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Learning, Sharing, and Teaching => Investor Alley => Topic started by: arebelspy on September 29, 2012, 10:03:44 PM

Title: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: arebelspy on September 29, 2012, 10:03:44 PM
http://www.biggerpockets.com/renewsblog/2012/09/29/why-real-estate-returns-are-higher-than-stocks-bonds-and-mutual-funds/

Nothing new for anyone experienced in real estate, but for newbies looking to compare returns, this article is a good place to start when trying to understand where your real estate returns come from (appreciation being only a small part).
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: Aurora on September 30, 2012, 02:41:51 AM
I agree. I've invested in property over the years and shied away from the stock market as I understand property and where you make profit. Never bank on appreciation it is a nice bonus if it happens but positive monthly cash flow is the only reason to invest in property and make real returns.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: Another Reader on September 30, 2012, 06:42:20 AM
The article is a little light on the facts - the author doesn't know if the returns on real estate stated by those she quotes include net income or not - but she does lay out the positives of real estate investing clearly.  I think Jeff Brown's response is better suited to the average long term buy and hold investor.  However, my objection to Jeff's analysis is his assumption of no increase in NOI.  Most unsophisticated readers think, well, rents are going to go up, so I'm going to do better.  In fact, in many markets, expense increases have far outweighed rent increases over the last 15 to 20 years.  Phoenix is a perfect example.  Operating expenses and the cost of capital improvements are up 75 to 100 percent since the late 90's, but rents are up less than 20 percent overall.  So your NOI and your overall return can go down as well as up.

Most people also forget liquidity risk in their analysis of real estate.  Want to sell a house or condo ay "market" value?  There had better be an employed buyer able to get financing out there.  Market going down?  You may not be able to sell at what you think is market value.  Leverage risk is present as well.  As expenses increase and rents stabilize or decrease, your leverage may drop or go negative.  The financing you thought was so great can turn into a drag on your return on equity.

Real estate can be a great investment, but it's not for the unsophisticated.  The writers on Bigger Pockets are great cheerleaders, but there is more to the story. 
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: arebelspy on September 30, 2012, 06:48:15 PM
I agree Another Reader.  NOI has to increase based on inflation.  Rents will increase, and properties will increase based on inflation.

I read Jeff's blog regularly though, and he always uses no appreciation and no NOI increases just to prove a point and be extra conservative in his estimates.  When it does happen, it makes an even better case for real estate.

I also agree about the liquidity risk and leverage risk.  I think both of these can be mitigated, however.  It's something to know about, but not something to worry about.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: Peter on October 02, 2012, 01:52:37 PM
In Canada, rent revenue is taxed as regular income, while dividend income (from Canadian companies) is given extremely favourable tax treatment.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: PaulM12345 on October 02, 2012, 02:01:06 PM
Can anyone recommend some good books that give more in depth info into real estate investment? Basically, something like this article, but with a lot more detail about everything that's involved in investing in rental property?
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: arebelspy on October 02, 2012, 02:37:38 PM
Can anyone recommend some good books that give more in depth info into real estate investment? Basically, something like this article, but with a lot more detail about everything that's involved in investing in rental property?

Yes.

https://forum.mrmoneymustache.com/real-estate-and-landlording/bookswebsites-to-learn-more-about-real-estate/
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: PaulM12345 on October 02, 2012, 02:50:16 PM
Thank you!
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: arebelspy on October 02, 2012, 04:40:23 PM
Of course.  :)

Drop a comment in that thread (or one of the threads linked to in there) if you have any questions or specific requests regarding real estate books.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: Mr Mark on October 02, 2012, 08:50:45 PM
Arebelspy,

The facts seem pretty good. Once you wade through the patronising syrup of mataphore...

Real estate should be a part of any balanced portfolio. Both via REITs and  hyper-local rental as per MMM/development [sweat equity] opportunities. Quality US real estate is so undervalued right now.

Still, too many people think:
- the house they live in is an investment [when it's an expense]
- tax deductability means a big mortgage is 'a good investment' [it isn't, unless you really are leveraging serious $, no other debt, see advice of accountant, etc]




Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: PaulM12345 on October 03, 2012, 11:34:39 AM
Following up on Mr Mark's post, and just out of curiosity, I wonder how many people who invest in real estate are renters of their own homes. That is, if owning your own home is not an investment, but renting out property is, it seems like it would be common for people own property that they rent, but not to own the house they live in.

I ask for a practical reason, which is that we've been rethinking the idea of buying a home (would have to be 3 BR) in favor of renting indefinitely, but it has occurred to me that it might be a good idea to still buy a small condo as an investment. But something feels weird about being a home owner who doesn't live in his own home...
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: arebelspy on October 03, 2012, 11:38:18 AM
Following up on Mr Mark's post, and just out of curiosity, I wonder how many people who invest in real estate are renters of their own homes. That is, if owning your own home is not an investment, but renting out property is, it seems like it would be common for people own property that they rent, but not to own the house they live in.

I ask for a practical reason, which is that we've been rethinking the idea of buying a home (would have to be 3 BR) in favor of renting indefinitely, but it has occurred to me that it might be a good idea to still buy a small condo as an investment. But something feels weird about being a home owner who doesn't live in his own home...

Absolutely makes sense. Maybe you buy a home bigger than you need, but will need someday, and rent it out in the meantime.

Maybe you have a job that requires flexibility (military, for example), so you own homes but rent yourself.

I plan on one day owning a few dozen homes, yet renting.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: joer1212 on October 17, 2012, 01:36:32 AM
....not to mention that owning real estate directly to make money is a royal pain in the neck. You're essentially earning your money, while investing in the stock market is free, unearned money.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: meadow lark on October 17, 2012, 03:43:49 PM
I want to be a landlord who owns the RV I live in (in the future) and rents the campground lot.  :-)  I guess that will make me both a renter and an owner.
Lark
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: VintageHouses.org on May 13, 2014, 09:34:34 PM
Here is another good article discussing the topic.
http://voices.yahoo.com/stocks-vs-real-estate-math-not-think-12276774.html


Hope that helps:

[MOD EDIT: Please put the link to your personal site in your signature, not the body of your post.]
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: arebelspy on May 13, 2014, 10:24:07 PM
Here is another good article discussing the topic.
http://voices.yahoo.com/stocks-vs-real-estate-math-not-think-12276774.html

That article is just arguing that leverage gives you higher returns.  Duh (if it's positive leverage).  ;)

I am a fan of real estate leverage over stock leverage (margin) though - it's not callable, if you're making your payments.

I was just working on a spreadsheet earlier though to calculate one's return with leverage, principal paydown, assuming $0 cash flow, and appreciation at the rate of inflation.  Was very interesting, and made me like RE even more as an investment, if that were possible.  :)
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: deborah on May 13, 2014, 11:36:36 PM
I'm not sure this is applicable everywhere. For instance, in Australia, rents are cheaper than owning in all bar a very few places (there was a lot of news about this last year, with about 1 or 2 suburbs per city where owning was better financially. I think that most people here count on their house increasing substantially in value rather than on rental returns. Also, I think stocks here are still giving better returns.

Part of the difference is the different taxation regimes in different countries. In Australia, your principle residence is not taxed (apart from rates, set by each council - and paying a huge amount of money in stamp duty when you buy), and rental properties are counted as income, so interest on the mortgage offsets that income, as does maintenance. When you sell a rental property any increase in value is taxed for capital gains. Many people are negatively leveraged to reduce their overall tax. As a result, houses cost more, and get less rent. As everyone outside Australia seems to think we have a housing bubble (it didn't really go down in 2007-2008), I am not sure that housing here is really a good idea.

Certainly most people writing about finance here say that stock has outperformed real estate for a long time, and is (of course) more liquid.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: grantmeaname on May 14, 2014, 02:08:16 AM
Certainly. Even among US cities there are vast differences in the profitability of real estate investment. It generally makes a lot more sense in the Midwest than the big cities, for example.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: hodedofome on May 14, 2014, 09:01:57 AM
To me this is article is apples vs oranges. We're comparing personally owning rental properties vs investing in an index fund or mutual fund. A better comparison would be personally actively managing stock investments vs owning rental properties, or comparing a REIT index fund vs a stock market index fund.

Of course a real estate expert is going to make more money in real estate vs stocks. With anything, you'll make more money investing in what you know, and what you're passionate about.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: arebelspy on May 14, 2014, 09:06:00 AM
To me this is article is apples vs oranges. We're comparing personally owning rental properties vs investing in an index fund or mutual fund. A better comparison would be personally actively managing stock investments vs owning rental properties, or comparing a REIT index fund vs a stock market index fund.

Of course a real estate expert is going to make more money in real estate vs stocks. With anything, you'll make more money investing in what you know, and what you're passionate about.

(Emphasis added.)

Oh, well dynamite, it'll come out even more in favor of real estate then.  We were trying to make it a fair fight.

;)
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: hodedofome on May 14, 2014, 09:13:58 AM
We've all known people who went to a real estate seminar and thought they were gonna be rich, and lost all their money trying to do what the speaker promised. The stock market is no different. Any investment has risk and only good risk managers make it in the long term. It took me 2 years of continuous study, thousands of hours of practice and about 40 books before I became a profitable trader. I have no doubt I can do 30%+/yr on average in the stock market. I can sell and move to cash any day that the market is open, and I pay only 1.6% for leverage. No, not everyone can do this, but neither can everyone make a lot of money in real estate. I'd lose my butt if I just jumped into real estate. The only people making better returns in rental properties, than an avg index fund, are the ones who are truly committed to it.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: arebelspy on May 14, 2014, 09:20:12 AM
I mean, I have a response, but it seems pointless:
I have no doubt I can do 30%+/yr on average in the stock market.

To each his own.  Best of luck to you.  :)

Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: hodedofome on May 14, 2014, 09:37:02 AM
There is not a 'best asset class' to invest in for optimal returns. There is what you are passionate about, and what you are willing to put in the deliberate practice to get really good at. That is what you will make the most money in the long term. Whether that's starting a business, the stock market, real estate, professional athlete, whatever. My only point is that this article misses the point.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: arebelspy on May 14, 2014, 09:51:27 AM
There is not a 'best asset class' to invest in

I would disagree and say that there is, and which one it is depends on your criteria for "best."

There is what you are passionate about, and what you are willing to put in the deliberate practice to get really good at.

Someone passionate about naps, perhaps, or playing with Legos?

There is a difference between what you care about and practice and love, and what qualifies as an "asset class," as well as what will give you optimal returns.

Even within actual investment classes, you may be passionate about something, but that won't give you the highest return.

I don't care if you love Gold or other precious metals, it's very very likely not the optimal investment class for an early retiree.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: catccc on May 14, 2014, 09:53:18 AM
....not to mention that owning real estate directly to make money is a royal pain in the neck. You're essentially earning your money, while investing in the stock market is free, unearned money.

This. 

I have thought a lot about owning RE for rental income, and it basically comes down to the input required in terms of property management, finding suitable tenants, etc.  Yes, you could contract that out.  But I guess I feel that someone saying "RE is better than stocks" is like saying "xyz-profitable-business is better than stocks."  With all businesses and investments, there is a range of passive activity, and everyone should evaluate where on the spectrum they are most comfortable.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: Jack on May 14, 2014, 10:02:06 AM
To me this is article is apples vs oranges. We're comparing personally owning rental properties vs investing in an index fund or mutual fund. A better comparison would be personally actively managing stock investments vs owning rental properties, or comparing a REIT index fund vs a stock market index fund.

Of course a real estate expert is going to make more money in real estate vs stocks. With anything, you'll make more money investing in what you know, and what you're passionate about.

(Emphasis added.)

Oh, well dynamite, it'll come out even more in favor of real estate then.  We were trying to make it a fair fight.

;)

I think a better comparison would be REIT vs. stock index fund, or owning and running a small business vs. owning rental properties.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: hodedofome on May 14, 2014, 10:08:04 AM
There is not a 'best asset class' to invest in

I would disagree and say that there is, and which one it is depends on your criteria for "best."

There is what you are passionate about, and what you are willing to put in the deliberate practice to get really good at.

Someone passionate about naps, perhaps, or playing with Legos?

There is a difference between what you care about and practice and love, and what qualifies as an "asset class," as well as what will give you optimal returns.

Even within actual investment classes, you may be passionate about something, but that won't give you the highest return.

I don't care if you love Gold or other precious metals, it's very very likely not the optimal investment class for an early retiree.

Obviously, if your intention is to make money, part of the learning process is to decide if you can make money from your passion. And we're talking about active management here. Not avg returns from index funds. A good bond trader can trounce any REIT or stock index, even though bonds as an asset class may return less than both over time. If you are passionate about running a business, and are willing to put in the work, then you'll make far more money doing that than anything else. If you are passionate about gold, then start a gold exchange business. :)
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: arebelspy on May 14, 2014, 10:18:45 AM
....not to mention that owning real estate directly to make money is a royal pain in the neck. You're essentially earning your money, while investing in the stock market is free, unearned money.

This. 

I have thought a lot about owning RE for rental income, and it basically comes down to the input required in terms of property management, finding suitable tenants, etc.  Yes, you could contract that out.  But I guess I feel that someone saying "RE is better than stocks" is like saying "xyz-profitable-business is better than stocks."  With all businesses and investments, there is a range of passive activity, and everyone should evaluate where on the spectrum they are most comfortable.

I think a better comparison would be REIT vs. stock index fund, or owning and running a small business vs. owning rental properties.

Both of you make good points, it is a spectrum, however I would say real estate is much closer to passive than active.

Running a business is a lot of work.  Real estate isn't necessarily a lot of work - I outsource all of that.  It does require a lot of knowledge, but once that's built up, it can be very passive.

It's running a business that takes a few hours per year and pays thousands of dollars per hour since it takes so little time.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: Jack on May 14, 2014, 10:21:37 AM
And we're talking about active management here. Not avg returns from index funds. A good bond trader can trounce any REIT or stock index...

Do you mean over the long term?

If so, then as they say on Wikipedia, [citation needed].
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: Cheddar Stacker on May 14, 2014, 10:22:29 AM
arebelspy - thanks for the initial post.

Vintagehouses - thanks for bumping this thread.

I've read a few hundred references to biggerpockets here, but always thought I'll do it later. This thread got me to join the community over there, and download their free e-book. My official real estate education begins today.

I want to be a landlord who owns the RV I live in (in the future) and rents the campground lot.  :-)  I guess that will make me both a renter and an owner.
Lark

+1
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: Franklin on May 14, 2014, 10:29:06 AM
Contrarian View:

I tend to view my stock investments as partial ownership in the company, especially since I have a long term strategy.  So let's just refer to them as "My Company".  Well, "my company" leverages the same principles the author uses for managing real estate.  We have cash flow from income, we buy money by manufacturing raw materials into a product with substantially higher value, we have tax-advantaged financing, tons of write-offs and depreciation.  As part owner, I have a top notch management team that knows the market and how to handle money.  I'm rewarded with periodic payments in the form of dividends, but more importantly, my company keeps growing and my thin slice of the pie keeps growing.  At some point, someone will make me an offer for that slice that I just can't refuse.  My only risk is my initial investment.  What's not to love about that?
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: hodedofome on May 14, 2014, 10:31:01 AM
And we're talking about active management here. Not avg returns from index funds. A good bond trader can trounce any REIT or stock index...

Do you mean over the long term?

If so, then as they say on Wikipedia, [citation needed].

David Tepper is mostly a bond guy. I think his fund has done around 30%/yr since the early '90s with billions under management. What do you think he could do with a few million? There's a lot of opportunity in the junk bond space.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: brewer12345 on May 14, 2014, 10:39:57 AM
What a goofy bunch of horse crap.  They should have used the space to lay out where real estate sources of potential return come from and how these differ from other investments.  Instead we get the usual rah-rah garbage that shows up among fans of all types of investments, but seems especially prevalent in gold and real estate.

Could real estate outperform other asset classes? Sure.  Could it underperform?  Sure.  More importantly from what I have seen is which real estate type in what local market vs. what alternative?  I can promise you that the house I sold when I relocated 3 years ago has dramatically underperformed the house I bought despite the fact that they were about the same deal price and they were the same type of house (SFR in suburbia).
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: FrenchyMustache on May 14, 2014, 10:43:44 AM
My main issue with rental houses is more arround time and the entry level without leveraging money. (Not counting french tax on property x_x)
Whats your opinion on REITS arabelspy  thought ?
But thanks anyway for the link, will keep lurking here aswell, sorry for the digression.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: totoro on May 14, 2014, 10:47:40 AM
We own two businesses and eight rental units.

Running a business is a significant amount of work and responsibility, particularly if you manage employees.  And you have lots of other responsibilities depending on the type of business such as :PST, GST, licensing, professional fees, billing, inventory, customer service, client retention, actually producing the work product, complicated bookkeeping, and separate income tax reporting.

Managing rentals is not like owning and running a regular business.  It takes maybe two hours a month on average.  Limited book-keeping because there are limited transactions.  You report on your income tax after calculating deductions.  The real work with rentals is finding the right one and getting it to good condition from the get go.

There is no way I could obtain better returns on my invested dollars in the stock market than I can with real estate using the same amount of cash.   I wouldn't use leverage on the stock market because I don't understand it well enough and there are risks I cannot mitigate like I can with real estate.

In Canada I do not have access to really great ROI properties.  The US is a much better market for this.  That said, we will still exceed 6% on our money per year by a significant margin.   The annual equity pay down alone is about a 20% return on the original investment in most cases.  I don't even count this until point of sale.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: Cheddar Stacker on May 14, 2014, 10:49:10 AM
Contrarian View:

I tend to view my stock investments as partial ownership in the company, especially since I have a long term strategy.  So let's just refer to them as "My Company".  Well, "my company" leverages the same principles the author uses for managing real estate.  We have cash flow from income, we buy money by manufacturing raw materials into a product with substantially higher value, we have tax-advantaged financing, tons of write-offs and depreciation.  As part owner, I have a top notch management team that knows the market and how to handle money.  I'm rewarded with periodic payments in the form of dividends, but more importantly, my company keeps growing and my thin slice of the pie keeps growing.  At some point, someone will make me an offer for that slice that I just can't refuse.  My only risk is my initial investment.  What's not to love about that?

Emphasis added.

I see your points, and real estate investing is clearly not for everyone, so I'm not really trying to convince you here, just some counter points that could be happening within your company:

- You have no control over the operations of your company. Your CEO earns millions of dollars while he sweeps some minor fraud under the rug. You don't get to use that corporate jet your management team just purchased. Are you aware your COO has a cocaine habit and repeatedly abuses your employees?

I'm invested in real estate and the stock market, and I plan to continually invest in both. I see the benefits of both, and the downside to both. I think the biggest downside to investing in stocks is the complete lack of control over the operations of your company. I'm not a control freak in any way, but it just makes me a bit uncomfortable knowing the company could all fold in like a house of cards due to poor management.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: arebelspy on May 14, 2014, 10:52:19 AM
We own two businesses and eight rental units.

Running a business is a significant amount of work and responsibility, particularly if you manage employees.  And you have lots of other responsibilities depending on the type of business such as :PST, GST, licensing, professional fees, billing, inventory, customer service, client retention, actually producing the work product, complicated bookkeeping, and separate income tax reporting.

Managing rentals is not like owning and running a regular business.  It takes maybe two hours a month on average.  Limited book-keeping because there are limited transactions.  You report on your income tax after calculating deductions.  The real work with rentals is finding the right one and getting it to good condition from the get go.

There is no way I could obtain better returns on my invested dollars in the stock market than I can with real estate using the same amount of cash.   I wouldn't use leverage on the stock market because I don't understand it well enough and there are risks I cannot mitigate like I can with real estate.

In Canada I do not have access to really great ROI properties.  The US is a much better market for this.  That said, we will still exceed 6% on our money per year by a significant margin.   The annual equity pay down alone is about a 20% return on the original investment in most cases.  I don't even count this until point of sale.

(Emphasis added.)

Completely agree.  Rentals should be structured and systematized like a business, but takes WAY less work and time than pretty much any other business.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: Franklin on May 14, 2014, 11:47:03 AM
Quote
You have no control over the operations of your company. Your CEO earns millions of dollars while he sweeps some minor fraud under the rug. You don't get to use that corporate jet your management team just purchased. Are you aware your COO has a cocaine habit and repeatedly abuses your employees?


But I think I have a lot of control.  I have the SEC, SOX, governance, and so on.  I know how to read a balance sheet and a QR.  I know exactly what my officers are getting paid and I indirectly control their pay and employment status through my BODs.  I think the mistake people make is lumping my company in with Wall Street.  I love owning my company but I hate Wall Street.  To generalize all of them together is to miss out on a great investment opportunity.    I understand the risks you stated about my CEO and COO, but they are less risky than your tenants and lenders because they are forced to be transparent.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: totoro on May 14, 2014, 12:47:01 PM
Quote
You have no control over the operations of your company. Your CEO earns millions of dollars while he sweeps some minor fraud under the rug. You don't get to use that corporate jet your management team just purchased. Are you aware your COO has a cocaine habit and repeatedly abuses your employees?


But I think I have a lot of control.  I have the SEC, SOX, governance, and so on.  I know how to read a balance sheet and a QR.  I know exactly what my officers are getting paid and I indirectly control their pay and employment status through my BODs.  I think the mistake people make is lumping my company in with Wall Street.  I love owning my company but I hate Wall Street.  To generalize all of them together is to miss out on a great investment opportunity.    I understand the risks you stated about my CEO and COO, but they are less risky than your tenants and lenders because they are forced to be transparent.

I think if you have deep knowledge of any income producing "thing" you can find the sweet spot.  If you are sure that a company is well-run and in a good profitable market you can control a lot of the risk.  That takes a significant amount of due diligence and fraud is always a possibility, as are black swan events. 

I do agree that if you have that degree of knowledge you can likely adequately mitigate risk.  I think this is a strategy that Warren Buffet follows? 

However, unless you are buying on margin/credit and using leverage to the same degree and the same lending rate as you would when you buy a house, you will most likely not make the same return on your initial investment.  I would not be comfortable with leveraging stocks myself. 

I definitely don't have the same deep knowledge as you do about stocks, but I do understand real estate in my local market.  I know every street and what the market value of a home is, whether the house can be suited, and any neighbourhood pros and cons including non-obvious ones like seasonal flooding or subsurface earthquake vulnerability. 

I also know my credit, mortgage rates, expected rents, taxation issues, how to evaluate replacement costs and timeframes for housing components, and vacancy rates.  I can calculate expected ROI in my head now and be fairly accurate. 

Mostly the numbers do not work where I live, but once in a while there is something that does.  In the past five years I've found three and purchased two of them.  I bought a third prior at a time when I had less knowledge and it does not perform as well.

I don't treat my primary residence any differently.  It needs to be cash flow positive too.  Your credit is limited and failing to make this significant source of leverage work for you seems like wasting an opportunity to me - at least prior to retiring anyway.

As far as lenders being risky, I don't see it.  As far as tenants being risky, that is what screening and written agreements are for.  You cannot control for everything, but you can control for most things.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: kyleaaa on May 14, 2014, 01:07:52 PM
The author of the article doesn't really understand how stocks work. Businesses get all the sources of returns that real estate investors get; how could they not? Investing in real estate is just another business. The only difference is that they go on the business's balance sheet instead of the investor's. But so what? Six of one, half dozen of the other.

Is the author attempting to say stock investors don't benefit from write-offs and depreciation? Ridiculous.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: Franklin on May 14, 2014, 01:37:11 PM
Agreed Totoro, and your knowledge of real estate is just as extensive as my knowledge of good stock investing:)  I think perceived risk is minimized by good knowledge.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: Cheddar Stacker on May 14, 2014, 01:42:28 PM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: kyleaaa on May 14, 2014, 01:53:05 PM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: totoro on May 14, 2014, 01:56:36 PM
The author of the article doesn't really understand how stocks work. Businesses get all the sources of returns that real estate investors get; how could they not? Investing in real estate is just another business. The only difference is that they go on the business's balance sheet instead of the investor's. But so what? Six of one, half dozen of the other.

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

Stock investors may benefit from these things but only to a tune of an average of a 6% or 7% return on cash invested.  Plus, it is possible you will pay tax on some of these profits. In Canada, borrowing to invest in stocks means a personal loan at a higher rate of interest and it is not very common.  I perceive it as quite risky.

Rental property ROI can be much higher on a well-located cash flow positive rental property that is in good shape when you account for the following:

1. equity pay down
2. appreciation on entire asset (equity plus mortgages amount) averaged at 3% per year
3. cash-flow

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. 

On average this is repeated each year, although the appreciation compounds and the equity pay down increases - unless you refinance to take some of the accumulated equity out to invest elsewhere.  Cash flow might increase with rent increases as well. 

Of course, if I sell I have to sell at a time which reflects a price that has risen 3% per year.  This is a risk, along with other things like interest rates and major repairs and vacancies.  In addition, I have to deduct transaction costs of approx. $18,000 unless I sell without a realtor plus any taxes on capital gains on a sale at the increased price less purchase price.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: Franklin on May 14, 2014, 01:58:35 PM
But when you buy a stock you are effectively buying the depreciation, tax advantages, and every other benefit baked in.  There really is no difference.   You bought an operating company, not a certificate.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: kyleaaa on May 14, 2014, 02:08:45 PM
Stock investors may benefit from these things but only to a tune of an average of a 6% or 7% return on cash invested. 

This certainly hasn't been true in the past. Why do you think it will be true in the future? Nobody really knows.

In Canada, borrowing to invest in stocks means a personal loan at a higher rate of interest and it is not very common.  I perceive it as quite risky.

Stock investors who want to use leverage actually rarely use margin loans. It's no more or less risky than borrowing for real estate. In fact, stock leverage tends to be cheaper than real estate leverage because it's more liquid (exactly as conventional economic theory predicts).

Rental property ROI can be much higher on a well-located cash flow positive rental property that is in good shape when you account for the following:

False. All long-term studies have shown returns are quite comparable on average. Of COURSE some people do better in real estate than in stocks. But a lot of people do better in stocks than in real estate, too. On average, they have roughly equal returns with roughly equal risk.

1. equity pay down

Equity pay down is not a source of return. It's just an additional period investment (exactly equivalent to investing in a 401k with every paycheck).

2. appreciation on entire asset (equity plus mortgages amount) averaged at 3% per year
3. cash-flow

Already accounted for in the studies above.

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.

On average this is repeated each year, although the appreciation compounds and the equity pay down increases - unless you refinance to take some of the accumulated equity out to invest elsewhere.  Cash flow might increase with rent increases as well. 

Same for stocks...

In addition, I have to deduct transaction costs of approx. $18,000 unless I sell without a realtor

This is an area where stocks have a MAJOR advantage over real estate.

TL;DR to believe there's some sort of magic free lunch with real estate is absurd. It is no better or worse than stocks, just different (but only very, very slightly).
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: totoro on May 14, 2014, 02:09:05 PM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: kyleaaa on May 14, 2014, 02:12:38 PM
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.

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?
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: totoro on May 14, 2014, 02:22:18 PM
Stock investors may benefit from these things but only to a tune of an average of a 6% or 7% return on cash invested. 

This certainly hasn't been true in the past. Why do you think it will be true in the future? Nobody really knows.

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

In Canada, borrowing to invest in stocks means a personal loan at a higher rate of interest and it is not very common.  I perceive it as quite risky.


Stock investors who want to use leverage actually rarely use margin loans. It's no more or less risky than borrowing for real estate. In fact, stock leverage tends to be cheaper than real estate leverage because it's more liquid (exactly as conventional economic theory predicts).

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.

Rental property ROI can be much higher on a well-located cash flow positive rental property that is in good shape when you account for the following:


False. All long-term studies have shown returns are quite comparable on average. Of COURSE some people do better in real estate than in stocks. But a lot of people do better in stocks than in real estate, too. On average, they have roughly equal returns with roughly equal risk.

1. equity pay down


Equity pay down is not a source of return. It's just an additional period investment (exactly equivalent to investing in a 401k with every paycheck).

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.

2. appreciation on entire asset (equity plus mortgages amount) averaged at 3% per year
3. cash-flow


Already accounted for in the studies above.

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

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.
 
On average this is repeated each year, although the appreciation compounds and the equity pay down increases - unless you refinance to take some of the accumulated equity out to invest elsewhere.  Cash flow might increase with rent increases as well. 


Same for stocks...

Yes, stock gains compound if you reinvest.  I have no idea where the equity pay down on stocks is?  Or the rent increases. 

In addition, I have to deduct transaction costs of approx. $18,000 unless I sell without a realtor


This is an area where stocks have a MAJOR advantage over real estate.

TL;DR to believe there's some sort of magic free lunch with real estate is absurd. It is no better or worse than stocks, just different (but only very, very slightly).

I agree that stocks are much more liquid and have lower transaction costs.

Do you actually own any rental properties?
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: totoro on May 14, 2014, 02:30:43 PM
My apologies for the quote failure.  Don't have time to fix it.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: arebelspy on May 14, 2014, 02:41:32 PM
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).
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: hodedofome on May 14, 2014, 02:55:03 PM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: Franklin on May 14, 2014, 03:01:20 PM
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
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: arebelspy on May 14, 2014, 03:06:08 PM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: kyleaaa on May 14, 2014, 03:06:25 PM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: kyleaaa on May 14, 2014, 03:13:14 PM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: Another Reader on May 14, 2014, 03:41:32 PM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: arebelspy on May 14, 2014, 03:42:59 PM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: hodedofome on May 14, 2014, 03:44:06 PM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: dragoncar on May 14, 2014, 04:11:30 PM
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. 
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: arebelspy on May 14, 2014, 04:24:30 PM
We'll just have to agree to disagree.

Indeed.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: Hugh H on May 14, 2014, 06:10:34 PM
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.



Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: totoro on May 14, 2014, 07:27:21 PM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: arebelspy on May 14, 2014, 08:29:27 PM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: Hugh H on May 14, 2014, 08:38:34 PM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: Another Reader on May 14, 2014, 08:48:34 PM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: foobar on May 14, 2014, 08:50:21 PM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: bobmarley9993 on May 14, 2014, 08:52:38 PM
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?
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: Hugh H on May 14, 2014, 09:05:40 PM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: Daleth on May 14, 2014, 09:08:14 PM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: bobmarley9993 on May 14, 2014, 09:19:48 PM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: Johnny Aloha on May 15, 2014, 05:47:11 AM
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.

Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: hodedofome on May 15, 2014, 08:03:43 AM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: arebelspy on May 15, 2014, 08:07:09 AM
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 (http://www.joshuakennon.com/eastman-kodak-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?"
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: RaveOregon on May 15, 2014, 08:56:52 AM
ARR is a bad choice for comparison in this discussion as they don't actually own properties
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: Undecided on May 15, 2014, 12:06:26 PM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: brewer12345 on May 15, 2014, 12:28:29 PM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: arebelspy on May 15, 2014, 12:48:58 PM
Of course it is ridiculous/disingenuous.  Compare asset class to asset class, not my experience vs. yours.

Agreed.  Anecdotes are irrelevant.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: totoro on May 15, 2014, 01:19:20 PM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: arebelspy on May 15, 2014, 01:24:48 PM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: rusty on May 15, 2014, 05:17:04 PM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: dragoncar on May 15, 2014, 06:56:33 PM
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 ???)
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: innerscorecard on May 15, 2014, 08:03:32 PM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: phred on May 15, 2014, 09:19:44 PM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: foobar on May 16, 2014, 09:11:00 AM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: Franklin on May 16, 2014, 11:03:16 AM
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. 

Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: totoro on May 16, 2014, 12:17:38 PM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: phred on May 16, 2014, 12:23:59 PM
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
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: phred on May 16, 2014, 12:33:07 PM
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
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: grantmeaname on May 16, 2014, 12:40:34 PM
Debt!=equity
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: Cheddar Stacker on May 16, 2014, 01:12:48 PM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: hodedofome on May 16, 2014, 01:23:29 PM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: Franklin on May 16, 2014, 02:17:58 PM
Quote
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. 
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: DoubleDown on May 16, 2014, 02:36:53 PM
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?
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: deborah on May 16, 2014, 03:30:59 PM
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?
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: dragoncar on May 16, 2014, 04:25:24 PM
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).
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: totoro on May 16, 2014, 04:26:45 PM
Quote
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: arebelspy on May 16, 2014, 05:37:44 PM
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?  :)
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: deborah on May 16, 2014, 06:16:32 PM
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:
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: arebelspy on May 16, 2014, 06:22:03 PM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: dragoncar on May 16, 2014, 06:29:47 PM
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?
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: deborah on May 16, 2014, 07:20:56 PM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: arebelspy on May 16, 2014, 08:12:22 PM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: phred on May 16, 2014, 08:39:22 PM
  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
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: SDREMNGR on May 16, 2014, 08:52:06 PM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: phred on May 16, 2014, 08:58:53 PM

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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: dragoncar on May 16, 2014, 10:22:18 PM
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.

Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: Franklin on May 17, 2014, 08:18:47 AM
Quote
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".
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: Franklin on May 17, 2014, 08:33:12 AM
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. 
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: totoro on May 17, 2014, 09:03:02 AM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: Franklin on May 17, 2014, 09:31:03 AM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: totoro on May 17, 2014, 10:52:04 AM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: Franklin on May 17, 2014, 12:39:32 PM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: mooreprop on May 17, 2014, 03:12:03 PM
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!
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: arebelspy on May 17, 2014, 04:44:36 PM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: SDREMNGR on May 17, 2014, 07:10:59 PM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: grantmeaname on May 18, 2014, 01:28:09 AM
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 (http://en.wikipedia.org/wiki/Compound_annual_growth_rate) 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.)
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: Franklin on May 19, 2014, 10:30:34 AM
Quote
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: totoro on May 19, 2014, 10:59:00 AM
Quote
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.
 
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: brewer12345 on May 19, 2014, 03:20:41 PM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: Mississippi Mudstache on May 19, 2014, 03:59:11 PM
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?
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: arebelspy on May 19, 2014, 08:05:30 PM
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.  :)
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: Mississippi Mudstache on May 19, 2014, 09:20:33 PM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: dragoncar on May 19, 2014, 10:09:17 PM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: arebelspy on May 19, 2014, 11:17:57 PM
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/
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: AMustachianMurse on May 26, 2014, 03:06:48 AM
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? 
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: arebelspy on May 26, 2014, 08:31:29 AM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: Mississippi Mudstache on May 26, 2014, 09:02:47 AM
What % of your holdings are in counties other than the one you live in?

Looks like you may have mis-read the question, arebelspy.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: kyleaaa on May 26, 2014, 09:55:04 AM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: kyleaaa on May 26, 2014, 09:58:32 AM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: AMustachianMurse on May 26, 2014, 10:50:02 AM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: totoro on May 26, 2014, 11:21:16 AM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: arebelspy on May 26, 2014, 12:34:07 PM
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).
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: arebelspy on May 26, 2014, 12:42:01 PM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: kyleaaa on May 26, 2014, 01:35:44 PM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: arebelspy on May 26, 2014, 01:37:25 PM
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?
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: kyleaaa on May 26, 2014, 01:41:54 PM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: kyleaaa on May 26, 2014, 01:46:52 PM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: Another Reader on May 26, 2014, 02:11:02 PM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: arebelspy on May 26, 2014, 02:35:03 PM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: totoro on May 26, 2014, 03:01:14 PM
[
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?
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: Mr Mark on May 26, 2014, 04:32:17 PM
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.

Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: clifp on May 26, 2014, 05:11:23 PM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: SDREMNGR on May 26, 2014, 05:23:45 PM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: totoro on May 26, 2014, 06:03:52 PM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: Mr Mark on May 26, 2014, 06:23:41 PM
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... )

Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: lano on May 26, 2014, 09:39:24 PM
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. 








 
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: totoro on May 26, 2014, 09:51:46 PM
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.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: butchmonkey on May 26, 2014, 09:57:50 PM
Amazing how well buffet did investing in an inferior product, (stocks.)


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Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: lano on May 26, 2014, 10:14:19 PM
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...
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: totoro on May 26, 2014, 10:24:15 PM
I forgot that was the original topic.  I expect we have arebelspy... 

Yes, Warren Buffet has done well.  His results are not easily repeatable.   

I'm not sure stocks are inferior.  They are less easily managed to optimal result by a mere mortal than real estate imo.

Your borrowing room is a natural cap on your ability to invest in RE.  Your good credit is an asset worth protecting.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: lano on May 26, 2014, 10:36:00 PM
I mean, what are the capital limits at which it becomes impossible to generate good profits in RE.

Mr. Buffet is still not paying out dividends while his company invests tens of billions of dollars.  Which means that he is still able to find good investment opportunities with those kind of money sums.

I assume that the real estate "investment" market is the total RE value of US minus all non investment properties.  Is that market enough for tens of billions of investment?  What are some of the biggest RE deals that occurred? 

Can Mr. Buffet sell his BRK stake tomorrow and start trading top city skyscrapers? 

What is the highest net worth of a person who only invest in RE? 

Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: clifp on May 26, 2014, 10:37:15 PM
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.

Naw that isn't right either..

Doing some Googling.  The formula is very simple. ROE  it is cash flow after taxes/initial cash investment.

In the example income is $24,000 expense are $13,730 = $10,270 before taxes benefits.
ROE = 10,720/25000 (down) = 41.1% which will change every years based on rent, and expenses but not principal repayment.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: SDREMNGR on May 26, 2014, 11:21:05 PM
Nope.   RoE definitely does change with paydown as well as changes in valuation.  That is your equity.  Your formula is just for calculating it on the 1st year. 

Think about it.  Your equity is your down payment less fees in the 1st year.  But your equity changes with both changes in your property's value and how much you have paid down the loan.  If you paid off the loan in year 2, your equity is now 100% and your ROE and ROI is the same. 
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: clifp on May 27, 2014, 01:01:16 AM
Geez all this indexer on the forum and nobody has posted the "correct" answer.. :-)

Over the long term, On risk adjusted basis the return of real estate and stocks are the same.

Capital flows to asset classes that offer the best risk adjusted returns.

But risk matter a ton in this discussion.  The beta of real estate is historically much lower than stocks.
If you look at the Case Shiller chart from 1987 to 2005 there is hardly any volatility just a nice steady increase
http://us.spindices.com/indices/real-estate/sp-case-shiller-us-national-home-price-index (http://us.spindices.com/indices/real-estate/sp-case-shiller-us-national-home-price-index).
If CS went back further we'd see more of the same I bet with a few 10-30% dips in some markets.

Now weird stuff happened between 2005 until about 2012.  The volatility of housing jump dramatically this in turn increased the perceived risk.
The higher risk meant higher returns.  This made stock guys like myself, Warren Buffett, and hedge fund managers take a look real estate, some of us for the first time. We took our money from stocks and started buying real estate.  Now that prices have risen real estate just doesn't look as attractive as it did back in 2011 and 2012. So I'll probably start shifting some back, and you no longer hear of hedge funds raising billions to invest in real estates.

The cash buyer of real estate is going to earn significantly lower returns than the cash buyer of stocks.  As you would expect, other than the once in lifetime events of the last few years,  real estate appreciates at the roughly the rate of inflation plus population growth. The cash buyer of real estate could have comfortably slept through the last crisis, perhaps had to lower rents modestly once or twice.   The road was a lot rockier for stock buyer since income is typical a much smaller component of returns than price appreciation and dividend cuts were pretty dramatic.
It is hard to ask risk though.   The real estate market is lot less efficient than the stock market so it is easier to find bargains.  You have to look at small cap stocks, and exotic debt instruments to be able find the same bargains a good RE can find.

However the typical real estate buyer employees leverage and the typical stock buyer doesn't.  Using leverage makes a ton of sense in real estate, and not a lot in equity investing except for in extraordinary circumstances.  My guess is that an real estate investor who puts 20 to 25% down on his property probably gets a higher ROE than stock investor. On the other hand somebody who had million dollars invested in RE in 2005-2007 and  borrowed 4 or 5 million more to buy 10 properties in say 2 or 3 market is probably broke right...  Where as the equity investor is worht more than $1 million.  Now will we see more risk in Real Estate going forward, I somewhat doubt it. 
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: Mr Mark on May 27, 2014, 06:23:22 AM
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.

well spotted. The roe equation should be
= 24000 - 6000 - 1250 - 4920  / (25000 + 1560)
= 44.5%

As noted, principal payment increases equity over time, reducing roe as net leverage decreases.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: totoro on May 27, 2014, 09:47:18 AM
I mean, what are the capital limits at which it becomes impossible to generate good profits in RE.

Mr. Buffet is still not paying out dividends while his company invests tens of billions of dollars.  Which means that he is still able to find good investment opportunities with those kind of money sums.

I assume that the real estate "investment" market is the total RE value of US minus all non investment properties.  Is that market enough for tens of billions of investment?  What are some of the biggest RE deals that occurred? 

Can Mr. Buffet sell his BRK stake tomorrow and start trading top city skyscrapers? 

What is the highest net worth of a person who only invest in RE?

What is your point?  Extrapolating a theory or making money?  I'm not too interested in the first without practical application so I'll leave it to others if they wish to respond.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: totoro on May 27, 2014, 10:00:20 AM
Geez all this indexer on the forum and nobody has posted the "correct" answer.. :-)

Over the long term, On risk adjusted basis the return of real estate and stocks are the same.

Capital flows to asset classes that offer the best risk adjusted returns.

But risk matter a ton in this discussion.  The beta of real estate is historically much lower than stocks.
If you look at the Case Shiller chart from 1987 to 2005 there is hardly any volatility just a nice steady increase
http://us.spindices.com/indices/real-estate/sp-case-shiller-us-national-home-price-index (http://us.spindices.com/indices/real-estate/sp-case-shiller-us-national-home-price-index).
If CS went back further we'd see more of the same I bet with a few 10-30% dips in some markets.

Now weird stuff happened between 2005 until about 2012.  The volatility of housing jump dramatically this in turn increased the perceived risk.
The higher risk meant higher returns.  This made stock guys like myself, Warren Buffett, and hedge fund managers take a look real estate, some of us for the first time. We took our money from stocks and started buying real estate.  Now that prices have risen real estate just doesn't look as attractive as it did back in 2011 and 2012. So I'll probably start shifting some back, and you no longer hear of hedge funds raising billions to invest in real estates.

The cash buyer of real estate is going to earn significantly lower returns than the cash buyer of stocks.  As you would expect, other than the once in lifetime events of the last few years,  real estate appreciates at the roughly the rate of inflation plus population growth. The cash buyer of real estate could have comfortably slept through the last crisis, perhaps had to lower rents modestly once or twice.   The road was a lot rockier for stock buyer since income is typical a much smaller component of returns than price appreciation and dividend cuts were pretty dramatic.
It is hard to ask risk though.   The real estate market is lot less efficient than the stock market so it is easier to find bargains.  You have to look at small cap stocks, and exotic debt instruments to be able find the same bargains a good RE can find.

However the typical real estate buyer employees leverage and the typical stock buyer doesn't.  Using leverage makes a ton of sense in real estate, and not a lot in equity investing except for in extraordinary circumstances.  My guess is that an real estate investor who puts 20 to 25% down on his property probably gets a higher ROE than stock investor. On the other hand somebody who had million dollars invested in RE in 2005-2007 and  borrowed 4 or 5 million more to buy 10 properties in say 2 or 3 market is probably broke right...  Where as the equity investor is worht more than $1 million.  Now will we see more risk in Real Estate going forward, I somewhat doubt it.

You have hit on some of the differences and made a lot of good points, but I do not believe your statement that:

"Over the long term, On risk adjusted basis the return of real estate and stocks are the same."

is actually correct for rental property in good condition in a good area that is cash flow positive.

Appreciation, including on the leveraged amount, is not the only factor here.  Rental income needs to be accounted for as well in your comparison.

I think the best way to predict returns is to use a RE analyzer-type spreadsheet that accounts for all variables, (preferably including some of the hidden ones like lost opportunity costs on invested capital and your time).  You'll get the different measures, including the current and projected internal rate of return. 

My IRR is higher than 7% over the long-term and I'm not in a very good RE market.  I think most people could learn how to choose good properties fairly easily.  Not sure I could increase the long term stock returns past 7% easily or at all myself.  It seems like the average person cannot.

The reason that stocks might be more attractive to  individuals and investment companies and therefore "capital flows into them" is that the returns are acceptable and the management of RE is much more hands-on and dependant on individual attention to details than invest and leave it stocks.   RE is also much less liquid with higher costs of entry.

I think MMM captured the hands-on aspect in his review of owning rental properties: http://www.mrmoneymustache.com/2011/05/23/get-rich-with-owning-rental-houses/
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: arebelspy on May 28, 2014, 09:07:38 AM
I'd probably side closer with clif, totoro, in that if you took out a fair wage for the time you put into finding properties, managers, learning about real estate, etc. etc. that IRR would be similar to stocks.  Stocks are much more passive, so naturally with real estate, if you know what you're doing, you'll do better, doing more work.  (Both sweat equity - physical labor - and mental equity from knowledge and network.)
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: dragoncar on May 28, 2014, 10:18:05 AM
I'd probably side closer with clif, totoro, in that if you took out a fair wage for the time you put into finding properties, managers, learning about real estate, etc. etc. that IRR would be similar to stocks.  Stocks are much more passive, so naturally with real estate, if you know what you're doing, you'll do better, doing more work.  (Both sweat equity - physical labor - and mental equity from knowledge and network.)

And if you know what you are doing, I'm guiding your time is worth more to potential employers.  I wonder what the extra return is on illiquid investments.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: totoro on May 28, 2014, 12:43:10 PM
You may be right in that, but if we apply that analysis we also have to apply the same analysis to those individuals for whom stocks and other instruments are a passion and who earn a higher return as a result.  Or to people who have gained expertise to allow them to learn a higher hourly wage or DIY things that others pay for.

How much time is spent reviewing background materials and analyzing a stock pick?  My guess is a fair bit for many and that it is ongoing if you are actively involved.  And my sense its that for those who do this it is not a chore but kind of fun and quite interesting.

For someone like me, stocks are not all that interesting, although they might become so once I understood more about them.  I'm interested enough in passive income to use the Canadian equivalent to Vanguard, but not interested enough yet to do the work that it would take to do more than that.   

I think the people that spend the time to get good at something have a passion for it.  I expect Warren Buffet can't wait to check up on companies.  He enjoys the thrill of finding the next good one and he cannot possibly need the money.

For me, real estate is also a hobby.  I enjoy seeing something work out as planned in a way that brings money and other benefits.  I like analyzing a deal.  I'm motivated to figure out how to make it work by figuring out what makes it work on multiple levels.

It is fun for me to turn my primary residence is something I live in with my family, pays for itself and keeps me occupied with interesting improvements.  Same with the vacation rental, it pays for itself, we use it ourselves regularly without any cost and it is a memory maker and refuge when I travel for work - I don't even need a suitcase. 

If we all started adding a dollar value to the time we spent on a hobby it would quickly seem like it was a worthless or less valuable use of time than it is.   Heck, we could all be earning money instead of posting here.

For me, it is about free time to do what I want and being able to spend it with the people I like to be with.  I happen to enjoy setting up events and systems that work for multiple reasons, and real estate is one of the things that matches that inclination.  Business development, cooking, home management, and dinner parties are some others that fit too. 

Now, if we are going to compare effort for return without looking at enjoyment and quality of life I guess it would be a mathematical exercise.  Life is not like that though.   We could all keep working for more money, heck, I could start working more for more money tomorrow, but I just don't want to.

So, as a mathematical comparison you might be right, although I'm not quite sure about that.  I'd have to do track my time to see. My view is that anything you spend your life's energy on justifies more than a mathematical analysis.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: hodedofome on May 28, 2014, 01:52:49 PM
My actual stock research takes about 5-10 minutes a day. Although I spend at least a few hours a day reading trading/investing/market history/psychology books to keep me continually learning and doing research on new systems. I enjoy it so it's what I do instead of watching tv or playing on the internet.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: totoro on May 28, 2014, 01:59:17 PM
My actual stock research takes about 5-10 minutes a day. Although I spend at least a few hours a day reading trading/investing/market history/psychology books to keep me continually learning and doing research on new systems. I enjoy it so it's what I do instead of watching tv or playing on the internet.

Real estate takes much less on specific research daily, and more time when evaluating a purchase, which for me is every couple of years.  I spend 30 min-one hour a day reading on real estate and business-related topics.  Almost all of this is online now.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: clifp on May 29, 2014, 03:09:35 PM
For me stocks are more interesting that real estate, now how much is because I have a much better knack for picking stocks than real estate I don't know.
While my timing is pretty good with real estate investing, the properties I buy tend not to appreciate as much similarly priced properties, in different neighborhoods. I also don't have a good feel for what improvement will produce the best ROI. I'm not sure I'll ever develop a feel for that.

You can be an above average stock investor by sticking with index mutual funds. I don't think there is a simple easy way to become an above average or even average real estate investor.

Most of the people I know that have done really well in RE have devoted  a lifetime to learning about 1 to 3 specific real estate markets.

I typically spend about an 1 or 2 before purchasing a stock, although that has expanded up to 30 hours over many, and much less time decide when to sell.  But I've never had a phone call from a stock about a flooded garage, or pigeons pooping.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: arebelspy on May 29, 2014, 05:11:57 PM
But I've never had a phone call from a stock about a flooded garage, or pigeons pooping.

I'm not understanding why you'd have gotten a call about that with your rentals, either.  That's what the property manager is for.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: butchmonkey on May 29, 2014, 05:18:32 PM
Property manager=active investment.

Costs matter.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: arebelspy on May 29, 2014, 05:32:53 PM
Property manager=active investment.

Costs matter.

I agree with both of those sentences, but I'm not sure what your point is.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: clifp on May 29, 2014, 07:34:14 PM
But I've never had a phone call from a stock about a flooded garage, or pigeons pooping.

I'm not understanding why you'd have gotten a call about that with your rentals, either.  That's what the property manager is for.

Property managers have to call you to get authorization for repair above a certain level,  home owner associations often will send the notifications to the home owner instead and/or addition to the Property manager.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: hodedofome on May 29, 2014, 08:41:00 PM
I don't know why ya'll are still arguing about this. Nobody is going to change anyone's entrenched beliefs here. To each his own. Now go out and slay the real estate or stock market of your choice.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: Cheddar Stacker on May 29, 2014, 09:25:44 PM
I don't know why ya'll are still arguing about this. Nobody is going to change anyone's entrenched beliefs here. To each his own. Now go out and slay the real estate or stock market of your choice.

Come on hoded, give it some time. Its only been 20 months since the OP. This topic just needs more time to evolve.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: dragoncar on May 29, 2014, 10:03:20 PM
I don't know why ya'll are still arguing about this. Nobody is going to change anyone's entrenched beliefs here. To each his own. Now go out and slay the real estate or stock market of your choice.

I changed my mind during this thread, but then I changed it back.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: Franklin on May 30, 2014, 07:12:48 AM
Quote
Come on hoded, give it some time. Its only been 20 months since the OP. This topic just needs more time to evolve.
...and the S&P is up about 40% since then, just out of spite.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: Mr Mark on May 30, 2014, 08:02:46 AM
Quote
Come on hoded, give it some time. Its only been 20 months since the OP. This topic just needs more time to evolve.
...and the S&P is up about 40% since then, just out of spite.

housing market up too, 10 - 40%. If you were mortgaged 4:1, that's a huge gain....
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: DoctorOctagon on June 02, 2014, 12:27:59 PM
Over 40 years it's not possible to top the gains from holding good American businesses.  If you compare UNLEVERAGED real estate to UNLEVERAGED equity in S&P index fund or berkshire-hathaway, the stocks win hands down as you increase the time horizon.  If you leverage both, stocks just win harder, but most people don't play with margin.  It be scary :)
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: Scandium on June 02, 2014, 03:03:06 PM
All fine and dandy, except (at least in my relatively low net worth case in an expensive area) it leads to a massive concentration of capital in a single unit in a single geographical area. Which might even be the same area where my job is located and my primary residence! Talk about risk concentration! Having ~50% or more of my net worth tied up to the fortunes of a 20 mi radius from my house? Not for me.

If buying a property would represent perhaps 10% of my net worth (unleveraged) then maybe, but for now I prefer to spread the risk over thousands of companies from all over the world.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: kyleaaa on June 03, 2014, 01:35:12 PM
Geez all this indexer on the forum and nobody has posted the "correct" answer.. :-)

I did :)
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: Mr Mark on June 03, 2014, 02:28:48 PM
Over 40 years it's not possible to top the gains from holding good American businesses.  If you compare UNLEVERAGED real estate to UNLEVERAGED equity in S&P index fund or berkshire-hathaway, the stocks win hands down as you increase the time horizon.  If you leverage both, stocks just win harder, but most people don't play with margin.  It be scary :)

agree, except for the last part.

a house in a solid place, that can rent out if required, with say 25% down, and you can leverage government subsidized with a fixed rate nominal loan, uncallable no matter underlying asset value, tax deductable interest and if you live there for 2 years in the last 5 capital gains tax free, with a rate for the debt at less than historic or projected long term market returns....
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: welliamwallace on June 05, 2014, 11:33:15 AM
Even though it may be frustrating to hold these types of back-and-forth conversations, I just want to thank you all for taking the time, as reading this whole thread has taught me lots. These discussions have more value than just bragging rights, and for more than just the people participating!

Thanks all.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: rmendpara on June 05, 2014, 02:24:20 PM
Disagree with the premise.

Almost any chart over long time periods will show you that real estate barely outpaces inflation on a price basis. Income from the property will likely offset the financing costs and operating expenses, but this is just a small amount of compensation for the numerous risks (litigation, vacancy, highway being built right behind your backyard, etc) which you cannot control.

I will say that it is much easier to find market inefficiencies in real estate than it is in the public markets (stocks, bonds, etc), as it's relatively easy to understand, and based on cash flow projections and reasonable risk estimates, you can identify properties that are undervalued much more accurately than a stock/bond that is undervalued.

That said, I own a rental property and greatly appreciate the cash flow (paid off now) when I consider it as a portion of my overall NW. The $6k/yr (net of operating expenses) on a $95k gross investment in 2012 is definitely an anomaly, as today it would likely be $6k/yr on a $130k investment, which is a much lower return.

But, to my earlier point, to an experienced investor who understands RE, it's easier to generate alpha.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: arebelspy on June 05, 2014, 02:26:38 PM
Even though it may be frustrating to hold these types of back-and-forth conversations, I just want to thank you all for taking the time, as reading this whole thread has taught me lots. These discussions have more value than just bragging rights, and for more than just the people participating!

Thanks all.

Thanks for the positive post welliam.  Appreciate it!  :)
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: Mr Mark on June 05, 2014, 07:28:01 PM

But, to my earlier point, to an experienced investor who understands RE, it's easier to generate alpha.

+1
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: Bob W on September 02, 2014, 10:22:21 AM
That article has me convinced.   I have been "in real estate" for several years.  My favorite tax write off is my auto mileage.   It seems that most times I drive I am always looking at real estate.  I mean seriously, I can't help but look at for sale signs.   I even ask people constantly what they paid or what the asking price is for a property.   I even look on the internet for bargains.   

Bottom line -- I deducted about 12,000 miles on my taxes the last several years.   That netted me around $2,500 a year in tax savings.   

To feel confident on this write off in the event of an audit  -  I keep a mileage log (this also helps you reduce your driving) and I often snap photos of properties.  I sometimes even make voice notes on my phone.   Yes, I have a paper trail.   

And by the way,  if I find a property like the one mentioned in the article (25K in plus 20K restore and rents for $750) count me in.   Anytime I can make that sort of money, I'm seriously down for it!   
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: chesebert on September 02, 2014, 11:30:45 AM
I evaluate my rentals as part of my investment portfolio and are therefore subject to period review based on IRR, NPV and efficient frontier analysis as compared to alternative investment in securities using net sales proceeds. So far the rentals are getting comparable risk-adjusted return as a basket of multi-class mutual funds. The one thing I really don't like about the rental investment is I am locked to the term of the lease agreement, and I can't sell the property during the term of the lease unless the buyer is also an investor, which limits the pool of buyers for the property. 
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: arebelspy on September 02, 2014, 11:52:40 AM
I evaluate my rentals as part of my investment portfolio and are therefore subject to period review based on IRR, NPV and efficient frontier analysis as compared to alternative investment in securities using net sales proceeds. So far the rentals are getting comparable risk-adjusted return as a basket of multi-class mutual funds. The one thing I really don't like about the rental investment is I am locked to the term of the lease agreement, and I can't sell the property during the term of the lease unless the buyer is also an investor, which limits the pool of buyers for the property.

It's certainly less liquid, and more work. There are definite downsides.  Give that, if your risk-adjusted return is equal, I'd suggest you stick with mutual funds, or find better RE investments.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: Mr Mark on September 02, 2014, 04:32:01 PM
I evaluate my rentals as part of my investment portfolio and are therefore subject to period review based on IRR, NPV and efficient frontier analysis as compared to alternative investment in securities using net sales proceeds. So far the rentals are getting comparable risk-adjusted return as a basket of multi-class mutual funds. The one thing I really don't like about the rental investment is I am locked to the term of the lease agreement, and I can't sell the property during the term of the lease unless the buyer is also an investor, which limits the pool of buyers for the property.

It's certainly less liquid, and more work. There are definite downsides.  Give that, if your risk-adjusted return is equal, I'd suggest you stick with mutual funds, or find better RE investments.

another post from the past! I think the original article is still en point. RE in the USA is a really unique opportunity,  IMHO. The way taxes work here is unbelievable.  A big slice of cash flowing RE in the stash is a huge enabler of a safe stable FIRE.

Now, our friends in Australia, UK, Canada, NZ, Germany, KL and Singapore probably have totally different numbers on this. Because in the end look at net after tax cashflow, and its impact on the whole portfolio.

 And quality rentals - as exemplified by early MMM - can enable you to withstand much greater volatility in your portfolio of stocks and bonds.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: DrF on October 06, 2014, 06:25:48 PM
I've been following this thread, and I want to throw my lot in with the stock crowd. It is much easier for an average investor to become FI through keeping their personal expenses low and putting 30-40-50% or more of their income into a low cost index fund. If the market goes down, it just means it is a good time to buy more, and that's what an average investor can do. While you are building your stash, you can keep on putting in your monthly deposit and eventually the market will reward you. Anything more than that and you have to develop quite a knowledge base before you can beat the market.

Now I turn to real estate. I think there are 2 camps here, those that have been burned and those that haven't. Both have happened to me, a little more burnt than not. I used to live in Nevada like arebelspy apparently does. I, unfortunately, am about 5-10 years older (I think, based on some of his posts). I say unfortunately because the second property I bought was a $311,000 condo in spring of 2005. By 2008 it was worth about 30% of that high. The same thing happened in Vegas, and much of the southwest. Well, if you were 5-10 years younger (arebelspy), and you start to look at real estate when you are 22-25 yo (around 2008/9 I would imagine) then things are looking really good. You can go out and buy a 2400 sqft house for $150000 that sold in 2005 for $500000. And wouldn't you know, it is cash flow positive from day 1. So, you buy a couple of these over 3-4 years and you think you are some real estate genius because you've made so much money, when if fact you just happened to come of age as a real estate investor at the bottom of the largest correction in over 50 years.

If you want to compare real estate to stocks, go out 50-70 years and see how equal they have been.  You haven't always been able to get a 4% mortgage for 30 years. Landlord costs used to be and soon will be much much higher, whereas stock market costs continue to decline.

Just a few thoughts, I'm not a hater. Congrats to arebelspy or anyone similar, you hit the real estate jackpot.

-DrFunk
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: gimp on October 06, 2014, 06:46:13 PM
I was just working on a spreadsheet earlier though to calculate one's return with leverage, principal paydown, assuming $0 cash flow, and appreciation at the rate of inflation.  Was very interesting, and made me like RE even more as an investment, if that were possible.  :)

Well hello. This caught my attention, since I'm likely to pursue precisely this strategy when I jump into the deep end - I have no need for cash flow, and am much more interested in principal paydown. Long-term buy-and-hold except without needing or wanting to live off of rent income until maybe 30-40 years down.

Got that spreadsheet available to share?
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: Bob W on October 07, 2014, 09:38:14 AM
Perhaps the biggest reason to own real estate as an investment is its inherent illiquidity.   

I had a friend that said money just ran through his fingers like water.   So he built his portfolio on rentals.   He couldn't sell them at the drop of hat or when the market went bad.   He has done very well.

Compare him to the average stock/bond investor.  (see another thread on this)  The average Joe is terrible and pulls their money out in down markets and buys in in up markets.   A huge, very high percentage of so called investors lose money in the market.  (something like 90%?)

Sadly,  even most MMM readers will do so.   The emotional pressures are huge.  So for those thinking that the market is better than rentals.  I'm pretty certain you're wrong.

Think of the stock market as a short term place to gather funds for future real estate purchases.

And perhaps the most important thing is to make your money going in on real estate.  Meaning buy distressed and below market properties only.  This takes patience and a daily look at your local market.

And don't forget to be cash flow positive from day one and  vette your renters intensely and keep your credit score sky high.

If you have to choose between 401Ks/IRAs and real estate rentals.  Choose the rentals.  They will have more tax advantages than the investment accounts.    You can even pass them along to your grandkids as inheritance at the basis purchase price.   And there is no mandatory withdrawal at age 72.
And there are no mandatory taxed dividends.   If you property starts cash flowing too much, simply refi and buy another property. 

Like everything else in life though,  it won't be easy.

   

Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: arebelspy on October 07, 2014, 10:19:08 AM
I was just working on a spreadsheet earlier though to calculate one's return with leverage, principal paydown, assuming $0 cash flow, and appreciation at the rate of inflation.  Was very interesting, and made me like RE even more as an investment, if that were possible.  :)

Well hello. This caught my attention, since I'm likely to pursue precisely this strategy when I jump into the deep end - I have no need for cash flow, and am much more interested in principal paydown. Long-term buy-and-hold except without needing or wanting to live off of rent income until maybe 30-40 years down.

Got that spreadsheet available to share?

Hmm, so I found the spreadsheet, and I have no idea what the fuck is going on in it.

Some documentation from past me would have been nice.

EDIT: Okay, I figured it out, there was just one superfluous column that had a 10% cash flow return that was being paid back down into the mortgage (it was assuming you didn't need the cash flow), but I had changed the spreadsheet halfway through to assume no cash flow, so that column wasn't doing anything or referenced anywhere, just confusing me with its existence.

Someone feel free to check my numbers.

Assumptions:
- Cash flow pays the mortgage payment, taxes, insurance, maintenance, vacancy, management, etc.  Overall property is "break even."
- 100k purchase price, 25k down, 75k financed @ 5.5%
- 3% inflation (and house appreciates at the rate of inflation).

In 10 years, house will be worth $134,391.64.  Loan balance will be $$61,763.64.  Equity is $72,628.00.

That is $54,042.05 equity in real dollars (backing up 10 years at 3%).  Putting 25k in for 10 years and getting 54k out gives you a real return of ~8% (11.25% nominal return).

So an 8% return just from using 5.5% leverage and breaking even on the cash flow (and assuming house appreciation = inflation rate), you'll make about 8% return.  Of course, that doesn't count transaction costs, but nor does it count tax benefits.

It's probably not worth buying a break even house, but if you're adding some decent cash flow on top of it...
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: DrF on October 07, 2014, 11:05:47 AM
I was just working on a spreadsheet earlier though to calculate one's return with leverage, principal paydown, assuming $0 cash flow, and appreciation at the rate of inflation.  Was very interesting, and made me like RE even more as an investment, if that were possible.  :)

Well hello. This caught my attention, since I'm likely to pursue precisely this strategy when I jump into the deep end - I have no need for cash flow, and am much more interested in principal paydown. Long-term buy-and-hold except without needing or wanting to live off of rent income until maybe 30-40 years down.

Got that spreadsheet available to share?

Hmm, so I found the spreadsheet, and I have no idea what the fuck is going on in it.

Some documentation from past me would have been nice.

EDIT: Okay, I figured it out, there was just one superfluous column that had a 10% cash flow return that was being paid back down into the mortgage (it was assuming you didn't need the cash flow), but I had changed the spreadsheet halfway through to assume no cash flow, so that column wasn't doing anything or referenced anywhere, just confusing me with its existence.

Someone feel free to check my numbers.

Assumptions:
- Cash flow pays the mortgage payment, taxes, insurance, maintenance, vacancy, management, etc.  Overall property is "break even."
- 100k purchase price, 25k down, 75k financed @ 5.5%
- 3% inflation (and house appreciates at the rate of inflation).

In 10 years, house will be worth $134,391.64.  Loan balance will be $$61,763.64.  Equity is $72,628.00.

That is $54,042.05 equity in real dollars (backing up 10 years at 3%).  Putting 25k in for 10 years and getting 54k out gives you a real return of ~8% (11.25% nominal return).

So an 8% return just from using 5.5% leverage and breaking even on the cash flow (and assuming house appreciation = inflation rate), you'll make about 8% return.  Of course, that doesn't count transaction costs, but nor does it count tax benefits.

It's probably not worth buying a break even house, but if you're adding some decent cash flow on top of it...

Arebelspy,

You are using "best case scenario" input on some of your assumptions. How many years have people been able to get a 5.5% mortgage for an investment property? In the past 10 years (from today) has any home in the US appreciated at 3% per year? I would say definitely not in Las Vegas, or much of the southwest. I understand the power of leverage when it comes to real estate, but recent investment vehicles are now offering 3x leveraged index funds for < 1% annual fee (URTY, UMDD, TQQQ, UPRO, UDOW). So, if you want to compare leverage to leverage if we "assume" a 7% return on average for the S&P500 over a 10 year period (inflation already accounted for), if you were to have bought the 3x leveraged S&P500 (UPRO) you would have garnered a $143,187 profit over that period (assuming you started with the same principle of 25k). This example is also "best case scenario", but the longer you stay in the better fit your results would be to the expected result. As you can see, this blows real estate out of the water.

The thing with stocks is that when prices dip, the average investor has the means to keep adding to their position. This is not always the case if you own real estate. If you buy a rental property and prices drop locally by 10-15% many people would have no way of capitalizing on that sweet drop. Additionally, if another house that was an even better investment came on the market, the "average investor" would lose out because of the opportunity cost of already owning another property. Sure, if you had $100,000 sitting in a brokerage account somewhere you would have that opportunity. But, most who are planning to FIRE are using tax advantaged accounts that prohibit withdrawals.

You are drinking your own cool-aid because it has worked for you, congratulations! Just realize that if you had bought your first rental just 5 years earlier you would not be singing the same sweet tune.

All the best,

DrFunk

edited for spelling
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: arebelspy on October 07, 2014, 11:49:07 AM
I disagree about using a best case scenario, I'm using a realistic one (appreciation at the rate of inflation, 5.5% mortgage rate).  Sure, historically 5.5% is a few percent lower than the average, but it's what we have right now, so it's relevant to someone investing right now.

As far as timing, you assume I would have bought 5 years earlier.  The people doing that were ones taking negative cash flow while speculating on appreciation bailing them out.  No thanks.  If one only buys when it cash flows, you don't have as much worry about buying in a bubble.

You stock market scenario has ridiculous amounts of risk, and very likely will get a margin call at some point in there, wiping you out.

I don't blindly trumpet "buy real estate" - I'm often advocating for people to NOT buy real estate in markets where it doesn't make sense - ask the Australia guys about that.

But the benefit of real estate is that it's an inefficient market - you can find deals.  Comparing certain real estate scenarios like those, it can make sense to buy real estate.  Lots of times it doesn't make sense though.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: DrF on October 07, 2014, 12:20:21 PM
With the 3x leveraged funds you are not using margin - so there would never be a margin call. You are using only your own dollars. Investing in leveraged funds with dollar cost averaging for a period of 10+ years will have no greater risk than a vanilla S&P500 fund! This is what I am doing and will do well into FI. I won't even have to screen new tenants to boot.

The point I am trying to make here is that the last 5 years in the real estate market is an anomaly. To find the kind of over-correction that most of the US went through from 2006-2011 you would have to go back to the great depression. It has "historically" been much harder to make real estate work on the single property side of investing. That is why the average investor will have done much better in the stock market, and as real estate corrects, the stock market will continue to be the preferred avenue for wealth accumulation vs risk.

As you like to say though, YMMV.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: arebelspy on October 07, 2014, 01:15:50 PM
With the 3x leveraged funds you are not using margin - so there would never be a margin call. You are using only your own dollars. Investing in leveraged funds with dollar cost averaging for a period of 10+ years will have no greater risk than a vanilla S&P500 fund! This is what I am doing and will do well into FI. I won't even have to screen new tenants to boot.

With 3x leveraged funds, decay eats you alive and you lose hard.

The point I am trying to make here is that the last 5 years in the real estate market is an anomaly. To find the kind of over-correction that most of the US went through from 2006-2011 you would have to go back to the great depression. It has "historically" been much harder to make real estate work on the single property side of investing. That is why the average investor will have done much better in the stock market, and as real estate corrects, the stock market will continue to be the preferred avenue for wealth accumulation vs risk.

The last 5 years were great for RE, but they were also great for stocks.

There is always opportunity in real estate, I believe, but you have to have the knowledge to take advantage of it.

Index funds certainly doesn't require that, and is a better choice for many.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: DrF on October 07, 2014, 01:28:14 PM
With the 3x leveraged funds you are not using margin - so there would never be a margin call. You are using only your own dollars. Investing in leveraged funds with dollar cost averaging for a period of 10+ years will have no greater risk than a vanilla S&P500 fund! This is what I am doing and will do well into FI. I won't even have to screen new tenants to boot.

With 3x leveraged funds, decay eats you alive and you lose hard.



http://seekingalpha.com/article/1457061-how-to-beat-leveraged-etf-decay?page=2

Long leveraged ETFs are completely viable, and in up markets they provide near "exponential" returns.

Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: johnhenry on October 07, 2014, 01:28:51 PM
I was just working on a spreadsheet earlier though to calculate one's return with leverage, principal paydown, assuming $0 cash flow, and appreciation at the rate of inflation.  Was very interesting, and made me like RE even more as an investment, if that were possible.  :)

Well hello. This caught my attention, since I'm likely to pursue precisely this strategy when I jump into the deep end - I have no need for cash flow, and am much more interested in principal paydown. Long-term buy-and-hold except without needing or wanting to live off of rent income until maybe 30-40 years down.

Got that spreadsheet available to share?

Hmm, so I found the spreadsheet, and I have no idea what the fuck is going on in it.

Some documentation from past me would have been nice.

EDIT: Okay, I figured it out, there was just one superfluous column that had a 10% cash flow return that was being paid back down into the mortgage (it was assuming you didn't need the cash flow), but I had changed the spreadsheet halfway through to assume no cash flow, so that column wasn't doing anything or referenced anywhere, just confusing me with its existence.

Someone feel free to check my numbers.

Assumptions:
- Cash flow pays the mortgage payment, taxes, insurance, maintenance, vacancy, management, etc.  Overall property is "break even."
- 100k purchase price, 25k down, 75k financed @ 5.5%
- 3% inflation (and house appreciates at the rate of inflation).

In 10 years, house will be worth $134,391.64.  Loan balance will be $$61,763.64.  Equity is $72,628.00.

That is $54,042.05 equity in real dollars (backing up 10 years at 3%).  Putting 25k in for 10 years and getting 54k out gives you a real return of ~8% (11.25% nominal return).

So an 8% return just from using 5.5% leverage and breaking even on the cash flow (and assuming house appreciation = inflation rate), you'll make about 8% return.  Of course, that doesn't count transaction costs, but nor does it count tax benefits.

It's probably not worth buying a break even house, but if you're adding some decent cash flow on top of it...

Arebelspy,

You are using "best case scenario" input on some of your assumptions. How many years have people been able to get a 5.5% mortgage for an investment property? In the past 10 years (from today) has any home in the US appreciated at 3% per year? I would say definitely not in Las Vegas, or much of the southwest. I understand the power of leverage when it comes to real estate, but recent investment vehicles are now offering 3x leveraged index funds for < 1% annual fee (URTY, UMDD, TQQQ, UPRO, UDOW). So, if you want to compare leverage to leverage if we "assume" a 7% return on average for the S&P500 over a 10 year period (inflation already accounted for), if you were to have bought the 3x leveraged S&P500 (UPRO) you would have garnered a $143,187 profit over that period (assuming you started with the same principle of 25k). This example is also "best case scenario", but the longer you stay in the better fit your results would be to the expected result. As you can see, this blows real estate out of the water.

The thing with stocks is that when prices dip, the average investor has the means to keep adding to their position. This is not always the case if you own real estate. If you buy a rental property and prices drop locally by 10-15% many people would have no way of capitalizing on that sweet drop. Additionally, if another house that was an even better investment came on the market, the "average investor" would lose out because of the opportunity cost of already owning another property. Sure, if you had $100,000 sitting in a brokerage account somewhere you would have that opportunity. But, most who are planning to FIRE are using tax advantaged accounts that prohibit withdrawals.

You are drinking your own cool-aid because it has worked for you, congratulations! Just realize that if you had bought your first rental just 5 years earlier you would not be singing the same sweet tune.

All the best,

DrFunk

edited for spelling

Your examples and your investment history prove that you don't understand the importance some of us place on investing for cash flow.  If I have a property that provides substantial cash flow, I'm not worried at all if the market value of that income-producing asset falls.... because I'm not selling!  In the midwest, I have more than one property that's appreciated at 3% per year over the past 10 years.  But that's irrelevant to me.  I own the properties because they make me money each year and the increased risk compared to index fund investing is worth the increased return.

And you don't need $100K in liquid, taxable funds to move quickly on a great real estate deal.  Nevermind that real estate prices move slowly, anyway.  But if the right deal comes along, a 15-20% down payment + closing costs is all you need.  My income from wages is WAY lower than many on this forum, but I've been able to have enough cash on hand to snap up what I thought were good deals in RE even after owning multiple properties.  Yes, it's true, running a business that produces significant cash flow can provide cash reserves that can be re-invested if the right deal comes along :)

Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: dragoncar on October 07, 2014, 02:15:48 PM
With the 3x leveraged funds you are not using margin - so there would never be a margin call. You are using only your own dollars. Investing in leveraged funds with dollar cost averaging for a period of 10+ years will have no greater risk than a vanilla S&P500 fund! This is what I am doing and will do well into FI. I won't even have to screen new tenants to boot.

With 3x leveraged funds, decay eats you alive and you lose hard.



http://seekingalpha.com/article/1457061-how-to-beat-leveraged-etf-decay?page=2

Long leveraged ETFs are completely viable, and in up markets they provide near "exponential" returns.

I read that article and while interesting, I don't think it supports your assertion of "completely viable"

That said, isn't there an easier way to accomish a leveraged long play with LEAPS options or similar?  Anyone have a strategy to share?
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: hodedofome on October 07, 2014, 03:23:39 PM
Index futures can give you 6-10x leverage with no interest, just trading commissions. You'll want to check the margin requirements however, and understand that margin requirements are not static. They can and do change, usually at the worst time for your account.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: gimp on October 07, 2014, 06:45:37 PM
Assumptions:
- Cash flow pays the mortgage payment, taxes, insurance, maintenance, vacancy, management, etc.  Overall property is "break even."
- 100k purchase price, 25k down, 75k financed @ 5.5%
- 3% inflation (and house appreciates at the rate of inflation).

In 10 years, house will be worth $134,391.64.  Loan balance will be $$61,763.64.  Equity is $72,628.00.

That is $54,042.05 equity in real dollars (backing up 10 years at 3%).  Putting 25k in for 10 years and getting 54k out gives you a real return of ~8% (11.25% nominal return).

So an 8% return just from using 5.5% leverage and breaking even on the cash flow (and assuming house appreciation = inflation rate), you'll make about 8% return.  Of course, that doesn't count transaction costs, but nor does it count tax benefits.

It's probably not worth buying a break even house, but if you're adding some decent cash flow on top of it...

Cool. I played with some numbers and came to some very interesting conclusions... such as your return % decreasing over time. After the loan is paid off, I can see why the % would decrease over time (profit isn't reinvested); however, I'm quite curious about whether it's normal during the loan term.

Using your numbers for example: 10 years, equity is 72.5k, 25k down, 11.25% nominal.

30 years, the loan is paid off, equity == house value == 243k, 7.9% nominal.

In short, am I missing something because I made a mistake in assumptions, or is this real behavior?
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: arebelspy on October 07, 2014, 08:28:24 PM
Yes, this is correct, though I bet you'll actually do better over time due to transaction costs being a smaller percentage of profit (though the same percentage overall).
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: gimp on October 08, 2014, 01:34:54 PM
Makes sense.

The numbers I ran show a much more pessimistic view of a break-even house than I thought. They also showed that it made sense, for example, to add some of my own cash (negative cash flow) for long-term returns. That part makes sense since I don't particularly care about cash flow as long as it's not sinking too much of my money. This, along with my preference to not leverage too much, confirms my desire to focus on a smaller number of paid-off houses than a larger number of leveraged ones, even if the returns are smaller; I'm more than happy to go 100% stock index funds because their ups and downs won't matter until I sell, but I don't want as much leverage as you're comfortable with because I don't want a confluence of crappy events to leave me with a bunch of negative cash flow that I didn't sign up for.

They also showed that, for example, a house at $50k renting for $600/month, especially if I add another $100 of my own, is a very good long-term (~40 year) investment. In other words, 1% is dandy, 1.15% is excellent, much more than I thought before I ran numbers.

I need to fix up my model by assuming compounding interest on the returns (so after the house is paid off and is cash flowing); because anything I invest in funds has compounding interest and dividend reinvestment. I think I will see a big benefit from that.

Out of curiosity - I know you're a big proponent of leverage. Have you done the math to show 40- or 50- or even 60-year returns using your leverage strategy versus one that uses much less? Do you care? (I feel like I've read you saying that you'd likely divest yourself by the time you got to those lengths of time, making the question moot.)
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: Bob W on October 08, 2014, 02:51:08 PM
I'm sure the leveraged long term returns vs. nonleveraged would be astronomically higher.  Although, the risk is much greater as well.  The risk can be somewhat covered by being a good business manager, since owning real estate directly makes you a real estate manager. 

The benefit of looking 50-60 years down wind would be that you get to decide which of your grandchildren will assume ownership at your cost basis upon death.   Would be so nice to give the grandkids 30 rentals cash flowing 800 per month!
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: gimp on October 08, 2014, 03:37:04 PM
I was sure too, until I did math. My models aren't complete because they account for neither compounding interest from returns, nor compounding interest from opportunity cost. So I'm not sure anymore. It's complex to account for all the variables, but it's definitely true that leverage has the downside of paying someone interest.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: arebelspy on October 08, 2014, 08:35:53 PM
I don't want as much leverage as you're comfortable with because I don't want a confluence of crappy events to leave me with a bunch of negative cash flow that I didn't sign up for.

Leverage shouldn't give you negative cash flow.  You should have positive cash flow, even with leverage, and eve if your rents drop somewhat (i.e. have a buffer).

Out of curiosity - I know you're a big proponent of leverage. Have you done the math to show 40- or 50- or even 60-year returns using your leverage strategy versus one that uses much less? Do you care? (I feel like I've read you saying that you'd likely divest yourself by the time you got to those lengths of time, making the question moot.)

I'm a proponent of certain type of leverage.  The low interest, long term rates we have available today that are often less than inflation are pretty incredible.

I am leveraged about 33% LTV (i.e. my debt is about 1/3 the value of my properties, and about 66% equity) across my entire portfolio.  Some of my properties have mortgages.  Others I own free and clear.

It's very situational, and one should always run the numbers to see what makes sense for their given situation, even on a per property basis.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: johnhenry on October 09, 2014, 01:10:02 PM
Makes sense.

The numbers I ran show a much more pessimistic view of a break-even house than I thought. They also showed that it made sense, for example, to add some of my own cash (negative cash flow) for long-term returns. That part makes sense since I don't particularly care about cash flow as long as it's not sinking too much of my money. This, along with my preference to not leverage too much, confirms my desire to focus on a smaller number of paid-off houses than a larger number of leveraged ones, even if the returns are smaller; I'm more than happy to go 100% stock index funds because their ups and downs won't matter until I sell, but I don't want as much leverage as you're comfortable with because I don't want a confluence of crappy events to leave me with a bunch of negative cash flow that I didn't sign up for.

They also showed that, for example, a house at $50k renting for $600/month, especially if I add another $100 of my own, is a very good long-term (~40 year) investment. In other words, 1% is dandy, 1.15% is excellent, much more than I thought before I ran numbers.

I need to fix up my model by assuming compounding interest on the returns (so after the house is paid off and is cash flowing); because anything I invest in funds has compounding interest and dividend reinvestment. I think I will see a big benefit from that.

Out of curiosity - I know you're a big proponent of leverage. Have you done the math to show 40- or 50- or even 60-year returns using your leverage strategy versus one that uses much less? Do you care? (I feel like I've read you saying that you'd likely divest yourself by the time you got to those lengths of time, making the question moot.)

Do you mind to share your spreadsheet in progress?

I see where you are coming from, not wanting to get over-leveraged. 

I'm a fan of leverage (for my situation and goals).  I like to think I employ it strategically and conservatively.  For example, my RE portfolio includes 4 places that I've bought in 2012-2014 that are in the $40K - $45K range and rent from $625 - $700.  Point being, there are still places to be had that exceed the 1% rule, well after the housing crisis rebound.  These aren't places that were bough 12-15 years ago.  They are in the sweet spot you are talking about.

To me the question of how much leverage to employ depends on many factors.  One is how fast I want to grow this business/portfolio. Even though I'm FIRE, I'm young enough that my goals are focused on growth.  My thinking is.... I'll continue to employ leverage at least until I want to scale back growth.  At that point I can put positive cash flow towards paying down mortgages as opposed to more RE.  But since there's also a hedge against inflation provided by the cheap mortgages, I doubt that will happen, even when I put the business on cruise control (stop buying new properties and possibly put some under management, or even 1031 exchange into one larger asset or business that's easier to manage).

As a business owner, I worry very much about the worst-case scenario like the confluence of crappy events you describe.  But run the numbers on a $40K place that rents for $625 or a $45k place that rents for $700.  Consider the event(s) that would have to happen to drive the market rent rate from $625 to $400! and from $700 to $450!  And even in that unlikely circumstance, I'd still have investments meeting the 1% rule!  Even with $1000 of expenses factored, the rent would have to fall from $625 to $350 (or $700 to $410) before it went ever-so-slightly cash flow negative!  I'm not saying it can't happen.  But my business is built to withstand drops even worse than that for a prolonged period.  I would never take on so much leverage that, as a whole, the business couldn't survive for a couple years in terrible circumstances.

Notice that my worst-case scenarios, as a cash-flow investor, don't have anything to do with the market value of my assets, but only the market value of my rents.  If one of my properties loses half it's value on paper, and I have to reduce rent by 10-15% to keep tenants, I just keep moving.  Now, if (somehow) I have to reduce rents by 50% but the property has only lost 10-15%, I may consider selling and taking the loss.... if I think that scenario will persist for that property.

Combine that strategy with one that diversifies holdings to include properties in different states, parts of town, numbers of bedrooms, etc and you can reduce the likelihood that ALL properties would suffer at the same time.

Instead of looking for deals that "will always win" I look for deals that "will almost never lose", just because I share your respect for a worst case scenario and believe in preparedness.  But I still think it's wise for me to exploit leverage while it's cheap since my current goal is to grow my assets.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: gimp on October 09, 2014, 01:18:40 PM
Leverage can give you negative cash flow if, say, you suddenly can't find renters for whatever reason. On the plus side, it seems that the weaker the housing market, the stronger the renter's market, and vice versa - meaning that if there's a systematic issue with finding renters, selling the property will probably work out nicely.

The appeal to me of owning free and clear is not worrying about it. A good safety net - always have a place to live, just in case, you know?

After taking some more things into account and improving my models, I would say that for me, I want about 1.15% rent at 5% APR, or better rent / lower APR, to make it worth it. I can see why sub-4% APRs, especially closer to 3%, made houses incredibly attractive long-term. The main difference between buying stock and cash-flowing real estate at the bottom of the market is that index funds will tend to revert to normal (tripling in a few years is awesome but unsustainable), whereas once you've paid the very low price for the house, you're going to be getting a higher rent : price paid ratio forever.

Though I would probably re-run models every year to see expected results vs extractable equity right now. So if prices go up much more than expected, I'd want to just sell and find cheaper opportunity elsewhere for the same rent.

I do appreciate the time to answer my questions and respond to my thoughts, by the way. Many people would pay quite a few dollars for the opportunity.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: gimp on October 09, 2014, 01:31:38 PM
Quote
Do you mind to share your spreadsheet in progress?

Attached. I didn't want to link to google drive, but maybe later.

Assumptions are at the top. I'm using monthly compounding, so certain assumed % looks low - because I did the calculations in reverse; eg, if I want to assume 7% compounded yearly, that's around 6.8% compounded monthly.

I have four cases, in a matrix:
- 30y @ 5.5%; and 15y at 5.0%
- Breaking even, so I'm paying precisely the mortgage; and getting $600/month on the $50k property (around 1.2%), with the extra being paid down.

The models aren't complete, but it shows that I really want to at least break even on a 15y@5% mortgage (just under 600/month needed - around 1.15%). Reducing the interest means I can accept a slightly lower than 1.15% result; increasing the rent means I can accept a slightly higher interest rate.

Any glaring mistakes?

I've also compared against a 7%/year index, and I also assumed that any profit I extract once the house is paid off is invested at the same 7%/year index. It ignores variation in returns because I'm thinking long-term enough where I don't really care.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: johnhenry on October 10, 2014, 07:21:08 AM
Quote
Do you mind to share your spreadsheet in progress?

Attached. I didn't want to link to google drive, but maybe later.

Assumptions are at the top. I'm using monthly compounding, so certain assumed % looks low - because I did the calculations in reverse; eg, if I want to assume 7% compounded yearly, that's around 6.8% compounded monthly.

I have four cases, in a matrix:
- 30y @ 5.5%; and 15y at 5.0%
- Breaking even, so I'm paying precisely the mortgage; and getting $600/month on the $50k property (around 1.2%), with the extra being paid down.

The models aren't complete, but it shows that I really want to at least break even on a 15y@5% mortgage (just under 600/month needed - around 1.15%). Reducing the interest means I can accept a slightly lower than 1.15% result; increasing the rent means I can accept a slightly higher interest rate.

Any glaring mistakes?

I've also compared against a 7%/year index, and I also assumed that any profit I extract once the house is paid off is invested at the same 7%/year index. It ignores variation in returns because I'm thinking long-term enough where I don't really care.

Awesome! I'll admit some of the math is making my brain hurt :) 

Help me understand:

- in lay terms, how is the return column being calculated?
- I see the assumptions along the top, but none for monthly rent.  If this isn't a variable or constant, it's built in somewhere as an assumption, right?

- in the sheets with "profit" what do the 22 and 100 represent?  Is that extra monthly cash flow?  Do these models have that amount going to pay down extra on the mortgage? Or going somewhere else?

Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: johnhenry on October 10, 2014, 08:03:47 AM
Leverage can give you negative cash flow if, say, you suddenly can't find renters for whatever reason. On the plus side, it seems that the weaker the housing market, the stronger the renter's market, and vice versa - meaning that if there's a systematic issue with finding renters, selling the property will probably work out nicely.

The appeal to me of owning free and clear is not worrying about it. A good safety net - always have a place to live, just in case, you know?

I agree completely about the worst-case safety net.  After being in the business quite a while, I doubt I'll ever have to do it.  But knowing I have an asset that I can use for shelter for myself and family brings peace of mind.  But that can still be your safety net even if you have a mortgage on it, right?  That safety net sounds good, but if things got bad enough in the area I live (and also have a place that could house my family of 4), I'll have the option of moving into the rental if I can't keep it rented.... but then what do I do with my house?  Which I own.  It also has a mortgage, but I have much more equity in it than most of my rentals.  If enough shit was hitting the fan to force me to move, I'm not sure I'd be better off living in my $50K house, trying to sell/rent my $150K house, which would have no chance of meeting the 1% rule in my area.

About leverage and negative cash flow....  I'll grant you that the more you are leveraged, the faster you can go cash flow negative if you can't find a tenant.  And believe me, I worried about that when I was first getting started.  But if you are running a place that is extremely cash flow positive (i.e. well over 1%), it would take months of vacancy each year (or a much reduced rent) to generate negative cash flow over an annual period.  One metric I like to calculate for each deal I pursue is "breakeven occupancy" along with it's counterpart, "breakeven rent", where cash flow is concerned.  This gives me an idea of how bad things would need to get before I'd actually be cash-flow negative. 

Final point about negative cash flow.  Owning free and clear doesn't prevent negative cash flow if you can't find any tenants at all! I have places where the the mortgage payments are under $200/mo but the taxes and insurance combined are around $115.  There is risk in this business, to be sure.  But owning outright doesn't eliminate that risk.  It still costs money to own a home, even if you don't owe money on it.  I don't feel any better about a property sitting empty just because I own it free and clear.

You are "worried" about all the right things.  You are wise to prepare well for worst-case scenarios.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: arebelspy on October 10, 2014, 09:22:47 AM
About leverage and negative cash flow....  I'll grant you that the more you are leveraged, the faster you can go cash flow negative if you can't find a tenant.  And believe me, I worried about that when I was first getting started.  But if you are running a place that is extremely cash flow positive (i.e. well over 1%), it would take months of vacancy each year (or a much reduced rent) to generate negative cash flow over an annual period.  One metric I like to calculate for each deal I pursue is "breakeven occupancy" along with it's counterpart, "breakeven rent", where cash flow is concerned.  This gives me an idea of how bad things would need to get before I'd actually be cash-flow negative. 

Well said.

I could have about a 75% vacancy rate right now and break even after PITI, though any maintenance occurring on those other 25% would put me cash flow negative. If I use standard assumptions for that, I could have around 30% occupancy and cover everything, but have no cash flow for myself to live on.

Given I don't ever expect more than a 20% or so vacancy rate as a worst case scenario, I'm not too worried about being cash flow negative.

Even when multiple properties go vacant at once, which happens (due to variance and the law of large numbers), you want to be fine in that circumstance by having your other properties cover that (AND have large reserves on top of that).

Be smart, play it safe, but don't worry or lose sleep about it, just plan and prepare.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: gimp on October 10, 2014, 12:35:39 PM
Help me understand:

- in lay terms, how is the return column being calculated?
- I see the assumptions along the top, but none for monthly rent.  If this isn't a variable or constant, it's built in somewhere as an assumption, right?

- in the sheets with "profit" what do the 22 and 100 represent?  Is that extra monthly cash flow?  Do these models have that amount going to pay down extra on the mortgage? Or going somewhere else?

Cool.

Return column is hard to describe in lay terms. Basically, you know how if you have a 5% return, your cash after 3 years is initial cash multiplied by (1 + 0.05) ^ 3? And if you compound monthly, it's initial cash multiplied by (1 + 0.05 / 12) ^ (3 * 12)?

So the return is the inverse of that. We start with a known initial cash, a known end result, a known time period, and do math to find out what the return must have been.

The monthly rent is assumed in break even cases to cover precisely double the fixed payments. That is, if I have to pay $250 ($150 interest, $50 principal, $50 tax) then I assume the rent is $500, because the other half covers management, maintenance, repairs, vacancy, insurance. It's fuzzy math, not one from actual case studies. Go with it. :)

"Profit" means that I am getting double the fixed payments + extra. EG, $100 profit means $500 + $100 = $600. $22 profit was actually the wrong number; if I assume the same fixed expenses as before, but a higher fixed payment, basically I made an oops when I was tired. I wanted to equalize the two as getting $600/month rent in the "profit" scenario - 1.2%. The "profit" models have the amount going to pay down extra on the mortgage, which is why that amount is considered part of the investment (money put in) to calculate return.

I appreciate your responses, john and reb. I have the strong suspicion that I may change my tune as I find myself more comfortable and with more properties. For _right now_, I want my first couple to be paid off asap.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: johnhenry on October 10, 2014, 02:10:37 PM
Help me understand:

- in lay terms, how is the return column being calculated?
- I see the assumptions along the top, but none for monthly rent.  If this isn't a variable or constant, it's built in somewhere as an assumption, right?

- in the sheets with "profit" what do the 22 and 100 represent?  Is that extra monthly cash flow?  Do these models have that amount going to pay down extra on the mortgage? Or going somewhere else?

Cool.

Return column is hard to describe in lay terms. Basically, you know how if you have a 5% return, your cash after 3 years is initial cash multiplied by (1 + 0.05) ^ 3? And if you compound monthly, it's initial cash multiplied by (1 + 0.05 / 12) ^ (3 * 12)?

So the return is the inverse of that. We start with a known initial cash, a known end result, a known time period, and do math to find out what the return must have been.

The monthly rent is assumed in break even cases to cover precisely double the fixed payments. That is, if I have to pay $250 ($150 interest, $50 principal, $50 tax) then I assume the rent is $500, because the other half covers management, maintenance, repairs, vacancy, insurance. It's fuzzy math, not one from actual case studies. Go with it. :)

"Profit" means that I am getting double the fixed payments + extra. EG, $100 profit means $500 + $100 = $600. $22 profit was actually the wrong number; if I assume the same fixed expenses as before, but a higher fixed payment, basically I made an oops when I was tired. I wanted to equalize the two as getting $600/month rent in the "profit" scenario - 1.2%. The "profit" models have the amount going to pay down extra on the mortgage, which is why that amount is considered part of the investment (money put in) to calculate return.

I appreciate your responses, john and reb. I have the strong suspicion that I may change my tune as I find myself more comfortable and with more properties. For _right now_, I want my first couple to be paid off asap.


I see.  Well, since you were kind enough to share a spreadsheet, I will share one too.  I tried to quickly clean it up a little and add some titles to each section.  Hopefully its useful to someone besides me.  Hopefully I didn't break any of the formulas during the rearranging.  It's one I use to quickly analyze potential deals based on purchase price, expected rent, and a few other variables.  Let me know if you have questions.

I'm interested to know if you ever adapt yours to include more variables/parameters.  And don't forget about the benefit of tax-deferred cash-flow through depreciation.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: gimp on October 10, 2014, 03:16:44 PM
That is a pretty cool spreadsheet. My income pushes me into a slightly higher tax bracket, but depreciation is nice and something I entirely ignored for now (as well as taxes in general.) I'll see about throwing them in.
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: arebelspy on October 10, 2014, 04:10:59 PM
I see.  Well, since you were kind enough to share a spreadsheet, I will share one too.  I tried to quickly clean it up a little and add some titles to each section.  Hopefully its useful to someone besides me.  Hopefully I didn't break any of the formulas during the rearranging.  It's one I use to quickly analyze potential deals based on purchase price, expected rent, and a few other variables.  Let me know if you have questions.

I'm interested to know if you ever adapt yours to include more variables/parameters.  And don't forget about the benefit of tax-deferred cash-flow through depreciation.

Nice.  Maybe add a total return, counting the cash flow, tax benefits, and principal pay down (up to you if you also want to add an appreciation assumption)?
Title: Re: Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds
Post by: aschmidt2930 on October 10, 2014, 05:59:13 PM
Some very interesting points all over the spectrum in this one. I have some skepticism into RE as most calculations I see never seem to be complete.  I'd be interested to see large data sets on what the margins on buying and renting really are after property taxes, interest on the initial loan (If applicable), repairs, periods of vacancy, insurance, ect are accounted for.

With that said, rental properties are absolutely a more consistent and safe form of income.  I currently own no rental properties, but the idea of having a check coming every month not dependent on dividend yields and price gains is appealing.