Comparing indexing with real estate investment property?

[Alchemisst]

Anyone have any thoughts on indexing vs investment properties? I am considering doing both mainly due to the cheap(er) leverage availability and tax benefits of property.

Are there any calculators or spreadsheets out there that compare the two? I have tried before but there are a lot of variables to consider.

[Ron Scott]

Have done both (was successfully renting 2 places for quite a few years) and have friends who still do.

At the end of the day, RE is a pain in the ass and index investing has been the better financial investment.

But there are a million stories so…

[aloevera1]

They are so different in terms of hands-on involvement, potential issues, skills required, etc. that no spreadsheet is going to give a valid comparison for you.

You would be better off reading some personal accounts of landlords and figuring out if that is something suitable for you.

[Telecaster]

@arebelspy became FI through real estate and latter did a big comparison, and if memory serves concluded that indexing was superior over the very long term. 

[surpasspro]

I have a rental and when you have a tenant for 10 years an no probelms everything is great.  My 10 year tenant moved out and new tenant is nothing but headaches.  That's with all the vetting that I did, so you just don't know for sure who you get.  Last year had pipes burst in the wall and spent close to $5k.  Old cast iron pipes, so stuff happens and you have to account for repairs.  So, with that said that may be ok for you, but its not a passive endevor.  That's just one rental, so you have to have the stomach for that.  So you can do a little bit a both and see what is best for you.

[rocketpj]

I do both.  The indexes are definitely easier, but the RE (with 2 years of upgrades done by me, 7 years ago) has increased in value by >300%.  Commercial property however, I am not at all interested in residential at this point.  Aside from the increase in value I also have a growing monthly cash return of 1.5% of my initial investment (18% pa).

It can go the other way of course.  I looked at 35 properties over 2 years before picking the one I currently own.  I have looked at about 200 in the last 5 years while considering whether to buy another.  It pays to be picky and careful.

[wageslave23]

Real estate can be better or worse depending on the market and there's no way to predict it. I made a killing on real estate by buying after the housing crisis, but I've also made a killing in the stock market.  When I was young and relatively broke real estate was a good side hustle. Now that I'm further in my career and have plenty of money, real estate is just a hassle. I wish I could snap my fingers and be done as a landlord but it's not that easy. So I wouldnt go the real estate route unless you really have a strong desire for it and a great buying opportunity. Otherwise it's just an annoying part time job.

[vand]

It's a useful as comparing being a self-employed Bricklayer to being a employed Credit Controller. Both are jobs, both are totally different.

[clarkfan1979]

Anyone have any thoughts on indexing vs investment properties? I am considering doing both mainly due to the cheap(er) leverage availability and tax benefits of property.

Are there any calculators or spreadsheets out there that compare the two? I have tried before but there are a lot of variables to consider.

Real estate pretty much always wins out. However, it's not passive. It requires work. If you don't mind the work, it's a great way to boost returns.

I really like the chainsaw analogy for cutting down a tree. It will accomplish the task in a shorter amount of time. However, it requires maturity and patience. If you are reckless, you can cut off your own leg.

[naturalhattrick]

Indexing will have greater returns in the long term, and it is much more passive, opening up free time for self-improvement and actualization. Financial and life quality compounding at the same time.

[wantstoinvest]

Anyone have any thoughts on indexing vs investment properties? I am considering doing both mainly due to the cheap(er) leverage availability and tax benefits of property.

Are there any calculators or spreadsheets out there that compare the two? I have tried before but there are a lot of variables to consider.

Real estate pretty much always wins out. However, it's not passive. It requires work. If you don't mind the work, it's a great way to boost returns.

I really like the chainsaw analogy for cutting down a tree. It will accomplish the task in a shorter amount of time. However, it requires maturity and patience. If you are reckless, you can cut off your own leg.

Indexing will have greater returns in the long term, and it is much more passive, opening up free time for self-improvement and actualization. Financial and life quality compounding at the same time.

Lol, i just do indexing but seeing these two comments back to back made me laugh.

I dont think the analysis could be that strightforward, but I would guess real estate since you can get extremely lucky and buy a prop in a soon to be hot area. Then you can charge whatever you want.

[Laura33]

Anyone have any thoughts on indexing vs investment properties? I am considering doing both mainly due to the cheap(er) leverage availability and tax benefits of property.

Are there any calculators or spreadsheets out there that compare the two? I have tried before but there are a lot of variables to consider.

Real estate pretty much always wins out. However, it's not passive. It requires work. If you don't mind the work, it's a great way to boost returns.

I really like the chainsaw analogy for cutting down a tree. It will accomplish the task in a shorter amount of time. However, it requires maturity and patience. If you are reckless, you can cut off your own leg.

Indexing will have greater returns in the long term, and it is much more passive, opening up free time for self-improvement and actualization. Financial and life quality compounding at the same time.

Lol, i just do indexing but seeing these two comments back to back made me laugh.

I dont think the analysis could be that strightforward, but I would guess real estate since you can get extremely lucky and buy a prop in a soon to be hot area. Then you can charge whatever you want.

If you want to do an apples-to-apples comparison, you'd need to compare owning rentals to owning specific stocks, and index investing to owning REITs.  Both of the individual options can offer the opportunity to hit it big, or crash and burn.  Owning broad swaths will mitigate both the upside and the downside.  Stocks give you the biggest rewards, because stock prices can go up to ridiculous multiples of their initial value; they also give you the biggest risk, because they can go to zero, whereas a property will likely always retain some value.

RE investing is appealing because of the leverage, period.  Sure, you may get lucky and get a bunch of appreciation, but that's not something you can count on -- buying based on future appreciation is just like buying a growth fund because you think the stock market is going up long-term.  The way serious RE investors do it is to buy only those properties that will get them a good ROI based on cash-flow alone.  It is also a long-term play for those of us who don't have access to parental millions.  You use leverage to buy a property, have the tenant pay the mortgage, save (or live off) the profits; then once you have notable equity, you refinance that property and use the money you took out + whatever you've saved to buy a couple of more properties (all of which generate a reasonable profit, too), rinse, repeat, and in 20 years you can have a serious RE empire throwing off lots of cash.

The problem is doing that, consistently, through a variety of markets.  Right now, interest rates make it tougher to find properties that generate significant cash flow; same can also be true when you're in an area with very high property values.  You can buy a clunker of a house that requires lots of repairs, buy into an area or market that goes into the toilet, get a terrible tenant and need lots of lawyers to evict them and more money to pay the damages, etc.  Oh, and when you are identifying properties, you're also competing with professional investors who do this all the time, have contacts who give them the inside scoop on properties and contractors they work with regularly to fix things up, and can generally do things quickly and more efficiently than you.  IOW, it's very much like trying to pick an individual stock when you're competing against all those highly-paid brokers. 

And because you are relying so much on leverage, you are at greater risk if something goes wrong -- you need the rental income to pay all those mortgages, so if a couple of your tenants bail at the same time, or you get something like the big crash of a few years ago, now you've got all the debt with not enough money to pay it.  There's a reason big real estate investment companies often go broke when the current cycle ends. 

Personally, I'd rather avoid the boom and bust to the extent possible, which means index funds and/or REITs.  And I don't know enough about REITs to bother.  I'm also lazy; trying to manage all of those properties to secure my income strikes me as a version of hell (I never did want to be a "property manager" for a career, so why would I choose that as a retirement job?). 

[clarkfan1979]

Oh, and when you are identifying properties, you're also competing with professional investors who do this all the time, have contacts who give them the inside scoop on properties and contractors they work with regularly to fix things up, and can generally do things quickly and more efficiently than you.  IOW, it's very much like trying to pick an individual stock when you're competing against all those highly-paid brokers.

That's a good point. For someone asking the question on this forum, they probably don't have the skills to beat other real estate investors. They are going to get the crumbs, which might not outperform the S & P 500, even leveraged. For me personally, I'm comfortable estimating real estate returns to be better than the S & P 500. However, that is also based on holding onto existing real estate with low interest rates.

And because you are relying so much on leverage, you are at greater risk if something goes wrong -- you need the rental income to pay all those mortgages, so if a couple of your tenants bail at the same time, or you get something like the big crash of a few years ago, now you've got all the debt with not enough money to pay it.  There's a reason big real estate investment companies often go broke when the current cycle ends.

I agree with this point as well. My analogy of leverage was a chainsaw. It can be helpful, but if you are reckless or stupid, you can cut off your own leg.

Personally, I'd rather avoid the boom and bust to the extent possible, which means index funds and/or REITs.  And I don't know enough about REITs to bother.  I'm also lazy; trying to manage all of those properties to secure my income strikes me as a version of hell (I never did want to be a "property manager" for a career, so why would I choose that as a retirement job?).

If someone doesn't want to manage properties that makes sense. It does take a specific skill set and personality. However, my wife can work part-time because we own rentals. Instead of working 2500 hours/year at her previous corporate job, she now works 750 hours/year at two different part-time jobs. My wife works 1750 hours/year less because of our rentals. She is a substitute teacher about 2 days/week and my son's K-5 school. She is also a virtual assistant for a real estate agent. We also do travel that would not be possible with her previous corporate job. She is currently in Hawaii for 10 days at one of our rentals. One of our tenants moved out 15 days early with 15 days left on the lease. My wife is staying at the unit for the last 10 days of the lease in which the previous tenant is still paying rent, but they are not there. We have it immediately rented out the day she leaves. The new person moving in is going to pay for 5 days of rent while it's vacant. My wife could stay another 5 days if she wanted with the new tenant paying for those 5 days. That is just the market there. We used points for the flight. 10 day vacation to Hawaii at pretty much zero cost. She has to pay for a cab to and from the airport in Hawaii.

From my personal experience, the most wealthy real estate investors go after appreciation, not cash flow. They pick neigborhoods in which they can be cash flow neutral, but get the biggest appreciation. They will not go to a lower SES neighborhood to get an extra $100-$200/month of cash flow. That is what people do when they first start out. You eventually graduate from a cash flow investor to an appreciation investor. From my experience, that is the normal progression.

[Laura33]

From my personal experience, the most wealthy real estate investors go after appreciation, not cash flow. They pick neigborhoods in which they can be cash flow neutral, but get the biggest appreciation. They will not go to a lower SES neighborhood to get an extra $100-$200/month of cash flow. That is what people do when they first start out. You eventually graduate from a cash flow investor to an appreciation investor. From my experience, that is the normal progression.

I think the issue with chasing appreciation is that you need to be very, very lucky.  And yes, people in certain areas of the country have been very very lucky, for a long time.  SF, NY, other cities -- prices have boomed.  Historically-low interest rates have been around for so long that most people can't even recall mortgage rates at their current level (my first mortgage was at 8 7/8%, btw -- and I was thrilled it was under 9%!).  But there are also huge swaths of the country where prices have not boomed to that same degree; even after 20 years, for example, I couldn't sell my house for as much as I put into it.  And even when prices do go up, the carrying costs can mean your overall return isn't awesome.  Example:  we have an investment condo that is now worth about 2.5x what we bought it for -- great on paper, eh?  It has been consistently rented and has required very little maintenance.  And our overall annual return has been something like 5%, even without considering costs of selling -- not terrible, but not exactly get-rich level, even with a massive increase in value.  Partly due to unanticipated things, like a condo developer that totally underfunded the reserves and had to be sued.  But also partly because we were focused on whether we could afford the carrying costs vs. assessing it as a pure investment and focusing on net income. 

Obviously, RE investing has been and is still a very good way to wealth, and I don't want to minimize that.  But whenever the housing market is hot, people get all excited about RE -- whether that's flipping, owning rentals, or whatever -- because you see people apparently making lots of money and jump in to do the same.  And I just think it is important that people really focus on the numbers instead of the messages on social media or in the newspapers or whatever.  The one really, really significant benefit that RE offers that index investing doesn't is a pretty firm baseline income from ongoing rents (assuming the whole area doesn't go into the shitter).  That is a huge safety net -- and, as you note, can provide a solid income that can significantly improve your daily life.  And so for someone who is new to the process and considering getting into rentals, I'd very much advise them to focus on properties that provide a positive cash-flow from the start, rather that buying something that is sort of borderline profitable and hoping that interest rates drop and property values in that particular area shoot up.

[ChpBstrd]

It's an apples-and-oranges comparison.

Indexing is a passive investment. Real estate is a job.

The better comparison would be to compare real estate with working a weekend job while investing your cash.

[roomtempmayo]

@Alchemisst as a general rule, people will pay you more to use your cash than they will pay you to use an object of the same value.  The fungibility of money makes it more valuable than physical objects.

The exceptions are:

a) when objects are in short supply so that the market isn't clearing, like in an area with restrictive zoning or physical barriers to growth.

b) when objects are subsidized, as housing often is through credit or tax policy.

Start with the baseline presumption that owning tangible stuff is suboptimal, and then work backwards to think about why that might not be true in your specific case (i.e. because of restricted markets or subsidies).

[Dicey]

I bought my first rental because I wanted to own real estate for the security it represented. I sold it eight years later, and barely broke even.

I bought my second in 2003 because I fell in love with the retirement community. I figured I'd never be able to afford it when I was ready to retire. I was wrong. Twenty-one years later, it hasn't even doubled in value. It is just now exceeding the 1% rule.

When I got married in 2012, DH hadn't even seen the house. When he did, he also liked the area, so we stole bought two more when the market was down in 2015 and 2016. They have done better than the original, but still haven't quite doubled. They are thisclose to the 1% threshold.

The original house has a casita, which we do not rent out. That's where we stay when we're working on the houses. As we are, at this very moment. Two months ago, we spent ten days working on the house, readying it for a new tenant. Happily, we rented it for a significant increase and are finally well above 1%. However, we are here again, just 60 days later, with a fairly long punch list. The garage door opener has decided it's about done, so we bought a new one yesterday and DH is installing it today. We know this because the trusted garage door guy we use said it was only a temporary fix and he didn't know how long it would last. The tenant asked for a cat door, which we have agreed to, so we will install that today. For fire safety, it has to go in a wall, not a door, which means we have to move the W/D over to make room for it (disconnect, reposition, reconnect and hope the hoses are long enough). A shower cartridge died, and a faucet started to leak. The doorbell that worked two months ago is not working now. A new transformer did not solve the problem. There are a couple of other small things on the list that I'm not remembering at the moment. My point is: we went over this place with a fine tooth comb very recently. All but one item on the list happened since we were here last.  BTW, this is only a 20 year old house and it has been well maintained. Oh, and it's about an eight-hour drive one way from our home.

Um, what was your question again?

[clarkfan1979]

I bought my first rental because I wanted to own real estate for the security it represented. I sold it eight years later, and barely broke even.

I bought my second in 2003 because I fell in love with the retirement community. I figured I'd never be able to afford it when I was ready to retire. I was wrong. Twenty-one years later, it hasn't even doubled in value. It is just now exceeding the 1% rule.

When I got married in 2012, DH hadn't even seen the house. When he did, he also liked the area, so we stole bought two more when the market was down in 2015 and 2016. They have done better than the original, but still haven't quite doubled. They are thisclose to the 1% threshold.

The original house has a casita, which we do not rent out. That's where we stay when we're working on the houses. As we are, at this very moment. Two months ago, we spent ten days working on the house, readying it for a new tenant. Happily, we rented it for a significant increase and are finally well above 1%. However, we are here again, just 60 days later, with a fairly long punch list. The garage door opener has decided it's about done, so we bought a new one yesterday and DH is installing it today. We know this because the trusted garage door guy we use said it was only a temporary fix and he didn't know how long it would last. The tenant asked for a cat door, which we have agreed to, so we will install that today. For fire safety, it has to go in a wall, not a door, which means we have to move the W/D over to make room for it (disconnect, reposition, reconnect and hope the hoses are long enough). A shower cartridge died, and a faucet started to leak. The doorbell that worked two months ago is not working now. A new transformer did not solve the problem. There are a couple of other small things on the list that I'm not remembering at the moment. My point is: we went over this place with a fine tooth comb very recently. All but one item on the list happened since we were here last.  BTW, this is only a 20 year old house and it has been well maintained. Oh, and it's about an eight-hour drive one way from our home.

Um, what was your question again?

I think this is a good illustration of appreciation vs. cash flow via the 1% rule. You bought a place in 2003 and it hasn't doubled in value. However, it's now finally exceeding the 1% rule.

I bought a rental in May 2007 for 182K with 10K of rehab and it was probably worth 205K post rehab. It rented for $1350/month, so that is around 0.66%. It's also worth noting that May 2007 was the top of the real estate market, nationally. It's now worth about 525K and current market rent is around $3200/month, which is 0.61%. If rates continue to be above 6.5%, I"m guessing rent increases will outpace price increases and it will eventually get back to 0.66%. It has almost tripled in value and will never be close to the 1% rule. When you get closer to the 1% rule, you get less appreciation.

When it comes to appreciation, luck can help, but it's not necessary. To get appreciation in real estate, you need lots of capital to afford to buy in class A and B neighborhoods that still make sense as a rental. Less experienced real estate investors chase cash flow in class C and D neighborhoods. Nothing wrong with that. It's a great place to start to learn the business.

Self-management is a hybrid business. When you have class A and B rentals, management is minimal. However, when you have class C and D rentals, it can be very time consuming. If I wanted to scale with class C and D rentals, I would hire property management. When it comes to class A and B rentals, it can be very unnecessary.

[TimCFJ40]

We're sitting on a good chunk of index funds, and have looked at jumping over to real estate multiple times.  The two things that kept me away were:
1) In my initial assessment of property values vs rent, cash returns from rent generally barely touched 10% of the initial property value plus repairs if paying cash (subtract your mortgage interest and it gets worse...)  The rest of your returns are depending on appreciation, which could be great as it has been in some markets, or could be negative.  There's some trending that could be done to predict appreciation, but we've all seen those types of predictions be wrong.
2) The best deals don't hit the MLS, or make it out of the closed circles of the RE community.  Most of the future appreciation potential comes on the purchase side.  Either you've got to have an inside deal, or you need to have a vision that others don't (and lots of those others are experienced investors).  Well priced fixer-uppers get bought by investors.  Overpriced fixer-uppers get bought by homeowners with a dream and no idea what it's going to cost them. Don't be the second and then call it an investment. 
That said, if I were to have an inside look at a deal (say neighbor selling off/below market or something similar) that was a significant bargain, I'd consider...

[clarkfan1979]

We're sitting on a good chunk of index funds, and have looked at jumping over to real estate multiple times.  The two things that kept me away were:
1) In my initial assessment of property values vs rent, cash returns from rent generally barely touched 10% of the initial property value plus repairs if paying cash (subtract your mortgage interest and it gets worse...)  The rest of your returns are depending on appreciation, which could be great as it has been in some markets, or could be negative.  There's some trending that could be done to predict appreciation, but we've all seen those types of predictions be wrong.
2) The best deals don't hit the MLS, or make it out of the closed circles of the RE community.  Most of the future appreciation potential comes on the purchase side.  Either you've got to have an inside deal, or you need to have a vision that others don't (and lots of those others are experienced investors).  Well priced fixer-uppers get bought by investors.  Overpriced fixer-uppers get bought by homeowners with a dream and no idea what it's going to cost them. Don't be the second and then call it an investment. 
That said, if I were to have an inside look at a deal (say neighbor selling off/below market or something similar) that was a significant bargain, I'd consider...

Well said. Great analysis.

[Baguvixx]

I went with index funds for simplicity and low effort, but I’ve seen friends do really well with rentals once they got systems in place and didn’t mind occasional headaches.

[Dicey]

I bought my first rental because I wanted to own real estate for the security it represented. I sold it eight years later, and barely broke even.

I bought my second in 2003 because I fell in love with the retirement community. I figured I'd never be able to afford it when I was ready to retire. I was wrong. Twenty-one years later, it hasn't even doubled in value. It is just now exceeding the 1% rule.

When I got married in 2012, DH hadn't even seen the house. When he did, he also liked the area, so we stole bought two more when the market was down in 2015 and 2016. They have done better than the original, but still haven't quite doubled. They are thisclose to the 1% threshold.

The original house has a casita, which we do not rent out. That's where we stay when we're working on the houses. As we are, at this very moment. Two months ago, we spent ten days working on the house, readying it for a new tenant. Happily, we rented it for a significant increase and are finally well above 1%. However, we are here again, just 60 days later, with a fairly long punch list. The garage door opener has decided it's about done, so we bought a new one yesterday and DH is installing it today. We know this because the trusted garage door guy we use said it was only a temporary fix and he didn't know how long it would last. The tenant asked for a cat door, which we have agreed to, so we will install that today. For fire safety, it has to go in a wall, not a door, which means we have to move the W/D over to make room for it (disconnect, reposition, reconnect and hope the hoses are long enough). A shower cartridge died, and a faucet started to leak. The doorbell that worked two months ago is not working now. A new transformer did not solve the problem. There are a couple of other small things on the list that I'm not remembering at the moment. My point is: we went over this place with a fine tooth comb very recently. All but one item on the list happened since we were here last.  BTW, this is only a 20 year old house and it has been well maintained. Oh, and it's about an eight-hour drive one way from our home.

Um, what was your question again?

...And the same property just had a sewage backup caused by tree roots. The plumber augered it out, but noted there were two blockages, one at 4.5' and the other at 5'. We gave him $5500 to make the problem go away. He did it in a day, and the house looks exactly the same as it did before. Ouch.