Article: Why Real Estate Returns Are Higher than Stocks, Bonds and Mutual Funds

[arebelspy]

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).

[Aurora]

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.

[Another Reader]

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. 

[arebelspy]

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.

[Peter]

In Canada, rent revenue is taxed as regular income, while dividend income (from Canadian companies) is given extremely favourable tax treatment.

[PaulM12345]

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?

[arebelspy]

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/

[PaulM12345]

Thank you!

[arebelspy]

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.

[Mr Mark]

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]

[PaulM12345]

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...

[arebelspy]

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.

[joer1212]

....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.

[meadow lark]

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

[VintageHouses.org]

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.]

[arebelspy]

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.  :)

[deborah]

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.

[grantmeaname]

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.

[hodedofome]

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.

[arebelspy]

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.

;)

[hodedofome]

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.

[arebelspy]

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.  :)

[hodedofome]

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.

[arebelspy]

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.

[catccc]

....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.

[Jack]

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.

[hodedofome]

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. :)

[arebelspy]

....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.

[Jack]

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].

[Cheddar Stacker]

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

[Franklin]

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?

[hodedofome]

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.

[brewer12345]

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).

[FrenchyMustache]

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.

[totoro]

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.

[Cheddar Stacker]

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.

[arebelspy]

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.

[Franklin]

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.

[totoro]

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.

[kyleaaa]

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.

[Franklin]

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.

[Cheddar Stacker]

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.

[kyleaaa]

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.

[totoro]

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.

[Franklin]

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.

[kyleaaa]

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).

[totoro]

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.

[kyleaaa]

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?

[totoro]

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?

[totoro]

My apologies for the quote failure.  Don't have time to fix it.