Author Topic: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds  (Read 59619 times)

dragoncar

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2.  First of all, the leverage available for real estate is way different than it is for stocks.  For stocks they can call it if the value drops on paper.  If the value of my properties on paper, the rents keep rolling in, and I can keep that cheap leverage.  So you can't really compare apples to apples with leverage, because real estate leverage is simply better.  But yes, I get 12%+ return on my properties that have no mortgage, so we can compare those oranges to oranges if you'd like.
Well, it depends upon how you leverage your stocks - you can get a loan, and buy the stocks. That means you don't get a call if the paper value drops.

Okay, but if you aren't using a margin loan that can get called, you're paying a lot higher interest rate and a lot shorter term.

Either way, my point of not being able to compare it to real estate leverage stands.

Unless you can tell me where I can get a 5-6% 30-year fixed loan for stocks for hundreds of thousands of dollars that isn't callable?  :)

Real estate leverage is just better.  That's what makes it hard to compare apples-to-apples.

Refinance your home?

deborah

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Okay, but if you aren't using a margin loan that can get called, you're paying a lot higher interest rate and a lot shorter term.

Either way, my point of not being able to compare it to real estate leverage stands.

Unless you can tell me where I can get a 5-6% 30-year fixed loan for stocks for hundreds of thousands of dollars that isn't callable?  :)

Real estate leverage is just better.  That's what makes it hard to compare apples-to-apples.
In Australia loans for houses are callable, and the loan rate you quote is what people with mortgages dream about! And yes, if I wanted to, as dragoncar says, I could get a mortgage on my home for that amount, and that is how many people do buy stocks here.

arebelspy

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Refinance your home?

Okay, so you can do that once, if you have equity.

And then?  With real estate you can do it every time you make a purchase (for at least the first 10 times).  You can't go get a fixed 30-year non-callable 5-6% loan every time you make a stock purchase.

Are you really arguing with me dragoncar that real estate leverage is possible with stocks?  Because the only similarity is you're borrowing money. But the terms are totally different.

Okay, but if you aren't using a margin loan that can get called, you're paying a lot higher interest rate and a lot shorter term.

Either way, my point of not being able to compare it to real estate leverage stands.

Unless you can tell me where I can get a 5-6% 30-year fixed loan for stocks for hundreds of thousands of dollars that isn't callable?  :)

Real estate leverage is just better.  That's what makes it hard to compare apples-to-apples.
In Australia loans for houses are callable, and the loan rate you quote is what people with mortgages dream about!

Right.  And that's why I say the real estate leverage (here in the US) is just better.
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with three kids.
If you want to know more about us, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
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phred

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  Or are you going to recognize that my equity ownership, while staying at 50%, is worth a lot more for a $2m/year company than it was for a $1m/year company. You are seeing a $.10 return and I am seeing a 100% return. 
If your reasoning was accurate in that the company was now worth twice as much, then shouldn't your stock be worth $2?  When you sell your stock, you are not going to get a hundred percent return, you are only getting  the ten cents

SDREMNGR

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I'm going to have to side with hodedofome on this one.  Who knows if either he or arebelspy, or anyone on this forum for that matter, does what they say, makes what they say that they make, etc.  But taking hodedofome's story at face value, if he feels that he has found a way to beat the market and has the bank account to prove it, then more power to him.  If arebelspy happens to believe that it's just luck and that it's impossible to best the stock market in the long run, then more power to him.  I'm sure it's not affecting hodedofome's bank account any.

While I like real estate and have made good returns in it as investments and as a business owner, I do not doubt that it is possible to beat the market consistently as a trader.  Just because studies show that MOST people cannot do it, or that even MOST PROFESSIONALS cannot do it, does not mean that it is not possible and that SOMEONE can do it.  It is funny that most people here take it as a matter of fact that Warren Buffett can and has beat the market consistently and his way of investing is one of the "right ways" to invest to beat the market.  Why do people believe that?  Historical record and social acceptance of an idea.  But through some stroke of freak bad luck, maybe all of his companies may go bankrupt in the same year somehow.  While not probable, it is theoretically possible, and then what will everyone think of Warren Buffett and his value investing strategy?

Yes, real estate has some built in benefits that are due to the tax laws and political climate of the U.S. in that we have tax deductions, tax sheltered investing, free capital gains for primary homes, big government entities that support real estate lending, big debt market for real estate debt, etc.  But tax laws may change and if the tax deduction went away (which it frequently threatens to do) then the real estate market would probably have a big price drop instantaneously.

Anyhow, I love me some real estate investing when the timing and price is right, but it's by no means a "safe" investment.  Just like hodedofome says, agree to disagree and each person can continue to make money their way.

phred

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1. I am reading that real estate is "easy" - takes up 4-5 hours a month (that comment was back on the first page), and I am reading it is hard work - so which is it? Or what do you need to do that is hard and what is easy?

2. I keep on thinking that people are comparing apples and oranges - fully paid up shares with heavily leveraged real estate.  If I borrow 80% of the cost of my shares, I will get a high ROI. If I have no mortgage on my property I will get a low ROI. So are people working on a level playing field, or is it all smoke and mirrors?
The hard part is finding that property worth buying.  That could take a year for a novice.  Afterwards, if you've a good tenant, it shouldn't take much time at all except for searching out the next property.
As your tenant pays down your mortgage for you, you can refinance it a little to get out your down payment as long as you maintain a positive cash flow.  If you don't refinance after that (to buy more property) your ROI approaches infinity because you've removed your initial skin.  If you can increase your rents a little each year because you've improved the property, that's even better because you've also created fresh depreciation deductions.

dragoncar

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Refinance your home?

Okay, so you can do that once, if you have equity.

And then?  With real estate you can do it every time you make a purchase (for at least the first 10 times).  You can't go get a fixed 30-year non-callable 5-6% loan every time you make a stock purchase.

Are you really arguing with me dragoncar that real estate leverage is possible with stocks?  Because the only similarity is you're borrowing money. But the terms are totally different.

Okay, but if you aren't using a margin loan that can get called, you're paying a lot higher interest rate and a lot shorter term.

Either way, my point of not being able to compare it to real estate leverage stands.

Unless you can tell me where I can get a 5-6% 30-year fixed loan for stocks for hundreds of thousands of dollars that isn't callable?  :)

Real estate leverage is just better.  That's what makes it hard to compare apples-to-apples.
In Australia loans for houses are callable, and the loan rate you quote is what people with mortgages dream about!

Right.  And that's why I say the real estate leverage (here in the US) is just better.

No sir, I would never argue with you. :-)

 I do agree real estate leverage is better.


Franklin

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The bottom line is that I exceed the 7% average return on stocks when you add the factors set out in the original article. 

If you are telling me that because you consistently pick companies that are more successful and you are using low-rate leverage to do it and that you are making over 15% compounding after-tax over the long-term on your invested capital (not leveraged purchase price), that is great.  You are closing in on Warren Buffet.

Totoro, I'm saying this with a smile on my face but, you're such a real estate investor.  I don't pick stocks, I pick companies.  I've never used leverage in my life and I never will.  (How deep are you in?  5:1, 10:1, yikes!)  I don't have to, the companies I invest in do it instead.  You are approaching the stock market as a transactional investment similar to real estate and it just doesn't work that way.

If you learn to value a company then that would be a good start.  Because once you know the TRUE value of a company - book, growth rate, IP, multiple, etc., then you will get a feel for what it's stock price should be.  Because the stock price is linked to these variables.  That's how analysts arrive at a target price.  So let's say you value a company at $2.  Then Putin invades Crimea and the price goes to $1.  Well I sincerely hope you place your purchase order because you just got your company for half price. 

So you are in at half price and now you wait, which doesn't cost anything or take any effort.  The company matches their average growth rate for the next ten years (you researched their last ten years).  In that time they reinvested your dividends, and they bought back some shares, which dropped your basis to .50 per share.  After ten years of simply matching their average growth rate, the price is at $5 per share simply by doing good business growth.  You now own a ten bagger.  You watch stochastic indicators to see if and when institutions are starting to get out, and you sell.  This is done every day by stock investors.  Now how am I supposed to answer your question?  It's a totally different model.  My biggest winner was 600% on Harley Davidson and my biggest loser was 34% on Nokia (damn you Steve Jobs!).   

My premise has been and always will be that the posted article is flawed in substance and form.  It's comparing the returns of a smart real estate guy like you to a retail stock investor investing in a market index, plus it's not recognizing that I am indirectly managing capital in the same exact way.  Then it is modeling return in an inconsistent manner.  So to me it's as confusing as saying "Reggie Jackson is a better hitter than George Steinbrenner".

Franklin

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Or are you going to recognize that my equity ownership, while staying at 50%, is worth a lot more for a $2m/year company than it was for a $1m/year company. You are seeing a $.10 return and I am seeing a 100% return.  If you're not understanding me then maybe you should be the one Googling.

I'll confess to not understanding the distinction here. If the stock is worth $1.10, what does your ownership stake matter with respect to the overall revenue or capitalization of the company? I mean, what's the difference between me owning, say, 100 shares of Apple at $1.10/share, and 100 shares of Joe's Cheeseburger Condiments Co. (a 2-person company) at $1.10/share? Aren't both worth $110, and the size of the company doesn't matter?

The more your ownership stake grows for free - through dividend reinvestment and stock buybacks - the more your investment basis drops. 

totoro

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First off, I'm a girl.   

I think we can compare long-term returns on initial capital investment with all the RE vs. all the stocks taken as a whole.  The rest doesn't really matter.

Taking advantage of corporate leverage that makes a profit through returns on stocks does not appear to provide the same kind of reliable returns over the long-term to me, but maybe there is a way to do this if you due a lot of due diligence on the companies you invest in as you are doing.  There certainly are difference in Canada between commercial financing and residential mortgages, as well as many other difference. 

With the stock market I rely on the Canadian Couch Potato currently because I haven't put the time in to understand how to do better, if that is indeed possible to do much better over the long-term in a reliable way.  I would find it interesting to investigate and understand the underlying variables.

There sure are a lot of articles out there that seem to indicate that it is hard to do better with stocks, but I would agree that there are also a lot of articles on real estate that are written by people with bad experiences or demonstrate poor understanding of the variables at play and how to manage risk.

Franklin

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First off, I'm a girl.   

I think we can compare long-term returns on initial capital investment with all the RE vs. all the stocks taken as a whole.  The rest doesn't really matter.

Taking advantage of corporate leverage that makes a profit through returns on stocks does not appear to provide the same kind of reliable returns over the long-term to me, but maybe there is a way to do this if you due a lot of due diligence on the companies you invest in as you are doing.  There certainly are difference in Canada between commercial financing and residential mortgages, as well as many other difference. 

With the stock market I rely on the Canadian Couch Potato currently because I haven't put the time in to understand how to do better, if that is indeed possible to do much better over the long-term in a reliable way.  I would find it interesting to investigate and understand the underlying variables.

There sure are a lot of articles out there that seem to indicate that it is hard to do better with stocks, but I would agree that there are also a lot of articles on real estate that are written by people with bad experiences or demonstrate poor understanding of the variables at play and how to manage risk.
My apologies.  I didn't mean to offend.  Assumptions can be embarrassing.

I always direct people to a book called "Rule #1 Investing" by Phil Town, because he takes a "value investing" approach and explains it in a humorous energetic way.  More importantly he shows you how to value a company using easily accessible public information.  You'll never look at the stock market the same way.

totoro

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No problem, it happens a lot.

Seems like Phil Town gets mixed reviews.  I do own the Intelligent Investor by Graham so maybe I should re-read that first.

Franklin

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Agreed.  Some of his methods are not for me, but his valuation method is textbook.  The fact that he does it with flare keeps you reading.  And his catchphrase "Now go play!" is very mustachian.

mooreprop

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I invested $4000 in real estate in 1991, then never another dollar out of my own pocket.  My equity is over $1,000,000 today. 
I invested $10,000 in index type funds in 1997, then continued to contribute small amounts each month.  Their total value today is $51,000.  I have no particular expertise in either area.  I just tried to buy low risk investments in each case.  I am not trying to say that no one can make more money in stocks, but I believe if you are the typical "dumb" investor, real estate is the better way to go.  I think others have already explained all the advantages including the ability to use leverage.

  I have been through crashes in both markets, but with real estate the rents held steady or went up.  My income improved.  This would not be the case if I were relying withdrawing a "safe" 4% of my investments from the stock market.  The average returns quoted by the mutual fund companies are lies.  For example, if you invest $100,000 and the market goes down 50% the first year, then you have $50,000.  If the market goes up 50% the next year, you have $75,000.  The company will say there was a zero percent average return for those two years, but somehow I lost $25,000.  That seems like a 25% loss to me!

arebelspy

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Seems like Phil Town gets mixed reviews.

Indeed.  Some previous discussion of him here: http://forum.mrmoneymustache.com/investor-alley/what-is-the-value-of-stock-x/

Note, in particular, grant's criticisms.
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with three kids.
If you want to know more about us, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

SDREMNGR

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I invested $4000 in real estate in 1991, then never another dollar out of my own pocket.  My equity is over $1,000,000 today. 
I invested $10,000 in index type funds in 1997, then continued to contribute small amounts each month.  Their total value today is $51,000.  I have no particular expertise in either area.  I just tried to buy low risk investments in each case.  I am not trying to say that no one can make more money in stocks, but I believe if you are the typical "dumb" investor, real estate is the better way to go.  I think others have already explained all the advantages including the ability to use leverage.

  I have been through crashes in both markets, but with real estate the rents held steady or went up.  My income improved.  This would not be the case if I were relying withdrawing a "safe" 4% of my investments from the stock market.  The average returns quoted by the mutual fund companies are lies.  For example, if you invest $100,000 and the market goes down 50% the first year, then you have $50,000.  If the market goes up 50% the next year, you have $75,000.  The company will say there was a zero percent average return for those two years, but somehow I lost $25,000.  That seems like a 25% loss to me!

Your point is a good one and taken, but fyi, the stock holding company wouldn't show it as zero loss, it'd be 25% loss like you showed.  They use actual prices to calculate returns, not relative percentages.  So a price move from 100 to 50 back to 100 would be zero return and that's what they would show.

grantmeaname

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For example, if you invest $100,000 and the market goes down 50% the first year, then you have $50,000.  If the market goes up 50% the next year, you have $75,000.  The company will say there was a zero percent average return for those two years, but somehow I lost $25,000.  That seems like a 25% loss to me!
It's an artificial consequence of you using the wrong average. You want the geometric mean return, not the arithmetic mean return. (And if you're using a less ridiculous example, like a 15% year followed by a 6% year, the two techniques get much closer anyway.)

Franklin

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I invested $4000 in real estate in 1991, then never another dollar out of my own pocket.  My equity is over $1,000,000 today. 
I applaud your skills, humility, and risk tolerance in achieving a 27% CAGR.  My CAGR for Buffalo Wild Wings is currently 39%, Apple 43%, S&P 6.5%, to name a few.  Due diligence was about 1 hour when I bought and/or averaged in.

totoro

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I invested $4000 in real estate in 1991, then never another dollar out of my own pocket.  My equity is over $1,000,000 today. 
I applaud your skills, humility, and risk tolerance in achieving a 27% CAGR.  My CAGR for Buffalo Wild Wings is currently 39%, Apple 43%, S&P 6.5%, to name a few.  Due diligence was about 1 hour when I bought and/or averaged in.

I think the issue might be the long-term average of all investments made since 1991, or whatever period you have been investing, assuming you have been investing for more than ten years so as to demonstrate long-term performance?

I would be concerned with stocks that, while you might have some big winners, they won't all be like that and they won't all be like that forever.   Did you make the same in 2008?  Are you riding the stock market up and have been since then?  What happens if there is a dip/crash as many are predicting?  Buy more?

If you bought at the right time with housing you can make a fortune and if you bought pre-1991 in Canada in my city you did.  Heck, if you bought prior to 2005 your house has doubled.  I bought high for all current properties, but  I think 14% return over the long-term is still sustainable due to rental income.   

Maybe stocks are the same?  Maybe value investing can work reliably.  I guess I'd have to try it to really know.
 

brewer12345

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TASTES GREAT!

LESS FILLING!


As a point of interest, it is trivially easy to get extremely high levels of leverage on equities which is non-callable and non-recourse: buy call options/warrants/LEAPS.  I do so in very limited size when I find a name I think is a ridiculous bargain and want to add more exposure over a self-imposed position limit for a single equity.  Even easier to do this with indicies.

Mississippi Mudstache

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The reason I post is not to be right, but to share the information that I have about how it works with others because, just like the compound interest magic, the right real estate purchase can end up leap-frogging you ahead in life and, for whatever reason, it is not common knowledge.

Well said.

I personally am going to FIRE by age 30 a millionaire on teacher's salaries via real estate, about a decade before I could via a traditional SWR, and that's after not getting started until our mid-20s and then having a 6-figure mistake.  It really does work, and is especially good for an early retiree due to the cash flow leading to lack of volatility leading to a higher "SWR" since there's less of a sequence of return risk.

Best of luck to everyone with their own personal path to FIRE.

[Emphasis mine]

The article and subsequent discussion was interesting, but my favorite way to learn is through other people's mistakes. Have you ever written about your 6-figure mistake, and if so, could you direct me to  your write-up? If not, would you mind sharing?

arebelspy

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Hmm, I don't think I have yet, but I might have mentioned it.  I'll have to search and see if there's a link for you.  If not, I'll definitely write about it some day.  Let's just say that, while others may be able to time the market, I'm pretty convinced I cannot.  And I still haven't decided if the lesson (which cost me 6-figures, cash, in my mind 20s) was cheap or expensive.  :)
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with three kids.
If you want to know more about us, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

Mississippi Mudstache

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Gotcha. I am interested in hearing about it, because I made stupid real estate mistake in my mid-20s as well. Mine was assuredly very different from yours, but it took me a long time to realize how massive my error was, and I was not able to unwind it until last September (right before my 30th birthday). It ended up with me giving the property back to the bank in a deed-in-lieu of foreclosure. I consider it a very costly education (more than my college education by a long shot). The biggest cost is probably opportunity cost, because my credit score is wrecked for the foreseeable future, which prevents me from taking advantage of the favorable credit terms afforded to real estate investors. I do plan to pursue real estate investment again when I am able, but with a much more critical eye. In the meantime, I'm simply taking advantage of the ridiculously awesome benefits that our government has seen fit to bestow upon stock and bond investors via tax-advantaged retirement accounts.

dragoncar

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Hmm, I don't think I have yet, but I might have mentioned it.  I'll have to search and see if there's a link for you.  If not, I'll definitely write about it some day.  Let's just say that, while others may be able to time the market, I'm pretty convinced I cannot.  And I still haven't decided if the lesson (which cost me 6-figures, cash, in my mind 20s) was cheap or expensive.  :)

Damn, I'm pretty sure I've never heard the story.  It's impressive that you even had 6 figures cash in your mid 20s either way.

arebelspy

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Gotcha. I am interested in hearing about it, because I made stupid real estate mistake in my mid-20s as well. Mine was assuredly very different from yours, but it took me a long time to realize how massive my error was, and I was not able to unwind it until last September (right before my 30th birthday). It ended up with me giving the property back to the bank in a deed-in-lieu of foreclosure. I consider it a very costly education (more than my college education by a long shot). The biggest cost is probably opportunity cost, because my credit score is wrecked for the foreseeable future, which prevents me from taking advantage of the favorable credit terms afforded to real estate investors. I do plan to pursue real estate investment again when I am able, but with a much more critical eye. In the meantime, I'm simply taking advantage of the ridiculously awesome benefits that our government has seen fit to bestow upon stock and bond investors via tax-advantaged retirement accounts.

Oh, I've made plenty of real estate mistakes too.  (Including a property I'm still underwater on tens of thousands of dollars and will have to bite the bullet on in a few years, and another one that was underwater and cash flow negative that I managed to salvage with owner financing.)  Those are whole other stories.  :)

Just goes to show you don't have to be perfect to FIRE fairly early, just keep at it..

Prime example:
http://www.mrmoneymustache.com/2012/02/01/mr-money-mustaches-big-mistake/
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with three kids.
If you want to know more about us, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

AMustachianMurse

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The reason I post is not to be right, but to share the information that I have about how it works with others because, just like the compound interest magic, the right real estate purchase can end up leap-frogging you ahead in life and, for whatever reason, it is not common knowledge.

Well said.

I personally am going to FIRE by age 30 a millionaire on teacher's salaries via real estate, about a decade before I could via a traditional SWR, and that's after not getting started until our mid-20s and then having a 6-figure mistake.  It really does work, and is especially good for an early retiree due to the cash flow leading to lack of volatility leading to a higher "SWR" since there's less of a sequence of return risk.

Best of luck to everyone with their own personal path to FIRE.

What % of your holdings are in counties other than the one you live in? 

arebelspy

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The reason I post is not to be right, but to share the information that I have about how it works with others because, just like the compound interest magic, the right real estate purchase can end up leap-frogging you ahead in life and, for whatever reason, it is not common knowledge.

Well said.

I personally am going to FIRE by age 30 a millionaire on teacher's salaries via real estate, about a decade before I could via a traditional SWR, and that's after not getting started until our mid-20s and then having a 6-figure mistake.  It really does work, and is especially good for an early retiree due to the cash flow leading to lack of volatility leading to a higher "SWR" since there's less of a sequence of return risk.

Best of luck to everyone with their own personal path to FIRE.

What % of your holdings are in counties other than the one you live in?

Not sure how relevant to this thread, but a fairly small percentage, almost all in international stock index funds.

Looking at purchasing some real estate overseas, but am luckily in a place (U.S.) where there's plenty of local (same country) opportunities.  If I were in a place like Canada, UK, or Australia, I'd likely be looking to invest in U.S. real estate.  As it is, I may be looking outside for diversification purposes, not return purposes.
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with three kids.
If you want to know more about us, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

Mississippi Mudstache

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What % of your holdings are in counties other than the one you live in?

Looks like you may have mis-read the question, arebelspy.

kyleaaa

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Kyleaaa:  YOU made the assertion, the burden of proof is on YOU.  I also don't think a lot of research is accurate just because it was performed by PhD's.  Minority?  I dunno, there are hundreds of thousands of real estate investors all across the country making it work exactly as described.

I do agree that the paper assets markets are neither random nor entirely efficient and a lot of people are able to beat paper market returns consistently with leverage or by other means.  Just not the average person.

No, I didn't make the assertion. I merely cited the empirical data and conventional wisdom. Rental real estate demonstrates similar risk and return characteristics as the stock market. This isn't even a controversial statement: it's accepted empirical fact by pretty much everybody who studies such things.

I'm sure there are hundreds of thousands of real estate investors all across the country making it work, AND I AM ONE OF THEM, but the assertions on this thread are just ridiculous. Principal pay down as a source of returns? That's absurd and shows a complete lack of understanding of how returns are measured. In my experience, most successful real estate investors out there really don't know much about real estate, business or the stock market, so their opinion on the subject isn't all that valuable.

kyleaaa

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Okay, but if you aren't using a margin loan that can get called, you're paying a lot higher interest rate and a lot shorter term.

Either way, my point of not being able to compare it to real estate leverage stands.

Unless you can tell me where I can get a 5-6% 30-year fixed loan for stocks for hundreds of thousands of dollars that isn't callable?  :)

Real estate leverage is just better.  That's what makes it hard to compare apples-to-apples.

No it isn't, you just don't understand how stock leverage works. Most people who leverage a stock portfolio don't take out loans in the traditional sense and so margin calls don't enter into the picture. There are more efficient ways of leveraging stocks through LEAPs and other forms of options contracts. Stocks are also easier to hedge. An since the stock market is more liquid than real estate, the cost of leverage is lower. So you see, STOCK leverage is just BETTER in terms of cost. And of course, according to basic economic theory, it couldn't really be any other way. Taking out a loan from a bank in order to buy an asset is a very primitive and inefficient form of leverage in today's world.
« Last Edit: May 26, 2014, 10:00:03 AM by kyleaaa »

AMustachianMurse

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The reason I post is not to be right, but to share the information that I have about how it works with others because, just like the compound interest magic, the right real estate purchase can end up leap-frogging you ahead in life and, for whatever reason, it is not common knowledge.

Well said.

I personally am going to FIRE by age 30 a millionaire on teacher's salaries via real estate, about a decade before I could via a traditional SWR, and that's after not getting started until our mid-20s and then having a 6-figure mistake.  It really does work, and is especially good for an early retiree due to the cash flow leading to lack of volatility leading to a higher "SWR" since there's less of a sequence of return risk.

Best of luck to everyone with their own personal path to FIRE.

What % of your holdings are in counties other than the one you live in?

Not sure how relevant to this thread, but a fairly small percentage, almost all in international stock index funds.

Looking at purchasing some real estate overseas, but am luckily in a place (U.S.) where there's plenty of local (same country) opportunities.  If I were in a place like Canada, UK, or Australia, I'd likely be looking to invest in U.S. real estate.  As it is, I may be looking outside for diversification purposes, not return purposes.

Sorry, I meant specifically real estate rental properties.  Are they all in vegas?  Or wherever in the u.s. you can find a good deal then use property management companies for the rest.

totoro

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No, I'm explicitly talking about leveraged rental properties: the long-term studies show they provide roughly the same return with roughly the same risk as stocks.

The real long-term returns of most primary residences are negative. It doesn't even come close to keeping up with treasury bills, much less stocks.

I assure you, I've done the math myself and I am not wrong. Nor are the people with PhDs who have studied the topic for decades and have also done the math. Or are you trying to say you know more about the topic than them?

First, principal pay down from rental income is an eventual source of ROI. 

Your tenants are paying this down after you pay tax on the profit.  You don't realize the equity and any appreciation until point of sale, but you can access it prior to this through a HELOC.   I personally do not count equity pay down until point of sale, but most RE spreadsheets do include this as part of the analysis on return: http://www.biggerpockets.com/forums/88/topics/25519-free-property-analysis-worksheet

I did not answer your question before as to whether people with PhDs who have studied the topic for years know more than I do about real estate.  In order to do so I would need to know who you are referring to.  Who are you referring to and for which particular point?

I myself have an advanced degree and am academically published, although not in real estate.  I would put the depth of my knowledge on RE on par with many academics as I am quite interested in it and have spent a lot of time reading up on it.  I spend some time each day on this and follow a number of sources of information regularly.  In this particular field practical experience is a significant factor. 

The use of LEAPS is not something I'm proficient with, but it seems that other investor opinions differ from yours and I would question their usefulness for the average investor.  Many seem to view it as a risky investment?http://www.bogleheads.org/forum/viewtopic.php?f=10&t=89114

I'm not sure of stock market leverage through a LEAP being better in terms of cost, but that is not the only factor.  There is also risk.  You may be correct for someone with in-depth knowledge. 

For me, I'm not qualified to comment on LEAPS and I'm definitely better off with the primitive and inefficient leverage available to me for RE.  I'm pretty grateful for it too.

arebelspy

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What % of your holdings are in counties other than the one you live in?

Looks like you may have mis-read the question, arebelspy.

lol, whoops. Thanks. Approximately 50% are in the county I live in.  When I FIRE it will be approximately 25% (in other words, I expect my real estate holdings to double, and none be local).
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with three kids.
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arebelspy

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First, principal pay down from rental income is an eventual source of ROI. 

Of course it is.  If the tenant is paying it down, not you, it's returns you realize in the form of equity.

Or you could not count the mortgage principal payment in your calculations, only the interest, and count ignore the transfer of principal paydown.  It works out to the same return.

Example:
1000 gross rent, 500 expenses, 300 mortgage payment that is made up of 200 interest, 100 principal.

You could either say your return is 1000-500-200 (only counting the interest part of the payment) = $300.

Or you could say it is 1000-500-300 = $200 cash, 100 equity.

Either way it works out the same, the advantage of the second method is you can break it up into cash on cash returns and such.

In neither case is your return just $200 - after 30 years you'll have a house paid off by your tenants, that's certainly part of your return.
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with three kids.
If you want to know more about us, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

kyleaaa

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First, principal pay down from rental income is an eventual source of ROI. 

No, it's NOT a source of ROI. You are counting the same cash flow twice if you do that. Principal pay down is a form of accumulating EQUITY, but equity accumulation and investment returns are not the same thing. You are flatly wrong with no room for interpretation. You could only mathematically count principal pay down as a source of return if you subtract it out from your net cash proceeds, which makes it a wash.

I myself have an advanced degree and am academically published, although not in real estate.  I would put the depth of my knowledge on RE on par with many academics as I am quite interested in it and have spent a lot of time reading up on it.  I spend some time each day on this and follow a number of sources of information regularly.  In this particular field practical experience is a significant factor. 

And yet you don't know how to correctly calculate returns and you made several other rookie errors throughout this thread. You may be experienced, but you're still wrong.

The use of LEAPS is not something I'm proficient with, but it seems that other investor opinions differ from yours and I would question their usefulness for the average investor.  Many seem to view it as a risky investment?http://www.bogleheads.org/forum/viewtopic.php?f=10&t=89114

The thread in question mostly centers around the insurance aspect of options, not using it to leverage up long positions. And of course LEAPS are risky investments. ALL forms of leverage are inherently risky. Doesn't change the fact that they are useful for stock investors who want leverage.

That said, margin leverage is now sub-1% in many places so you could use that if you were more comfortable with it.
« Last Edit: May 26, 2014, 02:03:49 PM by kyleaaa »

arebelspy

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First, principal pay down from rental income is an eventual source of ROI. 

No, it's NOT a source of ROI. You are counting the same cash flow twice if you do that. Principal paydown is a form of accumulating EQUITY, but equity accumulation and investment returns are not the same thing. You are flatly wrong with no room for interpretation.

Did you even read what I posted right above your post?  It's not counted twice, because it's take out of the gross received, and counted in the equity side, not anywhere else, so only counted once.

Could you maybe open your mind for a second and consider that we aren't complete idiots, and maybe are just doing it a different way than you?
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with three kids.
If you want to know more about us, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

kyleaaa

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Of course it is.  If the tenant is paying it down, not you, it's returns you realize in the form of equity.

Ah, so you agree with me. Accumulating equity and earning investment returns aren't the same thing. Glad we're on the same page now.

Or you could not count the mortgage principal payment in your calculations, only the interest, and count ignore the transfer of principal paydown.  It works out to the same return.

Example:
1000 gross rent, 500 expenses, 300 mortgage payment that is made up of 200 interest, 100 principal.

You could either say your return is 1000-500-200 (only counting the interest part of the payment) = $300.

Or you could say it is 1000-500-300 = $200 cash, 100 equity.

Either way it works out the same, the advantage of the second method is you can break it up into cash on cash returns and such.

In neither case is your return just $200 - after 30 years you'll have a house paid off by your tenants, that's certainly part of your return.
[/quote]

No, you can't count the equity as a source of return. The fact that the bank forces you to make a monthly mortgage payment every month that contributes to principal pay down is irrelevant.  You have the cash in hand. Just because you THEN invest some of that cash back into the property doesn't magically make it a source of return. It isn't. It is a source of equity accrual, sure, but those are very, very, very different things.

kyleaaa

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First, principal pay down from rental income is an eventual source of ROI. 

No, it's NOT a source of ROI. You are counting the same cash flow twice if you do that. Principal paydown is a form of accumulating EQUITY, but equity accumulation and investment returns are not the same thing. You are flatly wrong with no room for interpretation.

Did you even read what I posted right above your post?  It's not counted twice, because it's take out of the gross received, and counted in the equity side, not anywhere else, so only counted once.

Could you maybe open your mind for a second and consider that we aren't complete idiots, and maybe are just doing it a different way than you?

So let me see, you get called out as incorrect. Argue back and forth incorrectly. And then you reword my EXACT argument back to me and try to say I'm the one with the closed mind? Nice. Never, not even once, did I say or imply the return was "just" $200 in your example. Of course that $100 is part of your return. But the equity pay down isn't the return. The cash flow is.  Which of course, if you scroll up, is 100% exactly what I said in my very first post that you proceeded to argue belligerently with. So if you agree with me to begin with, why did you say I was wrong?

No, I 100% understand your original argument. But it's wrong. The cash flow is the return, not the equity pay down. The fact that you then choose to invest it back into the property is completely irrelevant. You are just confusing the issue using that terminology. If you want to reinvest it back in the property, GREAT! But that's not a return. That's an investment. Calling it a return is flat-out using the word incorrectly. Principal pay down isn't the source of ROI, it's the consequence.

If you continuously make idiotic comments, you will usually be labeled an idiot.
« Last Edit: May 26, 2014, 02:00:18 PM by kyleaaa »

Another Reader

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Do a DCF analysis for the equity position.  The equity holder gets net cash flow after all expenses, including the mortgage payments, and the net equity after sale.  The effect of the principal pay down is to increase the equity that the equity holder receives at sale.  To the extent that the sum of the discounted cash flows exceeds the initial cash invested, there is a return on the equity holder's investment.  In most cases, part of that return on capital is from the equity pay down.  The remainder is from appreciation.

arebelspy

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Never mind.  You clearly don't understand.

It's not worth arguing anymore, everyone else understands that I've ever met, and I'm not interested in convincing you.

Best of luck, Kyle.
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with three kids.
If you want to know more about us, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

totoro

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[
If I put in $50,000 on $350,000 and I get back $8,000 in principal pay-down, plus $12,500 in appreciation, plus $5000 in cash flow, after tax I earn $27,500 on $50,000 the first year. 

No, you get $12,500 + $5,000 - borrowing costs - current maintenance - amortized costs for the current period (real estate zealots almost never remember to include this one). You absolutely do NOT earn $27,500 the first year. This is Accounting 101. Your cash flow may or may not approach $27,500 the first year, but cash flow and earnings are not the same thing.


Of course they are not.  Do you think I'm incapable of understanding how my eight rental properties work?  These are my after expenses and after tax numbers.  I know how to calculate this and I account for every expense including interest costs.  Cash flow positive means after expenses, not before.

If you look back to the first page kyleaa you assumed that the "real estate zealots" were double-counting the return in failing to account for expenses such as interest and O&M when looking at ROI.  Look at your response above to my post.  I actually do account for all expenses in my scenario and I don't include the equity pay down until point of sale because it is not certain until that point.  It does not mean it does not exist or it is not tied to the investment itself.

It sounds like maybe you object to characterizing equity pay-down as part of the ROI analysis at all in purchasing rental property and it is not because of your initial response that it was double counting.  When it was explained that folks were not double-counting, you stated it is just "wrong" . 

The way I look at it is when I invest in a rental home the equity paid by rental income (not my income) is part of the consideration as to long-term return.  I have no choice but to pay this down in accordance with the mortgage, although I can remove it through a HELOC.  Why would I treat that as a separate and unrelated calculation?  Without my initial investment, it would not exist and the payment of it is a term and condition of the initial investment.

In your view, even though this is a requirement of the debt servicing instrument attached to the property, it constitutes a separate investment of your ROI and this needs to be accounted for in some separate calculation?  Where is your source for this and what is the practical purpose?  I'm not an accountant and maybe there is one, but I don't see it.  It doesn't help me at tax time, it doesn't help me analyze whether a deal works or not, it does not help with any depreciation analysis.... why do it that way?

Mr Mark

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Maybe we could use a worked example.

Frank buys a house for $125k, with 20% down ,$25k deposit, and a 30 yr mortgage for $100k at 5% fixed interest rate, standard amortization of principal. [ in year 1, that's $540 per month, comprising $410 in interest, and $130 in principal repayment. Property taxes at 1% are $1250  per year.

He decides to rent the house for a lease paying $2000 a month ( a shade over 1.5% within the 2% - 1% rule of thumb). Maintenance  plus management fees are 500/ mnth, a total of $6000  a year. (Its a good investment).

So, pre- tax, what is the return on investment,  and what is the return on equity?

I would propose the following ( lets assume simple averages for year 1):

ROI = Revenue - maintenance and fees - tax , divided by cost of the asset, $125k,
       = $24,000 - 6000 - 1250  /   125,000   
      =  13.4%

But what is the return on equity?

ROE = Revenue - maintenance and fees - tax - interest, divided by net equity
       =  $24,000 - 6000 -1250 - 4920  /   ($25,000 - 1560)
      = 50%

and you gain 1560 in cashflow and as equity on the balance sheet.

Note the principal repayment served to reduce equity in the ROE equation, and is simply included in revenue inthe ROIequation.

The return you receive on the principal repayment is the same as the interest rate on the mortgage, 5% pretax.

above calcs are also, note, pre tax.


clifp

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Maybe we could use a worked example.



I would propose the following ( lets assume simple averages for year 1):

ROI = Revenue - maintenance and fees - tax , divided by cost of the asset, $125k,
       = $24,000 - 6000 - 1250  /   125,000   
      =  13.4%

But what is the return on equity?

ROE = Revenue - maintenance and fees - tax - interest, divided by net equity
       =  $24,000 - 6000 -1250 - 4920  /   ($25,000 - 1560)
      = 50%



I like this example and it illustrates the difference between ROI and ROE..  But I wonder if the ROE equation is correct. In about a dozen years the principal pay down  will exceed $25,000 and the ROE will turn negative.

SDREMNGR

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You should be adding the principal pay downs to your down payment (initial equity).  So over time your ROE will also go down because your equity will grow and the returns will increase in dollar figure but decrease as a percentage.  So if you wanted to maximize ROE, you have to sell and buy somewhat frequently (maybe every 5-10 years or so) or refinance and reinvest the capital.

totoro

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You should be adding the principal pay downs to your down payment (initial equity).  So over time your ROE will also go down because your equity will grow and the returns will increase in dollar figure but decrease as a percentage.  So if you wanted to maximize ROE, you have to sell and buy somewhat frequently (maybe every 5-10 years or so) or refinance and reinvest the capital.

Unless you plan to retire early and live on the rental returns (at a lower tax rate because you don't have other income) and don't need more than the appreciation on the asset long-term. 

Otherwise pulling out equity and re-investing can be a good way to go.

Also, I think you need to account for the lost opportunity costs over time on your initial investment as an expense.

Mr Mark

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Quote from: totoro

Also, I think you need to account for the lost opportunity costs over time on your initial investment as an expense.

fully agree totoro. If you could get a 7% return elsewhere, that should be taken as an expense above, or more properly used as a 7% discount rate in the cashflow analysis. 

Where it gets complicated is wrt tax really. This changes everything.

but also why, as Arebelspy points out at every opportunity,  the us real estate market is a wonderful, wonderful place. You can see why the 2 % "rule" is perhaps born of a much higher interest rate and inflation world.

Even a modest 1.6 % rule is a damn good cash on cash investment. With access to quality no-call leverage,  a no brainer. Tax advantaged too. Wow. Sorry, people from really overvalued housing market countries ( Australia,  New Zealand,  UK, Canada (esp vancover and Calgary), etc... )


lano

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First, principal pay down from rental income is an eventual source of ROI. 

No, it's NOT a source of ROI. You are counting the same cash flow twice if you do that. Principal paydown is a form of accumulating EQUITY, but equity accumulation and investment returns are not the same thing. You are flatly wrong with no room for interpretation.

Did you even read what I posted right above your post?  It's not counted twice, because it's take out of the gross received, and counted in the equity side, not anywhere else, so only counted once.

Could you maybe open your mind for a second and consider that we aren't complete idiots, and maybe are just doing it a different way than you?

So let me see, you get called out as incorrect. Argue back and forth incorrectly. And then you reword my EXACT argument back to me and try to say I'm the one with the closed mind? Nice. Never, not even once, did I say or imply the return was "just" $200 in your example. Of course that $100 is part of your return. But the equity pay down isn't the return. The cash flow is.  Which of course, if you scroll up, is 100% exactly what I said in my very first post that you proceeded to argue belligerently with. So if you agree with me to begin with, why did you say I was wrong?

No, I 100% understand your original argument. But it's wrong. The cash flow is the return, not the equity pay down. The fact that you then choose to invest it back into the property is completely irrelevant. You are just confusing the issue using that terminology. If you want to reinvest it back in the property, GREAT! But that's not a return. That's an investment. Calling it a return is flat-out using the word incorrectly. Principal pay down isn't the source of ROI, it's the consequence.

If you continuously make idiotic comments, you will usually be labeled an idiot.


So all a person has to do to get the "full" leveraged ROI is account for his or her RE return right after receiving all the cashflows, but before making the mortgage payment to the bank?  (You can be super slick and calculate the interested and principal portions each month and send the two payments a day apart as well -- just remember which is which or this trick won't work :) )

As long as this continues every month all is fine? 

Instead of arguing semantics why not describe why pure ROI is very different from Equity accumulation?

The only explanation I have seen so far is that the money could instead be used for a vacation.  This of course means that the could be used for anything else.

Does this difference matter though in a practical sense?  Does this difference matter for a person looking for FIRE?

Is each principal payment a "bad" investment that only has the potential to grow along with the price of the property?  You already have full control of the cashflows, why pour more money than needed into the thing? 

Or is this just the price of doing RE business: the price you pay for getting the amazing leverage in the first place, is that you have to un-leverage yourself. 

Do you refinance over and over to stay leveraged?  What is the cost of that?

Do 100 year or indefinite interest only loans exist?  That would solve all the problems. 








 
« Last Edit: May 26, 2014, 09:43:40 PM by lano »

totoro

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Monthly cash flow does matter imo.  In my case, I  have properties that are cash flow positive without accounting for any principal pay down.  Peace of mind.

You don't realize principal pay down until point of sale or refinancing.  Refinancing RE in Canada is pretty easy in that we have HELOCs.  You can take the money out and if you invest it in something else like stocks your interest is tax deductible. 

As far as when to refinance, that is a good question.  In Canada you need a certain percentage of equity before you are permitted to use a HELOC.  I guess it depends on your other options and what kind of ROI for acceptable risk they bring.  It is often the way to finance another RE purchase or investment.

Some people just want a paid-off asset that generates income and continues to appreciate over time as a safety net.   Sometimes enough is enough, particularly when your long-term is becoming short-term ie. you don't have as many years left to ride out the markets/other investments and you want to spend your time otherwise.

butchmonkey

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Amazing how well buffet did investing in an inferior product, (stocks.)


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lano

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Amazing how well buffet did investing in an inferior product, (stocks.)


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So far in this thread there are two main viewpoints:

1. RE has the advantage of leverage and market inefficiency. 

2. Although differences exist, they are cosmetic and/or small and the return are the same.


Now we get to choose heroes:

Team Stocks has Mr. Buffet.

Team RE has who?  Mr. Trump?  :)


This does bring up an important point.  What are the capital limits of RE investing?  These limits though probably do not matter for mustache/ Fire oriented people. 

If RE people do choose Mr. Trump as their hero, a great irony will be upon them:  Mr Buffet is as thrifty as they come, while Mr Trump...
« Last Edit: May 26, 2014, 10:17:57 PM by lano »