Author Topic: Question about RE as an investment vehicle  (Read 2434 times)

pancakeplease

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Question about RE as an investment vehicle
« on: November 13, 2016, 11:40:17 PM »
This is going to sound stupid, I think I know the answer but I want confirmation from you guys. I'm new

So I always hear from people things like 'If youre making x% in RE why not just throw it in the stock market?" but I never understood that comparison. Here's why and please let me know if I'm missing something here.

If you invest $10k in the stock market and get a 10% return, in 1 year you made $1k.
If you invest $10k in say a SFR and get 10%, you made $1k in cash-on-cash..so same returns.
BUT, you have tenants paying your mortgage and essentially putting money in the piggy bank for you. Let's just say for the example it's a 10-year mortgage. in 10 years, you own essentially what is a cash producing machine because the property has been paid off by your tenants.

You can then cash out refinance and put that seed money into another property and property #1 is now a fully autonomous (assuming numbers work and are stable) cash machine just producing the 10% return on your initial 10k. So the initial 10k is no longer invested in that property. You can pull it out of the vehicle once it has enough "momentum" to run itself.

The stock market however, if you pull out your initial investment at any point, the returns stop.

of course we're over simplifying here about tenant risk, being qualified to even finance in the first place, etc. etc. and all the OTHER risks of RE but from a numbers standpoint, it seems like being able to pull out your seed money once your first investment vehicle gets kickstarted to be autonomous is a big reason why people choose RE.

Thoughts?
« Last Edit: November 13, 2016, 11:42:22 PM by pancakeplease »

mskyle

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Re: Question about RE as an investment vehicle
« Reply #1 on: November 14, 2016, 10:09:42 AM »
Well, for me it's all about the work, the financing, and the risk.

And besides there's no place near me where I could get those kinds of cash-on-cash returns on a rental property, so I would have to use brokers and property managers and things like that to invest in real estate; much easier to just put the money in the stock market.

EZcurrency

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Re: Question about RE as an investment vehicle
« Reply #2 on: November 14, 2016, 10:44:19 PM »
Well, I prefer real estate for the following reasons:

1)  Someone else pays down the mortgage when its rented
2)  You can depreciate the property over 27.5 yrs (which reduces taxes)
3)  You can write off repairs, taxes, utilities, management fees, and travel to visit your property (which reduces taxes)
4)  Once a property has significant equity (or paid off), you can take out a HELOC and buy another property, or use for large expenses (kids college, boat, etc).

(2) and (3) you don't get in the stock market.  You can actually have a rental which makes $$$ each year, but end of the year is a net loss on taxes, which offsets your other income.  Stock market can't do that.

EZ

pancakeplease

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Re: Question about RE as an investment vehicle
« Reply #3 on: November 14, 2016, 11:09:45 PM »
That's also why i like real estate but I just like the idea of being able to kickstart a cash flowing machine by injecting your money into it and then being able to pull it out and have it still produce.

WerKater

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Re: Question about RE as an investment vehicle
« Reply #4 on: November 14, 2016, 11:47:58 PM »

If you invest $10k in the stock market and get a 10% return, in 1 year you made $1k.
If you invest $10k in say a SFR and get 10%, you made $1k in cash-on-cash..so same returns.
BUT, you have tenants paying your mortgage and essentially putting money in the piggy bank for you. Let's just say for the example it's a 10-year mortgage. in 10 years, you own essentially what is a cash producing machine because the property has been paid off by your tenants.
You are comparing apples (return on investment of stocks) to oranges (cash-on-cash return of leveraged real estate). Let me illustrate, and at the same time show you why I will probably never invest in real estate:
Where I live, I might be able to buy a property for 300k and rent it for 1500/month. Let's say after expenses I clear 12k per year. That's a return on investment of 4% on the 300k investment. This you can directly compare to the 10% (or 7% or whatever) that you could get on the stock market.

If I finance this property over 20 years, using a downpayment of 60k and an interest rate of 3%, I will pay about 16k per year on the mortgage. So my cashflow is negative 4000/year for a cash-on-cash-return of negative 6.7%.

You see how in my case the stock market will probably wipe the floor with real estate.



AlexK

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Re: Question about RE as an investment vehicle
« Reply #5 on: November 14, 2016, 11:52:05 PM »
Well, I prefer real estate for the following reasons:

1)  Someone else pays down the mortgage when its rented
2)  You can depreciate the property over 27.5 yrs (which reduces taxes)
3)  You can write off repairs, taxes, utilities, management fees, and travel to visit your property (which reduces taxes)
4)  Once a property has significant equity (or paid off), you can take out a HELOC and buy another property, or use for large expenses (kids college, boat, etc).

(2) and (3) you don't get in the stock market.  You can actually have a rental which makes $$$ each year, but end of the year is a net loss on taxes, which offsets your other income.  Stock market can't do that.

EZ

While I'm not completely against real estate, I am now in the process of selling my rentals to buy stocks so I do have some insights into some of the negatives.

1)  Someone else pays down the mortgage when its rented
What about when it's not rented? A month of vacancy totally kills the returns for that year.

2)  You can depreciate the property over 27.5 yrs (which reduces taxes)
Not really. At some point you might want to sell the property. At which time all of the prior years depreciation will be recaptured as regular income in that single tax year. Which means it will be taxed at a very high rate. With stock sales you are taxed at long term capital gains rates which are from 0-15% (closer to 0% for most of us FIRE folks).

3)  You can write off repairs, taxes, utilities, management fees, and travel to visit your property (which reduces taxes)
Writing off doesn't mean you aren't first paying those expenses. Last year I had $7k in plumbing costs after the gas lines were determined to be out of code. Also there was a $3k bill when a tenant flushed a towel down a toilet and flooded the two adjoining units with sewage. That tenant went MIA after trashing the unit so I was stuck cleaning it up. Scooping up dried cat feces was not how I wanted to spend my 4th of July weekend. Whenever my phone rings and it's the property manager my heart skips a beat, it's never good news.

4)  Once a property has significant equity (or paid off), you can take out a HELOC and buy another property, or use for large expenses (kids college, boat, etc).
It's a great plan if everything goes well but I have quite a few friends who had leveraged rental properties in 2006. The ones that didn't foreclose during GFC are still underwater. I have rentals in a small town in Nevada that had a huge Amazon warehouse. They announced it would shut down and I was sure the property values would crash. By pure dumb luck two months later Tesla announced the Gigafactory would be built 10 miles away which saved my bacon. There is a lot of risk in real estate. How would you like to own a bunch of mortgaged properties in Flint, MI right now?

At tax time it is always so complicated with the piles of rental receipts and spreadsheets. I would much rather input a few numbers from the Vanguard statement and be done.




dividend hamster

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Re: Question about RE as an investment vehicle
« Reply #6 on: November 15, 2016, 04:55:23 AM »
1)  Someone else pays down the mortgage when its rented

That's a big issue right there. If it isn't rented you're paying the mortgage and your ROI is ruined. And if you're not in the US you might have strong tenant protection laws. Over here in Germany it can take up to two years to get someone out who doesn't pay rent and knows all the tricks. Some things are more landlord friendly though. You can sell real estate tax free if you've owned it for 10 years and some other things.

I thought about this a lot and even dipped my toes into the landlord pool. I came to the conclusion that it's not an investment vehicle. Investment vehicles are hands off and real estate is a business and even if you have a property manager it's nowhere near "hands off".


If I finance this property over 20 years, using a downpayment of 60k and an interest rate of 3%, I will pay about 16k per year on the mortgage. So my cashflow is negative 4000/year for a cash-on-cash-return of negative 6.7%.

You see how in my case the stock market will probably wipe the floor with real estate.

But, big BUT. You're comparing long term average stock market returns with first year cash on cash real estate returns. That's not exactly a fair comparison. Taxes play a big role in real estate and you'll own the property after the mortgage is paid off. If you're willing to take the risk and the time, real estate can beat the crap out of the stock market. Long term return on equity is where the magic happens. With me the issue is time but that doesn't make it a bad business to be in.

WerKater

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Re: Question about RE as an investment vehicle
« Reply #7 on: November 15, 2016, 08:55:55 AM »
If I finance this property over 20 years, using a downpayment of 60k and an interest rate of 3%, I will pay about 16k per year on the mortgage. So my cashflow is negative 4000/year for a cash-on-cash-return of negative 6.7%.

You see how in my case the stock market will probably wipe the floor with real estate.

But, big BUT. You're comparing long term average stock market returns with first year cash on cash real estate returns. That's not exactly a fair comparison.
That was exactly my point (one of my points anyway). The OP compared a return with a cash-on-cash return and I was illustrating that that is not a valid comparison. Sorry if that did not come across. My point was that the ROI on the property was positive (if not very good) but the cash-on-cash-return was negative.

My second point was that, in my area, real estate is a bad investment (nobody has ever been able to show me a property that I would consider buying for more than about 10 seconds). I am sure there are many other areas where that is also true.

Quote
Taxes play a big role in real estate and you'll own the property after the mortgage is paid off. If you're willing to take the risk and the time, real estate can beat the crap out of the stock market. Long term return on equity is where the magic happens. With me the issue is time but that doesn't make it a bad business to be in.
It's a good business to be in if the numbers fit. But I quoted numbers of 300k purchase price (actually, add about 10% for taxes, RE agent and registration) and about 1500/month in rent. This is reality in my area. In this particular environment there is no way that RE beats stocks on a risk-equivalent basis.

fishnfool

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Re: Question about RE as an investment vehicle
« Reply #8 on: November 15, 2016, 11:50:57 AM »
Op, what is your question regarding RE investing?

We could drum up pros vs cons all day. Some people make money investing, some don't. I'm not going to compare it to the stock market cause it is what it is, as much as I get tired of that expression.  :-)

Enigma

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Re: Question about RE as an investment vehicle
« Reply #9 on: November 15, 2016, 12:10:10 PM »
Investing in property is an avenue for poor/middle class people to become rich over time by making smart choices.  When I have nearly paid off one property, I have more buying power from lenders and I can invest more of other people's money.

While investing in the stock market is an avenue, that will not be the result of borrowing and leveraging someone else's money.  Unless you want to go down the path of buying and selling on margins.

Both are different roads to becoming wealthy.  In my experience investing in property has made me wealthy and investing in stocks hasn't produced the gains I wanted to see.

hucktard

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Re: Question about RE as an investment vehicle
« Reply #10 on: November 17, 2016, 01:54:36 PM »
Comparing real estate and index funds is apples to oranges. Index funds are a passive investment. Real estate is really more of a business or an active investment. Real estate takes work and knowledge, index funds really don't.

I personally love real estate because if you are smart/educated/hard working about your investments you can make a much bigger return than with Index funds. There are a 1000 ways you can make money in real estate.

Everybody will make the exact same returns (approximately) by investing in the same index funds. However, some real estate investors will lose money, while others will make a ton of money, even if they invest in the exact same thing, because skill is involved.

SeattleCPA

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Re: Question about RE as an investment vehicle
« Reply #11 on: November 17, 2016, 03:47:28 PM »
Perhaps it's foolish to wade into this good, spirited discussion. But here are some notions I'd share as CPA who does a fair amount of work with real estate investors.

1. You can make the return calculations for stocks and real estate easily comparable. A stock's return is the sum of the dividend rate plus the growth in the value of the stock. E.g., if the dividend rate is 3% and the price grows by 3%, the return equals 6%. A real estate investments return is the sum of the capitalization rate (income divided by value) and the appreciation rate. E.g., if the cap rate equals 3% and the appreciation rate equals 3%, the return equals 6%.

2. Leverage amplifies returns: E.g., if you're investing in something that earns 6% and you use no debt, you earn 6%. If you're investing in something that earns 6% and you fund a chunk of the purchase price with debt that costs 4%, you jack your returns by picking up that extra 2% spread.

Note: We give away an Excel workbook which does the internal rate of return calculations (so you're including leverage, taxes, etc) here: http://stephenlnelson.com/articles/multifamily-real-estate-investments/

3. In the real world, price-earnings multiples expand and contract and capitalization rates rise and fall over time. That impacts returns mightily.

4. Some people who really dig into the history of these alternatives see real estate as returning something roughly between stock market returns and bond market returns--which makes sense theoretically at least because the fixed contracted lease or rental payment stream resembles a bond and the anticipated by unknown profits beyond that resemble a stock.

5. Developed stock market returns tightly bunch around a median, which many people say reflects lots of market efficiency... and also argues for passive investment.

6. Alternative assets like real estate tend not to tightly bunch around a median, which presumably reflects a lack of market efficiency... and also suggests that while on average investors may lose, the top investors make out like bandits.

Note: It's probably a book you'd only want to borrow from library but the Yale Endowment Fund manager David Swensen has a great book called "Pioneering Portfolio Management" which provides really insightful discussions of traditional asset classes like stocks and alternative asset classes like real estate. Spoiler Alert: Most people probably want to go passive...

BTW, I agree with the posted comments about leverage and management issues of real estate, possibility of leveraging stock investments, and the extra risk of having your eggs in a single basic.

Blindsquirrel

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Re: Question about RE as an investment vehicle
« Reply #12 on: November 17, 2016, 05:55:17 PM »
    Thanks for the calculator! I use a much less complex one that does the job well enough.  RE has pros and cons just like SP500.  It really does depend on what you want to do  and what you want out of an investment. There are a number of astute folks on here who have retired early using RE investments. Arebelspy is a fellow I respect a great deal.  RE has been a good investment for me over the long haul and the passive income that well chosen RE investments kick off can be amazing.  As always, your results may vary. If you invest steadily and reinvest all RE profits, in 10 years or less you will have a very nice income stream that does not depend on your employer.
 HCOL areas are poor for cash on cash yield but can be stunners on appreciation. LCOL may have low to middling appreciation but the cash flow can be mighty nice to off the charts.
    To each his own. I have done it for awhile and the fire hose of cash that it can turn on is impressive. However, do be careful with leverage as it can jack your return up but it can magnify your loses in a horrible fashion.
At the end of the day it is up to you on what you invest in to become FI. RE can do it but RE returns are dependant on your business acumen and market knowledge. Anyone with a secret seminar is selling snake oil but the local REIA or BiggerPockets probably has more multi-millionaires than you would think.