houses are being snapped up by cash investors so fast that young families cannot get their hands on one. A few months ago one could offer 20% under the appraised value and get the property. Not so today.
I am weary for a couple of reasons. Is the Fed artificially inflating the housing bubble again through the purchase of 84 million dollars a month in mortgage backed securities? If it is so, I am afraid of losing out if todays real estate investment falls flat tomorrow. I ask myself if I should wait for this second anticipated real estate bubble to burst in order to take advantage – something that may never happen. Second, I don’t know if I could do the landlord thing. I may have to overcome these fears if I am to gain a tax advantage and diversify. Is there another way besides real estate?
A pension is even better!
If you wait for the next bubble, you/we might not be around long enough to enjoy the spoils. Are biggest enemy is time.
Once you learn about real estate and really get your hands dirty, it’s one of the most straight forward investments you can make that can be positively affected by effort. With stocks, no matter how much effort I put into stocks after purchase, nothing changes b/c the market and the operations are out of my control.
Could be, but I’d need to research the underlying holdings to make an informed decision.
What I talk real estate, I want to own the physical asset for all the reasons above. REITs can be part of a diversified portfolio, but give me a tangible asset instead.
Just a quick opinion – REITs have much more in common with stocks than with real estate and IMHO should not be counted as RE when viewing your allocation breakdown.
AFAIK, you don’t get any of the extra perks with REITs that you do with owning actual property (tax breaks, leverage, depreciation, the list is huge).
Adding to Jason’s thought, the dividends have to be paid out of the REIT to shareholders every year. Taxes paid on those dividends every year. And when the Real Estate the REIT is holding craters in value, or the neighborhood declines or the business cycle declines so rents/occupancy decline in response, then blah, blah, blah.
Where is your area?
If you plan to move within 5 years, or see a risk of losing your job, then yeah, stay away from physical RE. Wait until you know with 80%+ certainty you’ve found the place you want to be.
Makes sense. Ontario sounds like Detroit a little?
May I naively ask what prevents folks who live in Windsor or Hamilton from leaving to a brighter city in Canada given how solid the social safety net is?
The mortgage interest tax deduction is just a bonus and not the main reason why I invest in real estate. I’d much rather pay a lower mortgage interest rate than a higher one.
Nice. I am/was as well. But, I’m getting tired of DIY as I get older so will happily hire others to handle the fixes.
Screen your tenants like the CIA folks! It’s worth it in the long run.
My last landlord (over 13 years ago now), never ran a credit report on any of his tenants.
Of course, when you only let people like me (who called 3 months before planning on moving to the area, and they are upfront about past credit dings that would be caught on a credit report, and work for a rather safe employer in the immediate area), I guess they never felt the need to.
And the funny thing is that he and his wife could have raised rents by more than $100/month and I would’ve paid it because the rents were $150-$200 more in the surrounding area.
@Mr. 1500, it has to be fascinating. I used to run credit reports for prospective clients, and the most amazing thing to me was that they all had an excuse! Nobody ever said “I did the wrong thing.” “I messed up.” “It was my fault, and I shouldn’t have…” Never. It was always someone else’s fault (I recall a poster on this site stating that her credit report was bad because her parents didn’t forward her mail. Speaks for itself, doesn’t she ever talk with her parents?). My favorite response, when I asked why a person didn’t pay the bill they knew was outstanding and rightfully owed, was, “Well, I have to have a cocktail, too!” Guess they revealed a little too much about their priorities.:-)
Bad credit indicates character issues.
Right on about real estate being a tangible asset. I always tell my wife that if the world implodes, we cant’ do anything with numbers on a screen, but we can still live in our home.
What do you think of REIT socks? I like the monthly dividend payers.
I’m not big on the DIY aspect of real estate and I don’t really want to spend that time messing with the repairs/headaches, etc. On the other hand, I think the market is overpriced so I’m not loving stocks. Eh, what to do, what to do…
I like stocks better. It’s so much easier. Rental properties can be a big PITA. Our 4 plex needs their fireplaces repair and it will probably cost over $2,000. This year isn’t going to be very good. On the other hand the 4 plex in that area is selling at +$50,000 the price I paid 18 months ago.
I have known for quite sometime you can build your wealth a lot faster with real estate than you can with stocks, given you take the same amount of risk. As of right now I like stocks better than real estate because I’m not educated enough in real estate to conduct the transactions you speak of. Of course that’s not to say I couldn’t learn it over the course of three months but my current situation is different than others. For example SFH in my area go for no less than 600k, town homes no less than 300k, apts around 150k. Needless to say you would need a hefty 20% deposit. Once we relocate to another area where the cost of living is signficantly lower I plan to lock myself into a room and educate myself on real estate deals to take advantage of.
No question, real estate for all of your reasons. I always liked real estate because I had total control over my investment. I can raise rents and increase the value of my investment. The value of income property is based on how much revenue is generated.
Regarding sale of your primary residence, you can only claim the tax advantage ($250/500K) if it is a primary resident for at least 2 out of the last 5 years.
Good addendum, and something I’ll add so there is no confusion.
I just discovered this website 2 weeks ago and have been reading pretty religiously ever since. I really like what I’ve been seeing. Maybe this is discussed in another post, but what is the samurai’s position on precious metals. I own all the asset classes discussed here except CDs. I much prefer precious metals. I treat it like a bond or CD — something that I figure over the long haul will do well (especially with the FED printing money)
Welcome to my site Lyle! Be prepared for a mix of curve balls, just be forewarned! Over time, you’ll get the various messages I have embedded in my more kooky posts.
I actually just bought GDX and GLD. I can’t believe how slaughtered the miners have gotten. I’d like to think GLD outperforms in a market downturn I’m expecting this summer. We shall see. It’s just a trade.
It’s killing me that I can’t get in to U.S. real estate right now. I’m living offshore on a corporate expat assignment and don’t know when I’ll be coming back or to what city. I’m pretty much 80/10/10 equities/bonds/cash… the cash I am keeping around for a house down payment when I do get back. If I knew where/when that would be, I’d be buying right now instead of hoarding all that cash that’s doing nothing for me. Would probably buy 1-2 rental properties too if I knew I was going to stay in one place for 5 years, but no way I’m going to try and manage rental properties from another country. I just hope the govt keeps rates artficially low until I get back.
US real estate is SO CHEAP compared to foreign real estate. If I was from HK, London, Moscow, Paris, Singapore, Rio, Sao Paulo, Beijing, etc I would be buying hand over fist here as well.
An expat assignment is nice though, so enjoy! Where are you currently?
I’m in the Cayman Islands…not a bad place to live for a few years :)
Oh wow! Nice work! I’d love to learn more about all the offshore accounts and tax evasion strategies and benefits there.
I have an old client who made his fortune in SF and who is now chilling out there.
I’m solidly in the REI camp since, in my mind, retirement and/or good living is all about a steady cash flow. If my portfolio goes up, that doesn’t put food on the table unless I sell something.
True. Although the case can be made by just buying dividend funds or dividend stocks.. But given the volatility in stocks, as a retiree, I’m less sanguine.
I guess it boils down to your phase of life. For retirees and soon-to-be-retirees, REI is probably more attractive because of the cash flow. But if you plan to keep working, stocks may be better.
(I keep forgetting that your blog is not exclusively for the FIRE folks.)
FIRE = Financially Independent Retired Early? Never heard of that acronym, but may have to start using it.
The phase of your life depends a great deal. I would actually argue a little on the opposite side. When I’m over 50, the last thing I want to do is to manage my real estate. Although it doesn’t take that much effort, it still requires effort. I will hire someone to do everything for me and pay 1 month’s rent to do so, or whatever the going rate is.
If only we weren’t bombarded with stock news every day, and if only stocks didn’t take huge dives, cut dividends, and get crushed due to corporate malfeasance, I would just buy and hold the “highest quality” dividend stocks forever.
Hi JT
I think you’ll find that REI offers the same or even more “digging” and number crunching than stocks do. Not only do you have to know the housing market, but you’ve got to have an idea of rental rates as well as more boots-on-the-ground stuff like “how much money will it take to reno and put tile into this bathroom”, “which contractor should I go with?”and “would this tenant be a good fit ?”
But, you are right about the skills transference – someone who’s well-versed in stocks needs to start at the beginning in order to be confident approaching REI.
In 2008 and 2009 I saw blood in the streets and scooped up as much real estate as my risk profile would tolerate. Now I’m at 50% own small biz, 35% real estate, 10% cash, 5% stocks. This is the lowest percentage stocks I’ve had in 20 years. I am selectively selling some properties to upgrade to higher quality, meaning easier to manage and better chance at appreciation. The caveat is that the higher quality properties have lower yields.
Nice. But at least higher quality properties have more capital appreciation upside and theoretically higher quality tenants.
An instant classic. After thinking about this issue for the past few years, I’ve come to some of the same conclusions. Everyone should be forced to read this post before they start investing in properties or stocks.
Thanks for helping spread the word!
My preference is stocks because of the liquidity. It is also easier to set limit orders for stocks both on the buy/sell sides of the house. While the market is more volatile than real estate typically, the use of limit (or even trailing limit) orders is a lot easier and as long as you buy enough shares, the transactions fees are WAY less.
If you’ve got the discipline to sell and buy with sliding limits, I think that’s great. The problem is.. folks tend to hold losers too long and sell winners too quick, including myself.
One big reason why I don’t plan to sell my properties is b/c of transaction costs. With inventory down 55% in SF, I’m looking for the real estate industry to cry UNCLE and finally cut their ridiculous commission fees of 5%.
I don’t try to time the market at all, and don’t care if I’ve sold one too quickly.
As for buying, I usually set buy orders anywhere from 2%-8% less than whatever it may be trading at the time, and depending upon how volatile that particular stock is.
Why would you care if you didn’t get the complete uptick? I have a tendency to set the sell order within 24 hours after the purchase was acquired, unless I managed to get the buy so low that I plan on holding onto the stock for a longer time because it pays dividends or the stock will appreciate back up towards it’s 52 week highs in relatively short period of time.
Not being too greedy has been one of the biggest hurdles I overcame to improving my portfolio by more than 26% two years ago, and 22% last year. And of course the markets climbing the way they since the end of last year certainly hasn’t hurt much as far as this year has transpired so far.
As far as the RE commission fees, I don’t particularly like them either. One of my siblings sold his own residence by FSBO (For Sale By Owner), some 6-7 years ago now for a tiny $495 cost and another $250 to a lawyer to finish up the paperwork. Since that house sold for over $200k – I can’t remember the final amount, they certainly made out on that deal. :-) With that being said, I don’t know how many FSBO properties are being sold in that way anymore.
I’m a big fan of Real Estate. Closing on house #3 in the next week. It’s a crazy, competitive market in NorCal right now. I got out bid twice and then found an abandoned home that didn’t have a for sale sign on it, researched it, and should close shortly. I like the tangible asset part of it and I’m fascinated with researching and understanding the real estate game. Passive income is my goal. If things work out, I should have 2-3 paid-off houses in the next 6 years.
It is crazy how things can turn on a dime. Where were all the buyers last year?
Downsides of real estate: namely rental real estate… your forgot the hassle of dealing with renters. Also potential liability and the need for insurance, etc.
Didn’t forget. Just focused on the positives between the two. See point #4 for Stocks:
4) Less work. Real estate takes constant managing due to maintenance, conflicts with neighbors, and tenant rotation. Stocks can literally be left alone forever and pay out dividends to investors. Without maintenance you’re able to focus your attention elsewhere such as spending time with family, your business, or traveling the world. You can easily pay a mutual fund manager 0.5% a year to pick stocks for you or hire a financial advisor at 1% a year.
I have to agree with you, I do prefer real estate over stocks. But, I have more than half of my net worth in stock, it was actually less in the past but the money that I have in stocks has rapidly outpaced my real estate in terms of growth. Once I get some of my personal financial obligations settled, I will be putting more of my available cash flow into real estate.
That’s not a bad problem to have! I would just be extra careful now that you are in job transition, just like I’m more conservative now that I’m unemployed. Protect your net worth’s value at all cost.
Even though I prefer real estate, we are about 85% stocks and 15% real estate. Ideally, I’d like this to be about 50% RE, 40% stocks, 10% cash. So the question is, do we sell some stock to buy more real estate now (the town we live in was one of the worst hit in the country so now is a good time to buy) or do we save cash for a few years and buy then, but prices will be higher?
If you have the means to buy real estate, I would buy now as I do believe we are in at least a 3-5 year uptrend. But if you don’t, hopefully your stocks will do well too. The problem is what you want to buy will get that much more expensive vs the appreciation of what you own.
I find real estate much more interesting than stocks. But both are great investment opportunities and I think diversification is important. Real estate is a huge commitment though so I wouldn’t recommend someone buy property if they don’t have the means. The banks are much more strict now too so that helps people from some premature buying.
I’ve never thought about which is “better” because IMO a serious investor should own both. I tend to prefer stocks at this point just due to the lower barriers of entry and low commitment level. Real estate requires a lot of work in order to maintain your investment. With stocks, you basically have to just keep up and make sure a company you own isn’t pumping oil into the ocean or a CEO isn’t selling technology to North Korea and you should be ok.
Is that all? Easy peasy Japanesey then!
Excellent article, Sam.
I have been trying to take some cash out of my equities and move some into a multi-family property. The problem is in northen NJ the market is so damn competitive. People are paying above asking price, and I keep getting priced out. Pretty frustrating to say the least.
How do you, or other readers, go about crunching the numbers when it comes to a property? I’m curious because this will be my first foray into real estate, and would like to get some other perspectives.
Hi John, interesting to hear about a competitive market in northern NJ! When did things start heating up? I’ll have to write or look to see if I wrote a post on your question, or we can do a consult.
Paying above asking price just seems crazy to me. How do you negotiate against yourself, logically? Do you also pay $20 for a Big Mac? Or $7.00 for a gallon of gas? (in the U.S.) That would never fly in the Midwest.
The key word you said is “Midwest.” There’s a reason why demand is more robust in coastal cities. The law of demand!
Around the Bay Area, RE did a huge uptick in the Spring of 2012. We were getting bidding wars just like the old days, only this time it was multiple all-cash offers instead of ninja loans, LOL.
I did manage to get a rental at that time, but I had to really have my ear to the ground and happened to be in a city I don’t normally go to when I saw it.
Best thing I can say is keep looking all the time and don’t ever pay so much that it doesn’t cashflow. You should also know your numbers/tolerences well enough that you can look at a property and say “yes” or “no” almost immediately. I find that the zillow android mortgage calculator is great for this.
After $150K paid in rent over the prior 14 years, I bought a nice short sale 2000 sf single family during Sep. 2011 at a rock bottom price, all cash. I had made two previous offers on this house over two years, but got no response. Then one day out of the blue the listing agent called and asked if I was still interested. I got the house at 30% less than my original offers! In early 2012, Bank of America appraised the place at twice what I paid for it!
I’ve found that ownership of a 55-year old home requires a bit of work. I realize that I’m not interested in working on more than my primary residence after a 38-hour work week (max!). So, I remain heavily invested in balanced mutual funds, 3-year CDs, and investment grade corporate bonds. 30/30/30 + 10% real estate. And I sleep well.
Hi Sam,
I have recently started following your site and your posts. I was wondering if you have shared your portfolio details/net assets etc. I would love to know how I stand compared to you and that will give me motivation to invest more.
I am 37 years old, working for a Pharma company in Philadelphia.
Thanks
It is very difficult to tell that which one is better investment option between real estate and stocks. I would prefer investing in stocks because they not only increase profits every year but also increase the cash dividends. Stocks are often more liquid than real estate investments and borrowing against stocks is also much easier than real estate.
I guess this is completely a choice of people based on their experience and their knowledge. We have seen how explicitly the advantages and disadvantages have been covered.
You talk about real estate vs. stocks without talking about REITs. Obviously REITs don’t have the benefit of the leverage you can find in a physical property and it’s just another piece of paper. But it seems that if you want to get the counter-cyclical effect of real estate, all you need is a REIT. I personally keep my REITs in my retirement accounts so that I don’t pay a higher tax rate for them. After watching my father have bad tenants and vacancies, I’m more inclined to the hands off approach. How do you approach REITs?
I approach REITs closer to the same way I approach stocks, rather than physical real estate and rental properties.
FS,
When considering rental properties to invest in, how much cash flow is considered a good ROI? For example, do you consider a $150 monthly cash flow on a $60K down payment to buy a 230K rental a good investment? If not, what are the parameters you use to decide if something is a worthwhile rental investment?
Good question. My main parameter is the 10-year yield (risk free rate) + 2%. If I can get a 10Y yield + 2% as my annual rental yield, and hope for potential price appreciation over the next 5-10 years, I’m a buyer.
After selling my house in 2009 and investing in a mix of mutual funds, stocks and bonds I am considering buying a condo. Doing this however will use almost all my free cash and leave me with a 50% mix of my retirement accounts (401k & Roth) and the condo. My investments have done quite well in the last year, about 8%. But for some of the reasons you stated above I’m inclined to get back into the real estate market.
The condo is not my first financial choice, HOA dues about $400 a month!… but I really like the location and condo itself…. Am I missing anything in my analysis that you would suggest I consider?
A lot of factors.
Why did u sell in 2009?
Do you currently rent?
How long do you plan to stay.
I think it’s wise to own at least the place you live in. Inflation is a killer.
I am not sure yet which is better as I have yet to get into real estate. For me its stocks as its all I know at this point. I am looking to get into real estate but cant really compare. Going from the comments it appears that more people prefer real estate. The goal however is to have them both.
Real estate all the way for me. I’ve bought 7 long term rentals in the last three years and I plan to buy many more. Those rentals produce over $4,000 a month in cash flow and I love it. I used to invest in stocks but they drove me crazy. It always seemed like the market drove the price more than te actual company.
The great thing about real estate is you can buy below market value and create equity right away.
I agree with your preferable allocation of 60/35/5. Personally I’d like to create more of a real estate portfolio over time due to the numerous tax advantages and leverage real estate investing offers.
I’ll keep investing in stocks via my 401k and etf’s but I think my focus will be on creating a larger real estate portfolio over time
I think real estate is a little easier to wrap my head around at times and Stocks can get a little technical ..I also don’t like the fact that so many factors out of our control can dictate the price of a stock.
Thanks for the great article Sam..I’ll make sure to share it
Frank, why are my articles 100% copied on your site?
Personally, the consolidated holdings of real-estate scare me. Of course there is insurance for natural disasters, etc., but real estate just leaves me feeling more exposed to a city bankruptcy, a general regional economic decline, and other unforeseen events such as terrorist attacks. These same unforeseen events can also impact stocks, but if you are index-investing, it seems that there is lower risk due to geographic and industry diversification.
Of course, like you mention, there is a lot to be said for having the government on your side, tax advantages, and having more control over your owned assets. These things all appeal to me, but I don’t know if they are enough to incentivize me to own multiple properties (right now at least, as a soon-to-be first-time homeowner).
In this market today and a potential depression around the corner, tax free municipal bonds or real property. which one is better?
Cash, if there really is a depression.
(“Real estate is one of the three pillars for survival, the other two being food and shelter.” …the other two being food and clothing…)
I like that simple argument!
Stocks aren’t needed for survival!
I have a condo which I lived in for 8 years. Simply got tired of living in the same place, so rented it out.
Now, we are just enjoying moving to different areas (within the same city of course) every year or so (downtown, beach areas). We are renting where we live and renting out our own real estate.
Tax-wise -> not the wisest decision, but who wants to be pigeonholed into the same place for the rest of his/her life.
Are we real estate neutral? There is a strong lifestyle component associated with it.
Assume that you have $25k to invest. You might want to know which would be a better investment, buying a condo and renting it out or simply investing in an ETF.
Scenario #1. Buy a Condo and rent it out:
15 year fixed 3.92% APR
$125k borrowed $25k down
$736 Monthly Payment
$400 Home owners fees
Monthly cost = $1,136 X 12 = $13,632 + $2,000 Misc. $15,632 (Annual Cost)
Monthly rent = $1,500 X 10 = $15,000 (Annual Income if rented ten months of the year or %80)
$1,368 Annual Income. Now consider your time finding a condo, securing financing, making the purchase and interviewing renters. Also consider the time and materials cost for replacing the carpet/paint between renters, property tax and any insurance costs. Lets be generous and call it -$3000 annually. In fifteen years that adds up to a cost of $45k But after 15 years you own it and lets assume it is now worth $150,000 so if you sell you make $105,000.
Scenario #2 Investing in an ETF
$25k invested in an ETF earning %7. Compounded annually it will equal $68, 975 after fifteen years (There may be some capital gains taxes depending on the fund but there will be capital gains taxes when you sell the condo too). But wait, Lets also assume that you invested that extra $3,000 annually that you spent on misc expenses for the condo back into the fund, now it comes up to $149,639.
You can see that you actually make more with Scenario #2 the ETF. There are lots of variables here but this is not an unreasonable scenario especially in California.
I rent properties. I have always been 100% rented out, I’ve spent less then $1k a year on each property in maintenance (you’re adding 2k and 3k in costs), and you’re forgetting principle paid by renters and property increasing at 3% a year at least.
I’ve made over 90% a year on my real estate rental units, you just gotta do it right.
Real estate investing is vital to any investment portfolio I agree. However, actually owning physical real estate is too much of a hassle. I am 31 years old, own my own business, have 2 little kids and dont have much time to deal with the baggage that comes with being a land lord.
I have found REITs are more suited for my lifestyle and investment mentality.
Dealing with tenants is a hassle at best and a nightmare at worst. Owning even a few rental properties is a second job in and of itself. No such problems with a REIT. Finding tenants, collecting rent, and making repairs are all handled by a professional management team. All you have to do is count the dividend cheques as they roll in.
Sam you mentioned control.Most real estate investors will point out that the biggest benefit of owning your own properties is control. And this is definitely true. However, I feel like the liquidity of REITs outweighs the benefits of having full control. While leaving the control in the hands of industry experts does not always end well, in general it is a good idea.
Leverage is often touted as a benefit of owning real estate as you’ve done in this article Sam. Bankers will sometimes allow you to borrow up to 75%, 80%, maybe 100% of the property’s value. But REITs win once again here. Many trusts have leveraged their balance sheet 2:1 or more to enhance returns. Risk-hungry investors looking for more aggressive bets can always finance their purchase with margin
I am curious about your position on REITs Sam
You make some good points, and as I get older, I want to deal LESS with hassle.
It depends on which REIT, just like it depends on which property.
I have an extreme bias towards investing in something that is tangible or consumable. Everything else seems like paper wealth that means little.
The problem with an REIT is that it still takes the stock roller coaster up and down. It doesn’t seem to behave differently than any other stock or mutual fund. Look at REIT’s right now. Took a hit with the stock market, while actual real estate is UP….. make sense of that.
As an owner of several properties myself, I find the comments about the “hassle” kind of silly. You need 4 things to make being a land lord easy. A real estate agent, an A/C company, and appliance repair company, and a little bit of cash to replace appliances and pay the professionals when you need to.
Tenant calls about broken dishwasher, I go online and schedule appliance repair and email the details to tenant. I’ll get a call the next day and pay the bill. Big deal. How difficult is it to deal with a call or issue every couple of months that takes an hour of your time. Tenant moving out? I call my agent who works with the tenant on showings, gets new tenant, does lease, background check, credit check, etc.
I also agree with Sammy.
Leverage is nice when your asset goes up in value. Not so much when it goes down. I would likely need to personally guarantee a loan, so my downside isn’t protected.
Being local isn’t necessarily good either. I live in a college town in the midwest. Recently, a 6 bedroom, 1500 square foot house near campus has rented for $4200. In the past five years, about 10 apartment towers have gone up creating thousands of extra bedrooms. These $4200/month rent princes will have extreme downward pressure due to the extra supply. Landlords who bought these houses recently will be hosed. Of course, if you happen to live in a hot city like San Francisco, where mortgages don’t need to be guaranteed, taking on debt is probably a great idea.
I believe real estate is very good for getting rich, due to the leverage. But now that I am rich, I don’t want leverage or hassle. I’d rather spend my effort on my main business and put my savings into truly hassle-free investments like stocks, reits, online savings accounts, etc.
At the end of the day, the stock market and the real estate market have to provide comparable returns because they compete with each other for investors’ dollars. As a stock investor, I am very glad that (some) people make tons of money in real estate, because that keeps stock prices competitive and allows me to find good values. (The price of a stock is primarily determined by its anticipated return, and if those returns fall short of what you could get in real estate, the share price is inevitably going to fall.)
Also, it’s misleading to speak of “stocks” and “real estate” as though they were homogenous globs. There are many different ways to invest in either one. In stocks, you could be an essentially passive investor living on (or compounding) dividends from slow-growing blue chips. You could be a more active investor looking for anticipated capital gains. You could even be a day trader. (Serious investors LOVE volatility because they can take advantage of what they regard as mispriced stocks.) You can pick your own stocks; you can invest in baskets of stocks called ETF’s; or you can hire a money manager to invest on your behalf. In real estate, there is comparable variety. You could invest in single-family houses and condos scattered across different zip codes for rental income. You could invest in multi-family properties, which represent a more substantial investment in a single zip code. You could have a management company handle the details for you, or you could drive around collecting everybody’s rent yourself. And of course there’s commercial real estate–everything ranging from a corner bodega to an office building. You could be a sole owner; you could be part of an ownership group.
What you need to do is find the investment style that suits your temperament, your tolerance of risk, and of course your available capital. It doesn’t really matter whether it’s stocks or real estate (or bonds or alternate assets–although I really can’t recommend bonds right now …). If it works for you, it’s great.
Given the situation we were in a couple of years ago – may I say – cash would have been best.
Not sure I follow as the real estate and stock market have been heading higher through 2014.
Sadly, cash would of lost 2% per year to inflation. That’s a lot over 30 or 40 years. Make 4% a year average after that inflation is calculated, 6%, and that’s a lot more. Stocks its easy to make 6% return a year average over 30 or 40 years.
This was the best article I found online regarding real estate vs stock. Thank you! I’m 35 and I’m a teacher and I don’t make much, but I have 50,000 in a Roth. I bought two rental properties this year and I’m trying to buy a third right now because it makes more sense then opening up a 40 K with my employer. I’m willing to invest completely into real estate, but I like the idea of the Roth IRA, even though I believe I can make a lot more money through single family rental properties. I feel like I’m still buying at the right time, I just wish I could be certain how long it’ll take for the housing market to recover where it was in Southern California in 2005. I’m willing to invest everything into real estate but hopefully that’s not my real estate agent talking as he’s very good at convincing me real estate is way better than stock because it’s easy to cash flow where I live. Thanks again. And yes tenants and maintenance is a hassle, but if you screen for decent tenants its not that hard to manage your properties.
I’m glad you found it and enjoyed it!
I would still diversify your investments into stocks and bonds as well. You just never know when the party will end, and it’s good to have some offense and defensive when the time comes.
Hi; I am glad I read this article. I am in my early 40’s and trying to determine whether I should retain my real estate property built in 2009. The property appreciated about $100K in 5 years. However, my job is currently about 96 miles away from my home, so I am staying with my parents home for the time being. Will it be a reasonable step to sell the property in 5 years and just save the mortgage monthly payments for investing into portfolios with high return (ex. 7%)?
$100K is what % increase?
There’s something to be said with simplifying life and taking the TAX FREE gains of up to $250K per single person.
The problem with leverage is that you have effectively put more than 100% of your money into the asset class in question. Most advisors say not to own 100% equities in a mutual fund, because it is perceived as too risky. Yet when you buy a rental property with 25% down, you are effectively in 400% real estate. Seems a double standard here – how is 100% stock too much but 400% real estate isn’t?
A mortgage is essentially a negative bond allocation, since a bond represents the right to fixed payments at fixed times while a mortgage is the reverse – a pledge by you to make fixed payments at fixed times.
Thus a rental with 25% down is technically an allocation of 400/-300 real estate/fixed income.
When put like that, it should be clear why I don’t see leverage as the huge wonderful thing you make it out to be.
A mortgage is essentially a negative bond holding – instead of receiving fixed payments at fixed times, you make fixed payments at fixed times.
If you buy a rental with 25% down, your portfolio technically has an allocation of 400/-300 in real estate/fixed income.
If 100% stock in a portfolio is too much, then surely 400% real estate is also too much?
Sam – you mentioned being in control by owning physical property and others have mention REITs. Have you worked with Real Estate Investors looking for funding for their properties, ie: private funding? Some of them, including myself, are willing to pay higher interest rates to purchase real estate. What are your thoughts on that? Thanks, Jackie
I have not. I do not want to partner with people to invest in real estate as it will cause future headache. Things change over the years.
This is a good read. Im glad youre on the same side as I am. Im pretty early in my real estate investing but so far I have been averaging 20% returns on my properties. I dont see any stocks doing that. Keep in mind my calculations are based purely on cash flow. Im not even including possible appreciation which is icing on the cake. I dont like to include appreciation in my calculations because its really just speculation.
I’m having a little trouble with the comparison here. How are you coming up with only a 2% – 4% return on real estate? It seems you are comparing borrowed money (real estate) with unborrowed money (stocks).
Why must you have a mortgage on an investment property and pay interest? Remove the 4% interest and you have an 8% return on your money. Instead of $100k in a mutual fund, why not just buy a rental free and clear?
I own 3 rentals, free and clear (about to add a 4th) and average around 8% return on my initial investment, even after all expenses, including times the units are unoccupied. When you factor in the 3% increase in the value of the property, it only gets better.
Another thing about real estate is that your initial investment never changes, but rents go up. Rents will generally outpace taxes/maintenance/insurance fixed costs slightly as inflation brings up the value of the property. So after 5 – 10 years, instead of $1200/mo you may be at $1500 – $1600/mo, so an even better return as time goes on.
You could be pulling 8% cash, plus another 3%/year increase in the value of the property. Meaning a 10% return on your investment isn’t out of the question. That is better than stocks.
Another reason I like real estate, and you somewhat pointed this out, is even in a down market, rents are typically the same (even go up still). Which means I make my return no matter what, year after year. Since I hold for a long time, it’s only the equity in the property that takes a ride on the roller coaster like a stock, but the rental/cash return of 8% still continues. Generally, I don’t care if prices are up or down, as I’m still collecting my rent all the same.
Ok this might be a dumb question but I am only 23 years old and started investing in both the stock market and in real estate and don’t know if I should solely focus on one to become more successful. I started a Roth IRA at 19 and have done maximum contributions since and it’s doing really well but I am not much of a gambler. I was thinking about withdrawing my from my IRA to get closer to paying off my house earlier and stay focused in real estate. In my mind, if I pay off my house earlier then I could invest in more properties much faster and make more money but not having a mortgage payment. Like I said, I am not a gambler and I know that I shouldn’t constantly be checking on my IRA every week but it stresses me out that I don’t fell in control of my money. Thanks!
Home- Owe 80K/ Valued 90K
Roth IRA- 26K
In general, stocks may have the advantage in more categories than real estate. However, real estate seems to be better when it comes to stability and tax advantages. A good compromise may be to own a REIT, which combines some of the benefits of stocks with some of the benefits of real estate. While each area has its own benefits and drawbacks, to decide which one would work well for you depends on your overall financial situation and level of comfort.
Hi Guys, I’m 26 and a career newbie. My first big goal is to purchase property. To do this I am prepared to save for the down payment over some years.
Do you recommend accumulating the $$$ for the down payment in ETFs or in a CD?
Also, I’m torn between how much to allocate to my 401k and how much to allocate towards the big property purchase. Any good perspectives?
Hi,
ETF v/s CD will depend on the time frame in which you will be in a position to buy the property. It should certainly be a CD if the time frame is a year or so. It can be some bond ETF if the time frame is 3-4 years. Equity ETF if the time frame is 7+ years.
401k allocation will depend on the following:
1. If there is a company match, then it is a no brainer that you have to get the company match NO MATTER WHAT
2. 401k offers tax advantages – you get tax deduction
You did not talk about IRA but that is also a powerful retirement tool.
Since you are just starting out, my guess is that you will benefit more from 401k/ IRA (or Roth IRA) contributions than saving up for property down payments.
Bobby
hi,
thanks for the great article.
I am in the process of possibly purchasing a 100year old 4plex in a very desirable location in seattle. 1.25Million at sale price the upfront cost of the obtaining loan is $300K and just had the inspection, the place is livable but needs a lot of work. It is beautiful old house otherwise.
My draw is that this is a place I want to live and plan to live in the larger unit. the neighborhood is fantastic with home easily over 1-3million flanking the property. the rental market in Seattle of course is just crazy and I suspect will become like San Franscisco
Although I love the potential of this house, it will be a lot of work and now I am wondering if it makes more sense to invest 300K in stock market/mutual fund.
The added benefit in my mind was that i would move out of my single home that can be rented out and with low mortgage project positive cash flow and move into nicer neighborhood with a little more cost than what I am paying now to live in the house.
I would love any thoughts.
klee
I have a unique question/dilemna. I’m 37, own a home which I still owe more than 50% on, own a business and land associated with business, I’m about $70k in debt(no credit cards) in the form of a second mortgage and a business loan. Unfortunately I received over 50k from my brothers life insurance policy a few years back. It is currently all invested in the stock market. There was some resentment from other family members that I did not share this money. At the time I was worried that they would blow the money. I bear tremendous guilt that I have this money as a result of my brother dying. I refuse to spend this money, especially on myself or to pay off my debt or current mortgages. I want to pay everything with the money I make on my own. However, I’d like to buy a condo on Lake Erie where me, my brother and all of our family vacationed since we were little kids. There are many, many memories in this area. I was thinking that I would allow family to stay there in the summer to help dissolve some resentment , use it a little personally and use it for weekly and weekend rental income as it is a very popular location. I want to use the 50k to put about 50% down and then hopefully the rental income will pay the remaining monthly $300 mortgage plus HOA’s. I’m very scared that I will lose the money in the market or be tempted to spend it. I’m aware that paying off my current debt and mortgages is the smartest thing to do, but if I can preserve this money in a tangible investment and make income to pay down debt(along with my income from my job), some of the guilt and family problems will be resolved and I will feel like I was responsible with this money. Any advise, thoughts?
I am looking at starting a Real Estate Management company with three friends and our projected cost of Operating in year 1 is just over $500k, with just over $300k earmarked as our combined salaries, so we can quit our jobs and focus on this 100%. One of our partners is willing to provide us each with personal loans of $100k at 8% interest with the first two years being io, and our forecasted revenue in year 1 is approx. $250k.
The question comes in how to pay ourselves. Considering that these are personal loans that we will be paying interest on, does it make sense for us to invest the loans directly into the company and pay taxes on our salaries on top of our loan interest, or is it possible to hold on to the portion of the loans that we need for our personal upkeep and not take a salary from the business until such a time as the business can afford to fund our salaries?
I hope the question makes sense. We are just trying to figure out what we are legally obligated to do in a scenario like this. Perhaps another way of thinking about this is as follows: if we were each using money from our personal savings to stay afloat until our business could support our salaries, would we have to report our savings as income and pay income tax on them?
I have 450k sitting in a savings account what’s the smartest thing to do with it?
Commercial real estate is the best way to go. With $450K down you could buy, for example, a small-medium office building, with $200K NOI. Management is in place, so you would not have to worry about managing the building; after all expenses and mortgage payments, you would still earn $70K/year; your asset would be worth ~$2M (compare to your $450K in the bank); You would gain trough equity build-up, appreciation, rental income, tax benefits. Start looking for commercial real estate broker for assistance.
Start a hedge fund
If you decide to invest in real estate, remember that everything you use when doing your real estate work, even driving out to talk to local owners to discuss buying, etc. can be written off come tax time!
This means that you can write off your car expenses, insurance, even mobile phone that you use on these real estate calls.
That doesn’t mean you should blow money on these things. Minimize costs whenever you can if you want to be successful in real estate. I always use Gas Buddy to find cheap gas. I use Insurance Panda for car insurance ($25/month), and I use Metro PCS for cell phone (only $20/month).
Being frugal, and taking advantage of every single tax write-off is the best way to get ahead when you are first starting our in the real estate game, IMO!
Good luck!
I am tired of losing money in the stock market and have often considered purchasing another home or condo to rent out. I don’t have a lot of money in the market – 250k. I thought about cashing it out (my IRA) and possibly my other savings (Roth) to make this happen. What could I possibly do to get passive income more reliable at age 51?
Thanks in advance
Mike
You can lose money in real estate too, but the key difference is that you can do things to help improve your rental income. also, real estate tends to be a much longer term investment, therefore, you can ride the dips and ups better, stocks are much more volatile.
Is this the case now? I am seriously considering buying a commercial building as described above. With the change in government is this a good decision?
The problem I have with investing in stocks is that it’s purpose is retirement! Although everybody’s hope is to live long enough to see retirement, or SEE THE MONEY of retirement. The fact is some of us will not live to see it! If this topic was about our kids then stocks would be great. We die it pass on. People want to see, touch, and be able to enjoy the money. After all, life is for the LIVING! So with all that said I feel renting is best! And not renting site built home that cost a fortune and have to hopefully see the day u can sell and live off its appreciation. I’m talkin mobile homes! Nobody is talkin cheap single wide mobile homes! In my region (louisiana ) u can get a mobile home used for 15k-20 move in ready with little to absolutely no repairs!! Rent for a site home is pretty much the same as rent for a 3 bed mobile home! Get u 5 used mobile homes, rent them at a minimum of $600 a month. That’s 3k a month!!! No stock portfolio will cash out dividends of that magnitude unless u speND years building it up to 1M in shares! Which will take some people a lifetime. We can go back and forward about appreciation depreciation compound interest blah blah blah talk all day. The bottom line is money in your hand right now!! Not on paper that says u have a portfolio worth $500,000 BUT I can’t touch it because I’m not old enough lol cmon. Get u a portfolio, put a Lil money in it and forget about it is my say. Prioritize more towards fulfilling a life where u can retire or semi retire EARLY with passive cash flow from mobile homes!
Shoot guys, we have had it all wrong. All the real money is in the trailer parks!
I love your blog. I would like you to mentor me if possible. Please contact via email.
Never ask for something if you have nothing to offer.
Ha ha mentor me… too funny
All great advice; definitely appreciate that there isn’t a one size fits all approach. Your risk tolerance and life goals should play into your decision.
But, pure numbers wise, it’s better to own stocks and it’s not even close. I did an analysis for a super hot, hip, gentrifying neighborhood in city that’s almost doubled over the past five years.
An all cash payment would’ve netted you nearly 6% gains, but that’s nothing compared to the 15.5% you’d get from a passive S&P 500 strategy.
I didn’t realize people were paying cash for their first time homes nowadays? Usually first time homebuyers and even second and third time home buyers are only putting 20% down. So if you put down 20% and your property increases by 6%, the gross gain is really 30%.
But if people are paying cash, that makes me feel good that more and more people have stronger balance sheets now. You can cherry pick returns which ever way you want to argue your preference. Most people who cannot afford will be biased against housing. It’s just the way it is. My biggest regret was not buying a 1,300 sqft, 2/2 condo with a view of the Chrysler building in 2000 for $800,000. It’s worth well over $2M today.
Why not do both?
Related:
The Inflation and Interest Rate Paradox: Why You Must Continuously Invest
Buy Real Estate As Young As You Possible Can
So if you had bought that $800,000 office building in 2000 that is worth over 2 million now, your investment would have gone up 2.5 times in 17 years from appreciation (plus rent income, minus expenses).
But if you invested in an SP 500 index fund at $63/share in 2009, your investment would have gone up 3.5 times in 8 yrs since it’s at $220/share now. No rental income but also no maintanance expenses, or worries about the heat pump dying in winter so that the building’s pipe’s freeze and burst flooding and ruining the interior so it always has a funky smell after that or so it causes toxic mold to form and your tenants sue you bc the moldy air made them sick. Or maybe someone clogs the toilet and it overflows, or a sewer line breaks causing poo water to go everywhere. Also no worries about tenants trashing the place.
I think the place is worth more like $2.6M, so 3.25X.
I’d happily turn my $160,000 downpayment with a $640,000 mortgage into $2.6M with probably zero mortgage by now (I paid off one mortgage on a SF condo I bought in 2003 in 2015).
Let’s say the mortgage of $640,000 was 100% still there. $2.6M – 640K = $1.96M. That’s a 12.25X return on $160K. That’s not bad at all, especially since it owning would have been cheaper than renting for at least 14 of those 17 years.
Do you own real estate? If so, when and what did you buy?
I know so many people who could have bought and didn’t since 1999 and they are seriously regretting it.
Real estate has been my best asset class so far, and I do have a multi-million dollar equities portfolio fyi.
Related: A Long Road Home: Passive Income Update 2017
Hello Financial Samurai,
We too live in the SF bay area, and have had our primary investments in the RE market. May I ask about your equities portfolio? My husband and I have been discussing diversification prior to retirement, about what if anything to invest in index markets, etc or just to continue with RE investing. What would you recommend as to investments other than RE?
Thanks for this article. Real estate v investing is one tough discussion for me. I bought real estate at the peak of the market just before the credit crunch and today am still sitting with virtually no equity. Stocks on the other hand have, for the most part, rewarded me handsomely every year (bar some *stupid* penny stock investments I made when getting started)!
Part of me fears that there are still bubble’s in the real estate markets all over the world, and it will take many more years to work them out of the system!
All depend on your knowledge and experience. Because both provid good returns. If you have knowledge and experience of stock market, no real estate could have beat the returns you earned if you invested in a big companies like Microsoft, Wal-mart and Dell.
Same with real estate market, If you have knowledge and experience you can earn more money on your rental properties and they also allow you to retire much earlier than the stock market.
Rest all matters your knowledge and experience
If you would have bought one share of Walmart in 1999 when it was at $69 it would be worth $70 now. And if you fator inflation in the $8 to buy the stock and $8 to sell it, and 3% inflation/yr, you actually lost money. The amazing thing is that Walmart’s annual revenue went from $156 billion in 1999, to $485 billion in 2016! But that didn’t make the stock price go up.
You’re not counting dividends, which is the main reason people buy WMT.
This is completely inaccurate. If you put $10,000 into Walmart in April of 1999 you would have returned 4% annualized return.
With dividends reinvested Today that $10,000 would be worth $20,823.20. The advantage stocks have over real estate is dividend growth and reinvestment of dividends.
The key with investing in stocks is not to put all your eggs into 1 basket.
Here’s a fun one that shows the power of dividend growth and reinvestment. $10,000
Invested in Altria the tobacco company in 1970 with dividends reinvested would be worth $57,926,731.24 today.
I’m a big fan of real estate an stocks. There are advantages and disadvantages to both. If your looking for straight returns then stocks will be your best bet, but if your looking for tax advantages and to use leverage real estate is your friend.
I personally own 7 figures in real estate free and clear. I’m now working on building my equity portfolio.
I often read that real estate does not beat stocks and I don’t understand this. I asked my broker, “where do you recommend I put $400k that will give me $3k a month return.” He chuckled and said there was no place to put it in the stock market for that return. Well, I can buy a condo for that amount and make a $3k month return immediately. What am I missing?
Perhaps the fact your broker has never experienced owning physical real estate, and therefore has no perspective? I’ve owned both for a long time now, hence my comparison article here.
I’d also check out investing in real estate crowdfunding through RealtyShares or Fundrise. There are many deals with 8% – 12% annual returns where you can invest just $5,000 – $10,000.
I’ve currently got $260,000 with RealtyShares, hoping to make a 8% – 10% realistic annual return. I may invest $50,000 – $100,000 in the Heartland eREIT with Fundrise too.
How safe is investing in real estate crowd funding? Is your principle subject to losses? I recently took some money out of stocks to lock in gains and I am looking for a safer alternative which also has a decent return.
Sure, you can definitely lose principal if the operator can’t sell for at least cost or they can’t get enough tenants.
You may want to consider CDs or bonds if you are more risk averse. I’ve invested $260,000 so far with RealtyShares, and plan to top out at $500,000 by 2020 to try and generate $40,000 – $60,000 a year in passive income.
Related: The Case For Buying Bonds Now
The interest rates are very tempting. Why are people using realty shares instead of the much lower rate conventional mortgages? Do they not qualify? Also, are the borrowers rated for ability to pay? Probably better to spread your money among many borrowers to mitigate the risk. I think I am older than you, about to turn 58 and we are already retired. I was almost all in the stock market but recently pulled out a big chunk due to the old bull and the prevelance of corporate buy backs as opposed to true increases in production. Still have money in it, as well as a paid up house and a rental. If the market takes a “dump” (as my Dad would say), I might return. I will look at your article on bonds. Thank you for your time and energy!
Maybe find a new broker? Lots of stocks will give that rate of return or better but neither real estate or stocks has guaranteed returns long term.
I enjoy your blog and find it informative. Started looking into Realty Shares. Just would like to know other than your personal investment is there a financial relationship between Financial Samurai and Realty Shares?
Hi Mark,
Absolutely. In February 2017, I invested $250,000 with RealtyShares via their fund. I also decided they were the best real estate crowdfunding platform after meeting up with the CEO, VP of Finance, and multiple people from the firm as part of my due diligence. My goal is to find the best platforms and products in each field, use them/invest in them, and also build a business partnership. There are dozens of real estate crowdfunding platforms, but I think RealtyShares and Fundrise will be the two winners.
Sam
Folks, Arguments of situational investing are worthless. So lets put on our creative and positive thinking caps. Lets focus on the principle of getting your money to work. Don’t “put it all on black”, be patient, run the numbers to make sure the return is there, Don’t take undue risk, be willing to learn more before you invest. Looking back you don’t have 20/20 we tend to forget the majority of the emotional factors and the lack of knowledge we had that prevented us from getting in on the deal. The list goes on. Best wishes to all of us seeking to grow our net worth. There is a lot of good to be done in the world, lets get to work.
I believe it is all about what you personally want to do. I think the author explains the pros and cons very well. I will share my brief story on my 1st rental property and why I chose what to do.
I was 29 years old when I finally settled into a career and started making “real” money where I could comfortably save 35K a year. I bought a duplex 100k down. I am netting 2k a month after taxes, insurance, HOI and mortgage. It was a brand new construction townhome in a rapidly appreciating area for 460K. The house is worth 625K+ in less than 1 year.
I was extremely lucky, but my goal was to increase my monthly income so that I could save up more money the following year and buy another property. I now increased my savings/liquidity by 24k a year. If I had put that money in the stock market with a return of 7% I would have increased my income by 7k. Nothing to sneeze at, but it is also wrapped up in a stock, which can be easily cashed out, but then I lose out on that money earning 7% the next year.
Even if I compared my same situation and invested in Amazon which had 38% annual growth, I would have 38k in investment earnings in 1 Year, which is amazing. Compared to the rental income of 24k and the 145k increase in net worth in the home, it still isnt close. I am not even counting the tax advantages of writing off the taxes, mortgage interest and rental depreciation.
I believe that investing in a rental property is the best way for younger people to build wealth who dont have a lot of funds to begin with. Anyone who has 5 million dollars can just invest in a Vanguard fund and get 300k a year in investment earnings and never have to work again. For the “average” Joe who can save 20k a year…it would take forever for that person to build wealth through stocks unless they hit it big with a Microsoft or Netflix buy.
My plan however is to switch my strategy to stocks when I am 50 because I believe I will be better versed in understanding the economy and probably tired from 20 years of managing several rental properties and would like to just put my money away and not look at it for the remainder of my life and hope 200 years of US stock returns of 6+% continues.
I will put a disclaimer that my first rental property was a great first investment and I was lucky, but I believe they are easier to find then the next Amazon, Netflix, etc…General rule I try to stick to are 17% cash on cash returns and 8% cap rate. Understanding the rental market and area are critical as well.
For those frequently moving around with their job, stocks are way better. However, if you plan on staying in the same city forever, real estate can be an excellent option. For me, I have 3 rental properties. I don’t plan on getting any more. I would rather focus my time on building my stock portfolio and let the Fortune 500 CEOs manage my investments. I would rather spend my time in a hammock on the weekends compared to fixing the leaky pipe.
I think Mike’s comments sum things up quite well, it really depends upon each individual investor and what their goals are. No one financial plan fits all, and no one investment vehicle does either.
My Dad did well investing in paper assets, but got demolished in his real estate holdings. His RE strategy was an appreciation play (like the stock market) and unfortunately, did not work out for him.
My wife and I have some paper assets as part of our general retirement savings, but use RE for cashflow. We are not counting on appreciation to make the investments profitable, but rather use RE for tax reduction, equity, ability to use leverage, and if we get appreciation that’s the cherry on top.
I would take issue with the author’s assertion that real estate returns are 2-4% and easily beat by stocks. Appreciation may run 2-4%, but it is not difficult to find real estate (both residential and commercial) that provides 8% annualized returns. When you add in tax benefits, leverage and debt pay down, cash on cash returns are easily double digit.
Several people have commented that they are not interested in the 3 T’s of real estate- tenants, toilets, and trash. This is where property management is a no brainer on the residential side, or where commercial real estate and crowdfunding becomes attractive. Investing in real estate doesn’t mean becoming a landlord.
Speaking of real estate crowdfunding, I wholeheartedly agree! I just invested $500,000 through RealtyShares to take advantage of higher yields and no maintenance in the heartland of America. I hope to earn a 10% annual return, even though all the deals are shooting for 14% – 18% IRRs.
I think you’ll enjoy this last post: A Real Estate Investing Rule To Follow: Buy Utility, Rent Luxury
My investor group has about 5M in RE Crowdfunding currently, both on the debt and equity sides. Im watching closely to see which platforms end up performing the best.
Are you able to take depreciation benefits on RealtyShares equity plays?
After 35 years of RE investing (& buying heavily during the 18% mtg era) we have accumulated a significant portfolio of free & clear properties. (As an Mech.Eng I was able to do a lot of the rehab work myself). I retired at 49 when my W2 was eclipsed by my passive income & getting up @ 5am to endure the tedium of a JOB (politics etc) was just not worth it anymore. Our kids all graduated college without loans & all owned their own homes before they were 25. In fact our oldest daughter at 19 debated the cost of dorming vs buying a home. She rented rooms out in the home she bought (with our help…’estate planning’) to pay down her mtg.
Purely for the ‘tax deduction’ we each have significant 401(k) Solo portfolios of dividend producing equities.
When I recently interviewed for a maintenance manager for our commercial buildings I was amazed how many guys in their 50’s have nothing but an old vehicle, debt & little if any retirement savings.
Sam, love your blog! However, I find your chart comparing REITS to S&P a bit misleading. Your readers are more financially savvy (thanks to you!) to know that you should be comparing returns to a diversified portfolio of ETS across multiple asset classes. Do you have a chart that compares a diversified portfolio over time versus REITs in your data library somewhere :) ?
Furthermore, what’s the NET ROI (after closing fees, annual maintenance over 30 years, etc) on housing versus investing (management fees, taxes). Would be great to have your analysis on this!
Thanks so much!
Sounds great Moiz. What is the diversified portfolio of ETS across multiple asset classes I should use instead? Happy to include it in the post.
Are you trying to make a decision to buy or justify your decision to rent? If you still rent, what are your reasons for doing so? I just sold my rental house in the Marina, SF after 13 years of ownership b/c I wanted to simplify life. Someone was willing to buy 30X annual gross rent for the price, so I figure why not. I need as much time w/ my son as possible.
Related: The RE Investing Rule To Follow: Buy Utility, Rent Luxury
Sam