Author Topic: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds  (Read 59557 times)

arebelspy

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Is the author attempting to say stock investors don't benefit from write-offs and depreciation? Ridiculous.

He's saying you can't depreciate the cost basis of your stock purchase against the income it generates. Imagine if you were allowed to buy a stock for $5,000, that stock paid a $250 dividend ever year, and you weren't taxed on that dividend because you were able to depreciate $300 of your cost basis each year against that income. In fact, you can likely take a $50 loss against ordinary income while receiving $250 in cash. That's the equivalent of what real estate depreciation does for you.

Eventually the depreciation will be recaptured, but it's a very nice deferral feature.

But I'M saying the company already depreciates the cost basis of the assets IT buys against the income it generates. And since corporate tax rates are generally higher than individual tax rates, if anything, you get MORE depreciation benefit from owning stocks. The depreciation happens on the company's tax form instead of your personal tax form, but that doesn't mean it isn't real.

I agree it's a very nice deferral feature, but it isn't a feature only available to real estate investors. The IRS didn't write special tax laws for real estate investors, so it only stands to reason they receive the same tax benefits as any other business owner. In reality, the sources of return for real estate and stock investors are identical.

And the topic of the article is patently false to begin with: long-term returns of stocks and real estate are roughly equivalent with roughly equivalent levels of risk (controlling for differences in leverage). To expect it to be any other way is a bit naive.

"Real estate" is not all the same.

When you look at long-term returns of a primary residence which is protected from capital gains but generates no income and is simply paid off over time, you are likely correct that you will match the stock market. 

That is not what we are talking about here.

When you compare well chosen, leveraged rental properties that pay all their own costs and generate cash flow and which you hold until the market favours selling you are incorrect.

Best to do the math yourself rather than rely on something you read somewhere.  There are many calculators and links on biggerpockets.

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.

First of all, citation needed, and second of all, you're still missing his point.  The overall market may, but carefully selected ones done well should be able to beat that.

While beating the average is really tough in stock market picking (nigh impossible), in rental real estate it's much more possible.  Not simply from picking a certain property type, but based on the procedures and how you handle it.

Hell, even if you cash flow nothing and appreciate at the rate of inflation (i.e. 0% real appreciation), you should still earn a real return of 6-7% just based on the leverage and principal pay down.

That will match stocks.  (If that's what you meant by the studies showing they match stocks over time, no citation needed.  If you cash flow $0, are leveraged at 6%, and see appreciation matching inflation, you should match stocks in real return.)

Now add on the cash flow if you've done it right, and you blow it away (we.. several percent higher, which is nice).

EDIT: I'd guess most rentals are around break-even (no cash flow) and the negative cash flow ones offset positive cash flow ones.  So perhaps long term the average leveraged rental does match stocks.  But again, a good investor who buys right should cash flow quite well (10%+ cash on cash return) and if they are using prudent, low-cost leverage, they should do quite well and be able to beat that average (something that isn't really possible with stocks, IMO).
« Last Edit: May 14, 2014, 02:54:44 PM by arebelspy »
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hodedofome

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I'm sorry arebelspy, but assuming that it's possible to get outsized returns in real estate but not in the stock market is just closed minded. You believe it to be so because you know real estate. If you knew stocks the way you knew real estate, you wouldn't have that opinion.

Achieving abnormal returns is possible in inefficient markets. If everyone knew real estate, there wouldn't be the possibility for large returns because the market would be efficient. But because there's not 100k people in every city looking for rental properties, there exists the opportunity to buy something at a cheap or fair price and rent it out at a price higher than your bank note. In fact, in some cities the real estate market is pretty efficient and you can't make a lot in rental properties.

It is no different in stocks. There are stocks and markets that everyone is looking at and are largely efficient. There are other stocks and other markets that not many people are watching and they are very inefficient. Those are where the big opportunities are and will continue to be as long as humans and markets exist.

Franklin

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I'm sorry arebelspy, but assuming that it's possible to get outsized returns in real estate but not in the stock market is just closed minded. You believe it to be so because you know real estate. If you knew stocks the way you knew real estate, you wouldn't have that opinion.

Achieving abnormal returns is possible in inefficient markets. If everyone knew real estate, there wouldn't be the possibility for large returns because the market would be efficient. But because there's not 100k people in every city looking for rental properties, there exists the opportunity to buy something at a cheap or fair price and rent it out at a price higher than your bank note. In fact, in some cities the real estate market is pretty efficient and you can't make a lot in rental properties.

It is no different in stocks. There are stocks and markets that everyone is looking at and are largely efficient. There are other stocks and other markets that not many people are watching and they are very inefficient. Those are where the big opportunities are and will continue to be as long as humans and markets exist.

+1 with a tip of the hat to our OP

arebelspy

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I'm sorry arebelspy, but assuming that it's possible to get outsized returns in real estate but not in the stock market is just closed minded. You believe it to be so because you know real estate. If you knew stocks the way you knew real estate, you wouldn't have that opinion.

It's not closed minded, it's based on data and evidence.

All the research I have read has given me that opinion.

Achieving abnormal returns is possible in inefficient markets.

Absolutely.  But since the stock market is pretty damn efficient, it's simply not possible there the way it is with Real Estate, which is much more inefficient.

No, I don't believe you can beat the stock market long term, hodedofome, nor do I believe Franklin can.  I might concede that you may be able to beat it by one percent or so (but probably not).  Professional managers who spend all their time doing it can't outperform the market after the drag from their fees.
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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kyleaaa

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Maybe you have experienced better overall returns long-term.  The average annualized moderate allocation fund is 6.1%.
http://www.dallasnews.com/business/columnists/scott-burns/20140201-couch-potato-investing-report-2013.ece


Why would you compare a moderate allocation fund to a 100% real estate investment?

You would know better than I.  I don't use leverage for stocks.  I did look into it and found no equivalent long-term low-rate loans available that were secured against stocks rather than personal credit, but maybe I missed something.

Stock leverage can easily be had in the US for 0.99%. Not sure about Canada, but I would imagine it's close. But like I said, people who want stock leverage have other options.

Equity paydown from after tax rental income is a source of return on investment.  You could move it to the cash column instead if you'd prefer to account for it there and apply it to expenses instead, but I treat it separately and it does not come from my paycheque like a 401k.

No it isn't. You are investing more money into an asset when you could do literally anything else with it. It's exactly like a 401k contribution.

Show me the study and please make sure it done on a leveraged cash flow positive rental property as a comparison.

Google it. There are literally dozens done from every angle. Although since you are the one advocating the minority position, the burden of proof is really on you.

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.

Yes, I believe you don't understand how your eight rental properties work. Or at least how accounting works. Cash flow positive and earnings aren't the same thing. You are equating your positive cash flow with profits, and that's wrong.
 
Yes, stock gains compound if you reinvest.  I have no idea where the equity pay down on stocks is?  Or the rent increases. 

Equity pay down isn't a source of returns as discussed above, but even if they were, companies can use earnings to pay down debt and they can raise prices to keep up with inflation. Exact same thing.

Do you actually own any rental properties?

Yes.
« Last Edit: May 14, 2014, 03:15:23 PM by kyleaaa »

kyleaaa

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First of all, citation needed, and second of all, you're still missing his point.  The overall market may, but carefully selected ones done well should be able to beat that.

I'm definitely not missing the point. I 100% understand your argument, I'm just saying you're wrong.

While beating the average is really tough in stock market picking (nigh impossible), in rental real estate it's much more possible.  Not simply from picking a certain property type, but based on the procedures and how you handle it.

Beating the average is neither impossible nor difficult in the stock market if one doesn't mind taking on more risk to do so. This generally takes the form of increasing risk factor exposure and using leverage rather than stock picking, but the idea is the same.

Hell, even if you cash flow nothing and appreciate at the rate of inflation (i.e. 0% real appreciation), you should still earn a real return of 6-7% just based on the leverage and principal pay down.

As stated above, principal pay down is not a source of returns. It's simply investing more money you could have used to go on vacation.

That will match stocks.  (If that's what you meant by the studies showing they match stocks over time, no citation needed.  If you cash flow $0, are leveraged at 6%, and see appreciation matching inflation, you should match stocks in real return.)

I wonder, have you attempted to disprove your preconceived beliefs? A very quick Google search would disprove you. Have you tried it?

EDIT: I'd guess most rentals are around break-even (no cash flow) and the negative cash flow ones offset positive cash flow ones.  So perhaps long term the average leveraged rental does match stocks.  But again, a good investor who buys right should cash flow quite well (10%+ cash on cash return) and if they are using prudent, low-cost leverage, they should do quite well and be able to beat that average (something that isn't really possible with stocks, IMO).

Confusing luck with skill is pretty common. Many people who "buy right" do beat stocks. Many people who "buy right" don't. And many who "buy right" may earn a higher return than stocks but at much higher risk. But so what? You can leverage stocks to achieve the same return at similar risk. There is no free lunch with real estate.

Another Reader

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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.

arebelspy

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Beating the average is neither impossible nor difficult in the stock market if one doesn't mind taking on more risk to do so.


That's not sustainable or reliable long term.

Hell, even if you cash flow nothing and appreciate at the rate of inflation (i.e. 0% real appreciation), you should still earn a real return of 6-7% just based on the leverage and principal pay down.

As stated above, principal pay down is not a source of returns. It's simply investing more money you could have used to go on vacation.

No, it is a source of returns if the tenants are paying that principal down for you.  In other words, they give you the cash, you subtract out the expenses and mortgage and then look at your net.  You should count that principal paydown in your return, as it came from the tenants and is now your equity.  If you merely took your gross rent, subtracted out expenses and the interest paid, then paid the principal down out of your own money, that would be how you're looking at it, but then you'd have higher cash from the tenant.  It's six of one, half a dozen of the other, but principal pay down definitely should be counted as part of your return.

That will match stocks.  (If that's what you meant by the studies showing they match stocks over time, no citation needed.  If you cash flow $0, are leveraged at 6%, and see appreciation matching inflation, you should match stocks in real return.)

I wonder, have you attempted to disprove your preconceived beliefs? A very quick Google search would disprove you. Have you tried it?

Like I said, my opinions are based on data and research I've read.  Your calling it "preconceived beliefs," while doing its job to be insulting, is inaccurate.  A goodle search for what, exactly?  If it's so quick and easy, please provide the links. Thanks.
EDIT: I'd guess most rentals are around break-even (no cash flow) and the negative cash flow ones offset positive cash flow ones.  So perhaps long term the average leveraged rental does match stocks.  But again, a good investor who buys right should cash flow quite well (10%+ cash on cash return) and if they are using prudent, low-cost leverage, they should do quite well and be able to beat that average (something that isn't really possible with stocks, IMO).

Confusing luck with skill is pretty common. Many people who "buy right" do beat stocks. Many people who "buy right" don't. And many who "buy right" may earn a higher return than stocks but at much higher risk. But so what? You can leverage stocks to achieve the same return at similar risk. There is no free lunch with real estate.

It's not a free lunch.  It takes hard work and knowledge.  But due to the market inefficiencies, barriers to transactions (lack of liquidity, speed, etc.), etc. one can get a better return in real estate relative to their investment than with stocks, if it is done correctly.
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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hodedofome

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I'm sorry arebelspy, but assuming that it's possible to get outsized returns in real estate but not in the stock market is just closed minded. You believe it to be so because you know real estate. If you knew stocks the way you knew real estate, you wouldn't have that opinion.

It's not closed minded, it's based on data and evidence.

All the research I have read has given me that opinion.

Achieving abnormal returns is possible in inefficient markets.

Absolutely.  But since the stock market is pretty damn efficient, it's simply not possible there the way it is with Real Estate, which is much more inefficient.

No, I don't believe you can beat the stock market long term, hodedofome, nor do I believe Franklin can.  I might concede that you may be able to beat it by one percent or so (but probably not).  Professional managers who spend all their time doing it can't outperform the market after the drag from their fees.

I'm not gonna be able to change your beliefs. I could show you this: http://www.mercenarytrader.com/wp-content/uploads/2011/07/Interview-With-a-Trading-Legend.pdf or this http://www.amazon.com/Market-Wizards-Updated-Interviews-Traders/dp/1118273052/ref=sr_1_1?ie=UTF8&qid=1400102660&sr=8-1&keywords=market+wizards or this http://www.amazon.com/The-New-Market-Wizards-Conversations/dp/0887306675/ref=sr_1_3?ie=UTF8&qid=1400102660&sr=8-3&keywords=market+wizards or this http://www.amazon.com/Stock-Market-Wizards-Interviews-Americas/dp/0066620597/ref=sr_1_7?ie=UTF8&qid=1400102660&sr=8-7&keywords=market+wizards or this http://en.wikipedia.org/wiki/Martin_S._Schwartz or this http://en.wikipedia.org/wiki/Nicolas_Darvas or this http://www.iinews.com/site/pdfs/IIMagazine_March_2006_Secrets_of_Sovereign.pdf but it wouldn't make a difference. We'll just have to agree to disagree.

dragoncar

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I'm sorry arebelspy, but assuming that it's possible to get outsized returns in real estate but not in the stock market is just closed minded. You believe it to be so because you know real estate. If you knew stocks the way you knew real estate, you wouldn't have that opinion.

It's not closed minded, it's based on data and evidence.

All the research I have read has given me that opinion.


Now who needs a citation?  :-)

Are you saying that the average "retail" real estate investor will beat the average "retail" stock investor?  Based on what?

I think either way there are people who can consistently outperform the market... I am not one of those people but I do believe they exist for stocks. 

arebelspy

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We'll just have to agree to disagree.

Indeed.
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Hugh H

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Hi there, here I'm Hugh H and I outperformed the market in 2013 by over 30%. I outperformed it also in 2012, my first full year of trading, but don't know by how much since my broker didn't keep the Performance Report that it now has.

In 2014, I'm up 23% Year-to-Date (while the S&P 500 is up around 2%).

I own a rental property that's treating me well. Would like to diversify with more real estate, but don't like giving a 20% down payment and don't like PMI and high interest rates.

The "you can't outperform the market" is over 90% accurate, in my experience, with most individuals. But it still can be done. As there are stellar real estate investors with above normal returns, there are stock market investors with the same.




totoro

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Hey - thanks to Another Reader and arebelspy for stepping in.

I agree principal pay down is part of the return, but in real life I choose not to count it until sale because values fluctuate.  That said, I also make sure that I can hold until it is favourable to sell.

I don't see any reason to keep answering the counters.  I'm okay with the real estate investments I have and I think I have a fairly realistic expectation on the returns.  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.

As for stocks, I'm interested enough to do more research and I like the purely passive aspect of the Couch Potato approach.  I do have existing investments, but I've never taken up stocks with a passion so maybe that is something I should look into.
« Last Edit: May 14, 2014, 08:18:52 PM by totoro »

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.
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.

Hugh H

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Wow, arebelspy, that's a really good success story.

Do you recommend paying the 20% down on rental units, or going with less (say 5-10%) and paying PMI? (which is tax deductible, right? I guess it could also be "passed down" to renters).

I don't want to deviate a large amount of money from my stock market portfolio.

Another Reader

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The difference is that a large portion of your safe withdrawal rate (SWR) is not a withdrawal at all.  It is income from assets that you continue to own and will continue to produce income.  Sequence of returns risk affects you much less when you are not decumulating, just taking the relatively steady income the assets produce.  Like I said somewhere else, in the 2008-2012 period, my balance sheet deteriorated dramatically.  It did not matter much, because for the most part, the rental and dividend income checks kept coming.  Yes, it helped that I had pension income for peace of mind, I did lose some dividend income from banks, and there was some turnover in tenants as jobs were lost.  The important point is that at no time was I forced to sell assets for income.  In fact, I found enough cash to buy more houses at the bottom of the market.  And because I held on to the assets and added to them, the income has gone up since then.

foobar

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Check back in 10 years and let us know if your 20%+ outperformance continues. I beat the market by something like 60%/yr between 1995-1999 before giving up? What was my secret? AOL. The fact that my other 2 stock picks sucked didn't matter when you got a 10 bagger. Then I got a job and realized it wasn't a lot of fun to spend hours researching stocks and that my pick of AOL versus 3 others was pretty much blind luck.

Real estate is awesome but in a lot of times the deals people talk about don't exist in your market (i.e. good luck buying a cash flow+ from day one property in NYC) or require assets you don't have (i.e. you don't have a 200k downpayment and can't get an 800k mortgage to buy that nice duplex in Sunnyvale).  The plus of course is you are dealing in a very inefficient market (compared to the stock market) where a lot of the players are total amateurs. If you compare the fortunes made from stock trading (pretty much zero. The money is in managing other peoples money) versus real estate I would vote on the real estate person every time. But there are always exceptions. 

Hi there, here I'm Hugh H and I outperformed the market in 2013 by over 30%. I outperformed it also in 2012, my first full year of trading, but don't know by how much since my broker didn't keep the Performance Report that it now has.

In 2014, I'm up 23% Year-to-Date (while the S&P 500 is up around 2%).

I own a rental property that's treating me well. Would like to diversify with more real estate, but don't like giving a 20% down payment and don't like PMI and high interest rates.

The "you can't outperform the market" is over 90% accurate, in my experience, with most individuals. But it still can be done. As there are stellar real estate investors with above normal returns, there are stock market investors with the same.

bobmarley9993

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I tend to agree with the op on this one, have seen it too many times second hand.   I am just wondering if you couldn't catch some of that outperformance with REIT's?  Shouldn't a REIT be fundamentally the same as owning property yourself, less the management fee?

Hugh H

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I tend to agree with the op on this one, have seen it too many times second hand.   I am just wondering if you couldn't catch some of that outperformance with REIT's?  Shouldn't a REIT be fundamentally the same as owning property yourself, less the management fee?

With a REIT you're buying a business, like all business they can make mistakes, over leverage, buy at the wrong time, etc... And given they're business, their value can go to zero. ARR is a REIT invested in for a short amount of time; see how much value it has lost in a few years.

Your condo / house will never be worth zero.

And to the other poster, I don't buy stocks but sell options that place me mostly in a market-neutral position. The only reason why I'm up so much in a year where the markets are flat. I fully believe I will continue to outperform the markets for years to come.

Daleth

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Do you recommend paying the 20% down on rental units, or going with less (say 5-10%) and paying PMI?

These days you would be hard pressed to find a bank that would allow you to get an investment property with a 5%-10% down payment. If you buy real estate that you personally are not going to live in, you're looking at a requirement of 20% down. On the other hand, if you buy a multi-unit with 4 or fewer units and you are going to move into one of them, you can get a more "normal" mortgage. You can move out again after a reasonable period of time (say, a year), but you have to be moving in when you buy and most mortgages will specify the deadline by which you have to move in (60 days post-closing seems typical, but I've never seen anyone get in trouble for not meeting that deadline).

If you're looking at a place you are going to move into, which is how a lot of real estate investors start, I would recommend two mortgages over PMI. In other words, look for a loan that combines one 80% mortgage at a low rate, and one mortgage for the other 10%-15% (so you would put 10% or 5% down), at a higher interest rate. Then of course you direct all excess funds towards paying down the second mortgage ASAP, and when it's gone it's gone. The process of killing a second mortgage is a lot more straightforward and within your control than the process of killing PMI.
« Last Edit: May 14, 2014, 09:09:49 PM by Daleth »

bobmarley9993

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I tend to agree with the op on this one, have seen it too many times second hand.   I am just wondering if you couldn't catch some of that outperformance with REIT's?  Shouldn't a REIT be fundamentally the same as owning property yourself, less the management fee?

With a REIT you're buying a business, like all business they can make mistakes, over leverage, buy at the wrong time, etc... And given they're business, their value can go to zero. ARR is a REIT invested in for a short amount of time; see how much value it has lost in a few years.

Your condo / house will never be worth zero.

And to the other poster, I don't buy stocks but sell options that place me mostly in a market-neutral position. The only reason why I'm up so much in a year where the markets are flat. I fully believe I will continue to outperform the markets for years to come.

Yes, a house/condo will never be worth 0 but neither will the properties of the REIT.  I am honestly not familiar with ARR but it looks like they are leveraged almost 10 to 1.   So if you did the same and bought a 100k house with 10k down (if the bank let you), you would run the same risk of losing your initial capital if you had problems renting the place.

I think you can have some margin of safety by looking for companies with longer histories and lower leverage ratios.   Just digging around quickly I have found a few with the leverage only 50% of the property value for instance.

I agree that you are still dependent on the skill of the manager but balancing against that is you have limited downside with your investment whereas with a real estate investment, you are liable for the full debt amount owing on the house which is generally greater than your initial investment.

Honestly though I am no expert on REIT's, still just doing my due diligence.

Johnny Aloha

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Your condo / house will never be worth zero. 

It's worth 0 if no one will buy it from you (or if it doesn't give you income).

A good friend retired about 10 years ago due to his RE investments (about 10 SFRs within a couple hours of Chicago, and some MFRs in Chicago).  He's at the point that he needs to sell some of the SFRs to pay medical bills.  He is listing them now, and hoping they sell within a year.  They are in low income areas, and his vacancy rates are about 30-40%.   

To me, those properties are worth zero - and if you consider the headache or stress, they are negative value.

His returns on these always looked good on paper, but a combination of population loss and business closings had a negative effect on those deals.

His MFRs in the city do very well.


hodedofome

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Your condo / house will never be worth zero. 

It's worth 0 if no one will buy it from you (or if it doesn't give you income).

A good friend retired about 10 years ago due to his RE investments (about 10 SFRs within a couple hours of Chicago, and some MFRs in Chicago).  He's at the point that he needs to sell some of the SFRs to pay medical bills.  He is listing them now, and hoping they sell within a year.  They are in low income areas, and his vacancy rates are about 30-40%.   

To me, those properties are worth zero - and if you consider the headache or stress, they are negative value.

His returns on these always looked good on paper, but a combination of population loss and business closings had a negative effect on those deals.

His MFRs in the city do very well.

This is what I've said before. To be a good landlord you can't just look at the money you can make, you have to also manage risk. Having all your properties in a city than turns out like Detroit will make you go bust one day. There's entire neighborhoods that are literally worth $0 because everyone has moved out. It's no different that investing for the long term in companies that turn out like Kodak or Circuit City. Or being a leveraged option seller with no risk management. There's plenty of guys out there that made a ton of money in good times, and lost it all once the bad times hit. To really get my respect, you have to be able to make it through the bad times. That's when we find out who was really managing their risk.

arebelspy

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Your condo / house will never be worth zero. 

It's worth 0 if no one will buy it from you (or if it doesn't give you income).

A good friend retired about 10 years ago due to his RE investments (about 10 SFRs within a couple hours of Chicago, and some MFRs in Chicago).  He's at the point that he needs to sell some of the SFRs to pay medical bills.  He is listing them now, and hoping they sell within a year.  They are in low income areas, and his vacancy rates are about 30-40%.   

To me, those properties are worth zero - and if you consider the headache or stress, they are negative value.

His returns on these always looked good on paper, but a combination of population loss and business closings had a negative effect on those deals.

His MFRs in the city do very well.

This is what I've said before. To be a good landlord you can't just look at the money you can make, you have to also manage risk. Having all your properties in a city than turns out like Detroit will make you go bust one day. There's entire neighborhoods that are literally worth $0 because everyone has moved out. It's no different that investing for the long term in companies that turn out like Kodak or Circuit City. Or being a leveraged option seller with no risk management. There's plenty of guys out there that made a ton of money in good times, and lost it all once the bad times hit. To really get my respect, you have to be able to make it through the bad times. That's when we find out who was really managing their risk.

(Emphasis added.)

Funny that you mention Kodak when they're a prime example of how you can make a LOT of money even when a company goes BK (and no, not by shorting them, by actually just owning their stock), just like you could have made a LOT of money investing in Detroit even if your properties are (today) worth close to zero.  How much rents did you get along the way?

You need a deeper analysis than "they went bk, must be bad" or "detroit.. bad?"
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RaveOregon

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ARR is a bad choice for comparison in this discussion as they don't actually own properties

Undecided

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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.

As someone with feet in both camps, I still have to ask, does it seem like a fair comparison to look at numerous studies regarding the difficulty of beating the stock market to dismiss some other posters' claimed personal experience to the contrary, but not have any studies regarding real estate investors' performance overall, relying on your own personal experience for that side of the comparison? My inclination is that you're right with respect to real estate being significantly subject to individual factors and control, but how do I know I'm not deluding myself ....

Also, of course, you've just said that your experience with this success in RE is on a very short time frame. I don't doubt that there are people who had outsize stock wins in similar timeframes.

brewer12345

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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.

As someone with feet in both camps, I still have to ask, does it seem like a fair comparison to look at numerous studies regarding the difficulty of beating the stock market to dismiss some other posters' claimed personal experience to the contrary, but not have any studies regarding real estate investors' performance overall, relying on your own personal experience for that side of the comparison? My inclination is that you're right with respect to real estate being significantly subject to individual factors and control, but how do I know I'm not deluding myself ....

Also, of course, you've just said that your experience with this success in RE is on a very short time frame. I don't doubt that there are people who had outsize stock wins in similar timeframes.

Of course it is ridiculous/disingenuous.  Compare asset class to asset class, not my experience vs. yours.

arebelspy

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Of course it is ridiculous/disingenuous.  Compare asset class to asset class, not my experience vs. yours.

Agreed.  Anecdotes are irrelevant.
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totoro

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I think the only way you can know yourself is to do the work needed to understand all the factors at play and then apply them through the use of a spreadsheet or similar modelling.   

I don't dismiss people who claim they can outperform the average on the stock market, particularly if they have a long track record.  Warren Buffett is widely regarded as the most successful investor of all time, with a compound return of around 22.3% over 36 years.   With the knowledge I have I would probably not be one of them, plus I do not use leverage to buy stocks.

I don't think it much matters in the end.  It is not about being "right" about real estate or any other investment.  It is about sharing information and deciding if you are willing to do the work to develop the level of knowledge you will need to get better than average returns on any venture, whether it be starting a business, re, stocks or anything else. 

People seem to be looking for a magic formula or the one right answer.  I haven't found one except if you want average returns and are willing to wait for the effects of compound interest.
« Last Edit: May 15, 2014, 01:26:28 PM by totoro »

arebelspy

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People seem to be looking for a magic formula or the one right answer.  I haven't found one except if you want average returns and are willing to wait for the effects of compound interest.

Well said.

Hard work and consistent learning and effort is the most reliably (i.e. non-luck based) way I've found.
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.

rusty

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I fully believe I will continue to outperform the markets for years to come.

No offense intended, but that's a danger belief.  I was an option trader on my own for about 5 years, 2 of which were a retail broker with a brokerage house and worked with clients who traded options in large accounts. 

Many option traders don't analyze risks very well.  Take iron condor positions (what I used to do).  Depending on how tight you make the position, you can make a good profit.  However, when the market moves against your position, the loss of capital vs the return (risk to your account) becomes very apparent.  I used to make $1k a month on iron condor trades.  Risking 10k to make 1k per month.  Having 1 bad trade (gap opening below/above your short position) could cost you 10 successful trades.

Just be cautious and don't confuse skill with luck.  I have seen people lose a bunch on money with option trading.  Many of these online courses or traveling seminars gloss over the risk and how you can lose money.  Good luck.

dragoncar

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I fully believe I will continue to outperform the markets for years to come.

No offense intended, but that's a danger belief.  I was an option trader on my own for about 5 years, 2 of which were a retail broker with a brokerage house and worked with clients who traded options in large accounts. 

Many option traders don't analyze risks very well.  Take iron condor positions (what I used to do).  Depending on how tight you make the position, you can make a good profit.  However, when the market moves against your position, the loss of capital vs the return (risk to your account) becomes very apparent.  I used to make $1k a month on iron condor trades.  Risking 10k to make 1k per month.  Having 1 bad trade (gap opening below/above your short position) could cost you 10 successful trades.

Just be cautious and don't confuse skill with luck.  I have seen people lose a bunch on money with option trading.  Many of these online courses or traveling seminars gloss over the risk and how you can lose money.  Good luck.

That's kinda the point though, as real estate investors here are saying they will outperform the "market" (is that reits or ???)

innerscorecard

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I think investing in real estate can best be compared to investing in micro-cap stocks - both are ways to "beat the market" by taking on more idiosyncratic investment-specific risks in more inefficient markets.

phred

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When stocks appreciate and I sell them, I have more money but no stocks

When real estate appreciates and I refinance it, I have money I don't pay taxes on, I still have the real estate, and I still have the  monthly income.  Plus, I can use the fictional ongoing depreciation to lower reported income.

foobar

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And you also have a new monthly bill:) And deprecation is great up until the time you finally sell (which can be decades out).  Tax deferral is grand but some day the bill tends to come due.  Except of course if you die before then and everything gets a stepped up cost basis.

When stocks appreciate and I sell them, I have more money but no stocks

When real estate appreciates and I refinance it, I have money I don't pay taxes on, I still have the real estate, and I still have the  monthly income.  Plus, I can use the fictional ongoing depreciation to lower reported income.

Franklin

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When real estate appreciates and I refinance it, I have money I don't pay taxes on, I still have the real estate, and I still have the  monthly income.  Plus, I can use the fictional ongoing depreciation to lower reported income.
How is that different than buying stock in a company that uses the same financial practices?  The only difference is that you own all of the stock in your company so proportionally it only stands to reason that your return (and risk) is larger.  But there is nothing unique to what you are doing just because you are in real estate. 


totoro

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May I suggest you research this yourself? 

There are plenty of posts on this thread alone that set out some of the differences.  You should also look into tax treatment and use of leverage on your initial investment and what happens long term with stocks and RE.   Some of the variables change depending on the laws of the country/state/province you live in.

Unless you do the work yourself it seems like it might be difficult for many people to feel confident about their choices.  There are lots of books and online resources.  Run the numbers after you have identified all the variables making conservative assumptions where required.

As a start, if I invest in the stock market with $30,000, I would generally invest only $30,000.  If I invest in real estate I have the $30,000 plus, say, $200,000 in at 2.9% for five years with a 25 or 30 year amortization (in Canada) and my interest is tax deductible against rental income.  If you are investing on margin are you using leverage the same way with the same access to long-term low rate financing with the same tax treatment (in all ways)?   If not, there is one big difference right there than simply reaping a return on a stock even if the company is using leverage and tax planning ect.   

You need to be able to compare the math short-term and long-term.

I believe that mastery requires many hours.  I have put that in with real estate, mostly because I find it fascinating separate and apart from any returns.  The number of "truisms" out there in the general population about RE are truly puzzling.  Things like "pay your house off as fast as you can" "you must live in a SFH" or "rentals are hell to manage".  I find it odd that some are really motivated to put a lot of time and effort into things like getting a raise, yet they don't invest the same effort in finding a home that makes sense, and yet the ROI on the time invested to find it would be far in excess of the after-tax benefit of a raise.  And the fact that society judges status on income, not net income or sustainability of income - weird - but getting off track there.

I haven't done this type of work on stocks, so I see the appeal of following a guru, but I know I would never have confidence in my decisions without understanding how all the variables interrelate and impact returns.   With stocks I would be pleased to get 7% on my initial investment because that seems possible at my level of knowledge.

If you are not willing to put in the time you will not internalize the factors at play to the point where you no longer have the questions and can invest with confidence, and no-one here can provide that to you.

phred

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And you also have a new monthly bill:) And deprecation is great up until the time you finally sell (which can be decades out).  Tax deferral is grand but some day the bill tends to come due. 
New mortgage replaces old mortgage.  Increased rents still generate positive cash flow.

1031 exchanges may mitigate certain taxes

phred

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How is that different than buying stock in a company that uses the same financial practices?  The only difference is that you own all of the stock in your company so proportionally it only stands to reason that your return (and risk) is larger.  But there is nothing unique to what you are doing just because you are in real estate.

No, I don't own all the stock in my real estate investment.  I may only own 20% even though I control 100% and get all the income that 100% generates

grantmeaname

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Debt!=equity

Cheddar Stacker

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And you also have a new monthly bill:) And deprecation is great up until the time you finally sell (which can be decades out).  Tax deferral is grand but some day the bill tends to come due. 
New mortgage replaces old mortgage.  Increased rents still generate positive cash flow.

1031 exchanges may mitigate DELAY certain taxes

Just thought I'd fix your comment slightly. I've seen them work well, but they make you "upgrade" by purchasing a more expensive property. They also reduce the new cost basis which decreases annual depreciation. Eventually you will pay tax on the depreciation recapture for both properties, unless as foobar points out you die, in which case your heirs get a stepped up basis subject to estate tax rules.

I'm with you phred - I like real estate more than stocks. I just don't think 1031 exchanges fix all the problems people think they do.

hodedofome

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I haven't done this type of work on stocks, so I see the appeal of following a guru, but I know I would never have confidence in my decisions without understanding how all the variables interrelate and impact returns.   With stocks I would be pleased to get 7% on my initial investment because that seems possible at my level of knowledge.

If you are not willing to put in the time you will not internalize the factors at play to the point where you no longer have the questions and can invest with confidence, and no-one here can provide that to you.

This is 100% true. You can't go off someone else's work and hope to make the big money. You'll have to do the hard work yourself and learn it.

One thing I didn't see mentioned about stocks is that you can buy commodity futures on stock indexes and get at least 10:1 leverage with 0% financing and a 1 tick spread and pay about $7 commission round trip. Though you're a idiot if you leverage yourself that much and your strategy is to hope and pray it works out.

On the extreme side of things, you can get about 400:1 leverage in forex.
« Last Edit: May 16, 2014, 02:41:46 PM by hodedofome »

Franklin

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May I suggest you research this yourself? 

May I suggest you research how a balance sheet works?  You're stating basic economic principals that are used in every business but you're proposing that somehow they are unique to the real estate market. Then you are comparing the cash-flow of an asset to the equity ownership of an operation (whose underlying business may be to cash-flow an asset I might add).  Why are you recognizing the equity gain you make on your asset but not recognizing the equity gain that I make on my asset?

I'll use an exaggerated example to make a point.  Let's say I bought half of the shares of a public company for $1 a share.  In the first year, that company generates $1 million.  Then it uses the same cash flow and leverage practices that you are using for real estate, except they use it to manufacture widgets.  We'll assume they are as smart as you, therefore after ten years they have grown the business to the point that it generates $2 million per year.  But the stock price at that time has only reached $1.10.  Now, are you going to judge my paper return on how much the stock price has gone up?  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. 

DoubleDown

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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?

deborah

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Hard work and consistent learning and effort is the most reliably (i.e. non-luck based) way I've found.
I am getting really confused by this thread. Can someone explain 2 things:

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?

dragoncar

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Hard work and consistent learning and effort is the most reliably (i.e. non-luck based) way I've found.
I am getting really confused by this thread. Can someone explain 2 things:

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?

MAYBE the point is that with real estate, you do all your work up front to get a great deal, and then set it/forget it (for a year at a time?).  As opposed to stock picking where you have to watch it pretty much constantly.  (assuming they both have similar returns to a skilled investor, although that is also in debate I think).

totoro

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May I suggest you research this yourself? 

May I suggest you research how a balance sheet works?  You're stating basic economic principals that are used in every business but you're proposing that somehow they are unique to the real estate market. Then you are comparing the cash-flow of an asset to the equity ownership of an operation (whose underlying business may be to cash-flow an asset I might add).  Why are you recognizing the equity gain you make on your asset but not recognizing the equity gain that I make on my asset?

I'll use an exaggerated example to make a point.  Let's say I bought half of the shares of a public company for $1 a share.  In the first year, that company generates $1 million.  Then it uses the same cash flow and leverage practices that you are using for real estate, except they use it to manufacture widgets.  We'll assume they are as smart as you, therefore after ten years they have grown the business to the point that it generates $2 million per year.  But the stock price at that time has only reached $1.10.  Now, are you going to judge my paper return on how much the stock price has gone up?  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.

Franklin,  I don't pretend to be an expert in the stock market and I do plan to spend some time looking at this, but I do know what kind of returns I am getting on invested capital in real estate.  I am also fairly confident of the long-term forecasting on the returns using conservative forecasting.

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.

This still does not mean that owning a stock in a company is like owning a rental property.  While a company may increase in value using some of the same principles used in real estate your return is not going to include the return on leverage unless you buy stocks on margin on similar (or better) terms and conditions that mortgage financing is available: that being long-term, low-rate with 0-20% down.

deborah

Rental properties are fairly easy imo if you have the right one and you have good systems.  Gaining the knowledge required to analyze a deal and be confident that it will give you good ROI is not easy imo.  There are a lot of poor performing rentals.  There is a lot of misinformation.  There are a lot of variables that you cannot 'wing' but need to understand.  If you don't, you are relying on luck and that is not giving you the best odds you can get.

You have hit on one of the key differences between real estate and stocks: the use of leverage. 

I perceive the use of leverage for stock purchases as beyond my risk tolerance - but not everyone feels the same way.  Leverage in real estate, when carefully used, is a gift.  Thank you bank for giving me your money to use to make me money!  Without this, I would be stuck with saving my salary and getting 7% (hopefully) on the stock market on my invested savings only.

arebelspy

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Hard work and consistent learning and effort is the most reliably (i.e. non-luck based) way I've found.
I am getting really confused by this thread. Can someone explain 2 things:

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?

1.  It takes more knowledge and discipline than hard work, I suppose.  There is not a lot of time involvement once you have the properties.  But it's easy to fuck up getting those properties and having it done right.  In other words, what dragoncar responded to you is fairly accurate.

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.

Did those two answers sufficiently explain the two things you were confused on?  :)
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.

deborah

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Did those two answers sufficiently explain the two things you were confused on?  :)
Thank you both for clearing this up for me. I appreciate your answers, and they have given me food for thought.

Rental properties are fairly easy imo if you have the right one and you have good systems.  Gaining the knowledge required to analyze a deal and be confident that it will give you good ROI is not easy imo.  There are a lot of poor performing rentals.  There is a lot of misinformation.  There are a lot of variables that you cannot 'wing' but need to understand.  If you don't, you are relying on luck and that is not giving you the best odds you can get.

You have hit on one of the key differences between real estate and stocks: the use of leverage. 

I perceive the use of leverage for stock purchases as beyond my risk tolerance - but not everyone feels the same way.  Leverage in real estate, when carefully used, is a gift.  Thank you bank for giving me your money to use to make me money!  Without this, I would be stuck with saving my salary and getting 7% (hopefully) on the stock market on my invested savings only.
Thanks, that would work for most people, especially if nothing like 2007-8 happens again to real estate. In my situation, I am not interested in leverage (especially in real estate), since:
  • I am FI, so I don't need to leverage.
  • Where I live, the bubble is about to burst, and real estate will decline in value for the next few years - the government has just passed a budget that makes this a sure thing (in 1996 they passed a similar budget which did the same thing to our part of the country). Other parts of the country are also experiencing problems because the mining industry bubble has burst, and we have a country wide property bubble that never burst in the 2007-8 crash
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. When I look at the numbers I became FI through stocks, without leveraging, in 5 years. I am/was diversified, and houses here are so much more expensive that my "property" component is in my own home.

Because the drop in price (and subsequent rise) is fairly safe, I guess I have an opportunity to do the work and understand real estate, and get into it in a couple of years, when prices here will be at their bottom. I think it would be safer to have a property within my city (at least at first) so that I can drive past every so often and see how it is doing.

arebelspy

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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.
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