Stocks DO beat real estate in the long run, even with leverage

[Bearded Man]

I'm posting here rather than in the real estate and investing forums because I want to avoid biased opinions.

​I've been running the numbers and although real estate has been very attractive to me with leverage (I own 3 properties), running the numbers even with leverage real estate is not as attractive in the long run, because although you are earning higher CoC returns on leveraged real estate, the reality is the asset itself is eventually deleveraged once paid off, and it didn't appreciate in value as much as stocks would have over the same period. Over time, the advantage of leverage is removed, and you're left with an asset that barely kept pace with inflation. Even Seattle has been at 3-4% over the last 20+ years when averaged.


If I buy a 100K house that appreciates 3% over the long run (per study by famed economist who called the last crash, Robert Shiller), in 30 years I have 242,726.25 dollars. Not only is this a petty return, since it just keeps up with inflation, I got to pay for all kinds of repairs during that time.

Even if I Buy the house with leverage, due to the low appreciation rate, I'm still not earning that much. When you compare it with stocks:

100K invested in an index fund that earns 10% a year over 30 years, gives me: 1,744,940.22

To make it even worse, a 4% safe withdrawal rate for the actual value of what my assets would be in these two scenarios, I'm making about 900K a year in SWR eligible funds, compared to a paltry fraction of that with my real estate, which is ultimately a job. Even if we continue with the numbers for the above two scenarios, you are making $20,391 a year in profits after expenses (all rents and expenses adjusted for inflation of 3%) from the house being rented out, compared to what I could be making with the stocks $69,797

Am I wrong here? Was initially thinking real estate was the way to go, and it has certainly been good to me buying during the downturn, but I think I may be better off cashing out and putting 500+K to use in the market. Maybe not now, with the run up, but DCA over time.

[nereo]

The primary value of real-estate holdings is the income you get from renters. If your repairs, vacancies and taxes exceed the income from renters your properties are doing poorly, especially compared to the stock market
 Appreciation tends to keep up with inflation protecting principle).  Tax depreciation is just icing.

Also, someone correct me if I am wrong but another major strength of real estate holdings is that they do not have the volatility that stocks do. 

[Bearded Man]

The primary value of real-estate holdings is the income you get from renters. If your repairs, vacancies and taxes exceed the income from renters your properties are doing poorly, especially compared to the stock market
 Appreciation tends to keep up with inflation protecting principle).  Tax depreciation is just icing.

Also, someone correct me if I am wrong but another major strength of real estate holdings is that they do not have the volatility that stocks do.

The numbers I posted clearly point out that the income from stocks is FAR higher, in fact, a stock portfolio would pay you far more income with less hassle. Real estate is volatile, not only in prices, but also in risk you are exposed to (loss, law suit, severe damage due to a meth lab or something similar, etc.). But the volatility doesn't concern me as much as the loss in income.

[concealed stache]

Related to nereo's reply, but what are you doing with your rental cashflow during those 30 years? You mention "$20,391 a year in profits after expenses (all rents and expenses adjusted for inflation of 3%) from the house being rented out" so there clearly is some. In the case of the index fund, you are clearly reinvesting all dividends/not harvesting cap gains, as you're using a compounded gain. In that case, surely you should be investing (in some kind of other asset such as the index fund, or into snowballing down the leverage on your real estate and further increasing the net cashflow for larger investments/paydown) to get truly comparable numbers. Maybe you are but it doesn't quite read that way to me.

[Telecaster]

The numbers I posted clearly point out that the income from stocks is FAR higher, in fact, a stock portfolio would pay you far more income with less hassle. Real estate is volatile, not only in prices, but also in risk you are exposed to (loss, law suit, severe damage due to a meth lab or something similar, etc.). But the volatility doesn't concern me as much as the loss in income.

The less hassle part is certainly true, but you aren't posting enough information to let us evaluate your numbers.   Where did that  $20,391 a year number come from?   

The way real estate works (typically and simplified) is let's say you are evaluating say, $200,000 property that generates $15,000 in return after all expenses--not including interest.   If you put 20% down and borrow the rest, you get that $25,000 annual return for only $40,000, minus mortgage costs on the balance, which is about $10K.   So for a $40K investment (20% of $200K), you get an annual return of $5K/year, with is 12%   That's a good rate of return.  And hopefully overtime, rents will increase, but one of your main expenses, the mortgage, stays the same.   At the end of 30 years, you own the house and made a bundle of money on that $40.   

Obviously, that's a hypothetical but that's how it works in a nutshell.   And that's why leverage works in real estate.   

[MrsPete]

But you're ignoring one thing:  If you're talking about a primary residence, you can live in it AND see it increase. 

[okobrien]

Bearded Man, you talk about comparing a leveraged house to non leveraged stocks but then you compute a non leveraged house purchase. You should compute your return on $20,000 worth of stock to your $100k house to account for the standard leverage.

[SwordGuy]

Go read this book:

http://www.amazon.com/gp/product/0071603271?keywords=real%20estate%20in%20books&qid=1445302217&ref_=sr_1_4&s=books&sr=1-4

Then you'll have the knowledge on the real estate side to run the numbers.

[nereo]

Bearded Man, you talk about comparing a leveraged house to non leveraged stocks but then you compute a non leveraged house purchase. You should compute your return on $20,000 worth of stock to your $100k house to account for the standard leverage.

or consider stocks leveraged 5:1, and see what dangers that would theoretically hold (volatility).

Telecaster said it more eloquently than I - but you are computing the net returns ont he money invested.  Appreciation is often flat so that's simply protection of principle.

[okobrien]

Go read this book:

http://www.amazon.com/gp/product/0071603271?keywords=real%20estate%20in%20books&qid=1445302217&ref_=sr_1_4&s=books&sr=1-4

Then you'll have the knowledge on the real estate side to run the numbers.

Thanks for the book suggestion SwordGuy, I think I will add that to my list.

[Dr. Pepper]

I started typing out a long response to this but it got way to involved. Suffice to say that I think your correct with the conclusion, however the reasoning is way off.

1. Levered vs unlevered- you can continue to leverage the house, it can be paid off and then you take out another loan and do something productive with the money, in the same vein stocks can also be leveraged to different extents. This in and of itself does not make one superior to the other, its just a way to manipulate the return by adding risk.

2. I think the 10% scenario may be a fairly rosy prediction going forward, most likely we are not going to see that kind of compound return over the next three decades, just look at where the DOW is, with your math in 30 yrs we will see DOW at 300,000. That historical 10% number that is thrown around everywhere is based on so many factors which may not turn out to be true in the future. For example our currency remaining the reserve currency for the world for the next 30 years.

[Bearded Man]

Related to nereo's reply, but what are you doing with your rental cashflow during those 30 years? You mention "$20,391 a year in profits after expenses (all rents and expenses adjusted for inflation of 3%) from the house being rented out" so there clearly is some. In the case of the index fund, you are clearly reinvesting all dividends/not harvesting cap gains, as you're using a compounded gain. In that case, surely you should be investing (in some kind of other asset such as the index fund, or into snowballing down the leverage on your real estate and further increasing the net cashflow for larger investments/paydown) to get truly comparable numbers. Maybe you are but it doesn't quite read that way to me.

I could include dividends in either figure, for the rental income or stocks, and stocks still win by a landslide.

[Bearded Man]

The numbers I posted clearly point out that the income from stocks is FAR higher, in fact, a stock portfolio would pay you far more income with less hassle. Real estate is volatile, not only in prices, but also in risk you are exposed to (loss, law suit, severe damage due to a meth lab or something similar, etc.). But the volatility doesn't concern me as much as the loss in income.

The less hassle part is certainly true, but you aren't posting enough information to let us evaluate your numbers.   Where did that  $20,391 a year number come from?   

The way real estate works (typically and simplified) is let's say you are evaluating say, $200,000 property that generates $15,000 in return after all expenses--not including interest.   If you put 20% down and borrow the rest, you get that $25,000 annual return for only $40,000, minus mortgage costs on the balance, which is about $10K.   So for a $40K investment (20% of $200K), you get an annual return of $5K/year, with is 12%   That's a good rate of return.  And hopefully overtime, rents will increase, but one of your main expenses, the mortgage, stays the same.   At the end of 30 years, you own the house and made a bundle of money on that $40.   

Obviously, that's a hypothetical but that's how it works in a nutshell.   And that's why leverage works in real estate.

And if you read my post above, you will note that regardless of your use of leverage, a one time investment of the same dollar amount STILL gives stocks a net worth FAR higher than a house would, and produces FAR more income, with less hassle and risk. Leverage doesn't make up for an asset that only keeps pace with inflation, because one day the house is paid off, and your asset is basically just maintaining your purchasing power. It doesn't really increase your wealth or provide income like a similar investment in stocks would. This is the key point you seem to be missing.

[Bearded Man]

Bearded Man, you talk about comparing a leveraged house to non leveraged stocks but then you compute a non leveraged house purchase. You should compute your return on $20,000 worth of stock to your $100k house to account for the standard leverage.

As I already stated, it doesn't matter whether you use leverage, stocks still win by a landslide. I've already calculated it every way from Sunday, stocks win in the long run no matter what. I don't care if you pay cash for the house or leverage three of them with 100K (25% down, closing costs, etc.). Stocks still come out ahead.

[Bearded Man]

Go read this book:

http://www.amazon.com/gp/product/0071603271?keywords=real%20estate%20in%20books&qid=1445302217&ref_=sr_1_4&s=books&sr=1-4

Then you'll have the knowledge on the real estate side to run the numbers.

Ummm...why don't you post some actual numbers? This is what I have yet to see a single person in any forum do on this subject. I own multiple rental properties. I've learned from some of the best real estate investors in the country. I understand real estate. I also understand basic math. Rather than posting a book that tells me what I already know, why don't you post a logical, numbers based argument on how real estate beats stocks?

And please, don't be one of these guys who posts that he can buy 10 houses with no money down and no closing costs. Whatever...

[matchewed]

I don't see rental income at all in your numbers, just an appreciation %.

[Rewdoalb]

...4 straight posts bragging about "actual numbers", but it seems that your numbers are incomplete and perhaps flawed as well.

First, on the stock side, don't use average return. Use CAGR. Second, as others have said, show details on rental income especially as it increases over time / mortgage stays constant.  The burden of proof for " actual numbers" is back to you until you address the concerns that people keep addressing.

[nereo]

Bearded Man, you talk about comparing a leveraged house to non leveraged stocks but then you compute a non leveraged house purchase. You should compute your return on $20,000 worth of stock to your $100k house to account for the standard leverage.

As I already stated, it doesn't matter whether you use leverage, stocks still win by a landslide. I've already calculated it every way from Sunday, stocks win in the long run no matter what. I don't care if you pay cash for the house or leverage three of them with 100K (25% down, closing costs, etc.). Stocks still come out ahead.

Several sharply worded replies... I'll choose this one to respond to.  It very well may be that a theortical stock portfolio returning 10% beats the returns you are getting from your rental properties.  Also, landlording certainly is more work than piling everything into an index fund and forgetting about it - no arguments there.  Where I differ is your suggestion that stocks always win, "no matter what."

Let's use an example - you purchase a textbook duplex for $100k with an expected monthly rent from each unit of $1k ($2k gross each month).  Using the 50% guideline, half your rent goes towards vacancy, operating expenses, repairs and renovations, leaving you a net of $12k/year from your rental or $500/month from each rental.  You purchased the home with $20k down and a 30yr note at 4%.  This gives you a monthly mortgage payment of $381.93.  Your annual profit will be $7,416.  If you do nothing more than place that in a savings account earning 0% real returns, your net profits from rent after 30 years would be $222,480 + $100k (property) = $322.5k.  Your annualized returns on the original, leveraged investment of a $20k down payment was 9.7% - and that's with dumping all the profits in a stupid savings account and not putting all those green-employees continue to work. 
The obvious solution for landlorders is to keep buying properties.  After just the first ~decade you would have enough income to buy - with cash - a similar duplex, doubling cash flow.  By the end of the third decade you could have 3 or 4 duplexes, each generating $7k cash.

Since that's a bit complex to graph out, let's look at a 'hybrid approach' where you dump all of your net profits from the duplex into a index fund, and compare how THAT would do to just investing the original down payment into the market instead. 
Same scenarios as above - with a $20k down payment you could buy a duplex that throws off $7.4k after expenses.  Investing the profits you will have $1.44MM after 30 years (including the $100k property that just kept up with inflation).

Let's compare this to how you would have fared if you had taken your $20k and put it into an index fund.  After 30 years you would have $349k.  Your figure of $1.7MM would necessitate that you had $100k on hand to begin with, or that you leveraged your holdings 5:1 (difficult or impossible to do).  If you can somehow figure out how to take the $20k and get a bank to loan you $100k on the same terms (30yr fixed at 4%) you STILL wind up with less than the 'hybrid' example above - $905,109.

[Telecaster]

And if you read my post above, you will note that regardless of your use of leverage, a one time investment of the same dollar amount STILL gives stocks a net worth FAR higher than a house would, and produces FAR more income, with less hassle and risk. Leverage doesn't make up for an asset that only keeps pace with inflation, because one day the house is paid off, and your asset is basically just maintaining your purchasing power. It doesn't really increase your wealth or provide income like a similar investment in stocks would. This is the key point you seem to be missing.

Somebody is missing something.  If your first post, you didn't include rents or leverage in your calculations.     You used an investment of $100,000 in a house with no leverage or rent vs. $100K in stocks.    But $100,000 can buy a $500,000 house.   Now include rental income (minus expenses) and appreciate $500,000 out for 30 years. 

[index]

Bearded Man,

I was interested by this assertion and it turns out you are right based on the scenarios below:

Scenario A : You have 150k in cash and choose to buy a house with it outright or invest it in the stock market

Buy a 150k house appreciates at 3%/yr. Tax and maintenance liability is 2% of value per year- lets model this over 30 years.
So - 150k appreciating at 3% minus (tax and maintenance) 3k appreciating at 3% = $155,188

or

Put 150k in the stock market making 10% per year. Your rent is $1000 per month (12k per yr) increasing at 3%. 30 years -
So - 150k @ 10% minus 12k (housing liability) at 3% = $179,289

Scenario B: you have a 30k down payment and choose to borrow money at 4.5% for 30 years or invest in the stock market, hold housing cost constant at 12k between the two-

Buy 150K house with 20% down (30K) @ 4.5% - payment is $608/mo ($7300/yr) liabilities (tax maintenance insurance) are 3k per year growing at 3% - you have  $1700 left over to invest @ 10% vs the 12k housing liability after you pay for housing expenses.
So - 150k @ 3% + 1.7k annual annuity @ 10% - 3k expenses @ 3% = 435K

Put 30k in the market at 10%.
So 30K at 10% = 595k

To break down this scenario further - buying a house @ 4.5% interest for 20% down when housing costs are 85% of rental costs (meaning you have to buy a house when it makes sense to buy a house) provides a CAGR of 9.3% over 30 years. You would have to perform the scenario for every real estate transaction to see if it makes sense.

If you look at the first scenario, housing returns essentially nothing after taxes and maintenance meaning housing only makes sense when buying > renting.

I think the long term return from the stock market will be ~7.5%. If we use 7.5% as the CAGR from the stock market we can calculate how much cheaper housing must be than renting for buying a house to make sense.

In the above scenario 30k @ 7.5% for 30 years becomes 262k.

The home at the end of 30 years is worth 155k after expenses so for housing to be favorable -> (262k  - 155k) 107k = annual savings of owning over renting compounded at 7.5%. so - Annual Savings*(1.075)^30 = 107k  - I used this caluclator http://www.calculatorsoup.com/calculators/financial/savings-calculator.php to get: $910/yr

This means [1 - (910/12,000)] housing costs must be 92.4% or lower when compared to renting to make home ownership a better investment than investing your down payment in the market and renting for 30 years.   
     

[Terrestrial]

2. I think the 10% scenario may be a fairly rosy prediction going forward, most likely we are not going to see that kind of compound return over the next three decades, just look at where the DOW is, with your math in 30 yrs we will see DOW at 300,000. That historical 10% number that is thrown around everywhere is based on so many factors which may not turn out to be true in the future. For example our currency remaining the reserve currency for the world for the next 30 years.

This makes no sense.   The size of the index is immaterial because returns are exponential in nature.   I'm sure in the 50's when the S&P was in the teens, the index breaking 2000 seemed impossibly large as well.  One day in the future (baring collapse/catastrophe), the S&P will probably be at 10,000, and then 100,000.  There's a reason it makes alot more sense to look at long term stock growth on a log scale to get perspective.

I will absolutely agree with you that there is no 'guarantee' of 10% going forward as past results do not guarantee future returns.  I do not use 10% myself when I do personal projections...but using 'the Dow would be really big' as the reason is not valid IMO.

[concealed stache]

Go read this book:

http://www.amazon.com/gp/product/0071603271?keywords=real%20estate%20in%20books&qid=1445302217&ref_=sr_1_4&s=books&sr=1-4

Then you'll have the knowledge on the real estate side to run the numbers.

Ummm...why don't you post some actual numbers? This is what I have yet to see a single person in any forum do on this subject. I own multiple rental properties. I've learned from some of the best real estate investors in the country. I understand real estate. I also understand basic math. Rather than posting a book that tells me what I already know, why don't you post a logical, numbers based argument on how real estate beats stocks?

And please, don't be one of these guys who posts that he can buy 10 houses with no money down and no closing costs. Whatever...

I have over 70 doors and never put a penny down. 5 separate loans. No funny business. I definitely paid closing costs, but borrowed that money too. So far the carry is superb. I am not saying these opportunities turn up every day, but they are not impossible. Still, I happen to prefer stocks to real estate as well. But more because of their truly passive nature (when using tracker funds) and lack of day to day worry. I'm still not quite able to follow your numbers, not that that means they are wrong necessarily.

[Lowerbills]

Bearded Man, you talk about comparing a leveraged house to non leveraged stocks but then you compute a non leveraged house purchase. You should compute your return on $20,000 worth of stock to your $100k house to account for the standard leverage.

Let's use an example - you purchase a textbook duplex for $100k with an expected monthly rent from each unit of $1k ($2k gross each month). 

I think Nereo hit at the crux of this.  I would buy $100,000 duplexes that rent for $2k all day!  And rental properties that meet that criteria, likely will outperform index investing.  But rental properties where the gross rent is 1% or less will likely underperform.

Bearded - on your 3 rentals what are your monthly rents as a % of purchase price?

In my experience however, these "textbook" 2% duplexes aren't exactly laying around waiting to be purchased.

[nereo]

In my experience however, these "textbook" 2% duplexes aren't exactly laying around waiting to be purchased.

They are definitely hard to find at times, and that's one of the key points I'd like to make with this thread.  Many, many rentals situations do not do well when compared with the market.  Some don't even beat inflation after you factor in vacancies, repairs, upgrades, etc.

The idea that any rental is a good investment is just as ludicrous as the idea that owning a home is always a good investment.  I think a lot of people have been led down the landlording path by the siren's call of outsized returns without really understanding the fundamentals.  It is work, and you can't always find rentals that will beat a simple index fund.

The reality is that each situation is different.  Some will crush the market with lower volatility. 

[rob in cal]

   I think one of the key points in all this discussion is at what monthly rent vs purchase price ratio does real estate beat the market (assuming historic rate of return for the market)?  Seems to me its a little bit, (or maybe a lot) above 1.0, but somewhere below 2.0.

[clarkfan1979]

   I think one of the key points in all this discussion is at what monthly rent vs purchase price ratio does real estate beat the market (assuming historic rate of return for the market)?  Seems to me its a little bit, (or maybe a lot) above 1.0, but somewhere below 2.0.

This is a good point. Why type of return is needed in real estate to beat a 8% market return?

Real estate is always at the local level. It might not make sense to buy in some parts of the country, but it does in others. The market is going to be at the national level and more standard.

[Davids]

I stick with REITs as part of my overall portfolio, i have no desire take on the hassle of owning rental properties.

[JustGettingStarted1980]

Following...great discussion here

[jfisher3]

Tagged to follow... suddenly I'm considering flipping houses and investing more than than buy-and-hold...

[SwordGuy]

Go read this book:

http://www.amazon.com/gp/product/0071603271?keywords=real%20estate%20in%20books&qid=1445302217&ref_=sr_1_4&s=books&sr=1-4

Then you'll have the knowledge on the real estate side to run the numbers.

Ummm...why don't you post some actual numbers? This is what I have yet to see a single person in any forum do on this subject. I own multiple rental properties. I've learned from some of the best real estate investors in the country. I understand real estate. I also understand basic math. Rather than posting a book that tells me what I already know, why don't you post a logical, numbers based argument on how real estate beats stocks?

And please, don't be one of these guys who posts that he can buy 10 houses with no money down and no closing costs. Whatever...

Because I'm in the process of rehabbing a rental, buying a new house for myself, prepping to rehab another rental I've already bought, preparing to move into the new house and out of our old house, prepping our old house for resale, trying to sell my recently deceased mother's house and settle her estate, keep the cat boxes clean, keep my bosses at my day job happy, get enough sleep, and chase my wife around any of those houses we happen to be in - not necessarily in that order of priority.

But your original example didn't properly address rental income, tax sheltered depreciation, leverage, property appreciation (which may beat or lag inflation by quite a lot!), and reinvestment of profits on the rental property side.  That's why I recommended the above book.  It covers how to do the numbers the right way and does so in a very clear and interesting manner.  (At least as interesting as such a subject can be...)

As for buying properties with no money down and without closing costs coming out of my pocket, no, I haven't done that - yet.  But I've learned how it can be done and, had I known it last January, I could probably have pulled it off the no money down part on our 2nd rental.   Closing costs I would have had to pay on that one.

[SwordGuy]

Oh, one more thing.

I don't buy $100,000 houses that are worth $100,000 and rent them out.  That's crazy talk.

I buy $80,000 houses for $30,000 to $38,500 and fix them up.  After fix-up costs are included in the purchase price, I'm paying $47,000 to $55,000 for an $80,000 house.

That's an pretty good rate of return even before I rent them out...

And there are a lot of them like that in my very good rental property area, too.

[clifp]

Eventhough I've been arguing for real estate recently. I am primarily a stock guy, I made most of my money in the stock market and I'm far more knowledgeable about stocks than real estate.
The real  answer is stock haven't always beat real estate and as far the future goes who the hell knows.  Historically in some markets real estate has done very well, and if you are a smart real estate investor who is willing to look outside your home turf (like Arebelspy) you can do fabulously well.

Leverage and patience are the keys  to making great returns in real estate, but it is a double edge sword and if we learned anything from the financial crisis its that home prices can drop in the US and in some case quite a bit.

I'm going to the Bay Area tomorrow for a visit, and while I'm there I'll stop by and see my first house.
I bought in 1985 for $153,000. I put 10% down with a roommate and we had 14.75% mortgage with negative amortization.  After refinancing to an adjustable which went down every year, and buying my partner out, I sold it in 1999 for $444K.   In addition to my co owner I had up to 3 roommates (5 bedroom houses) and generally had one until the very end. So my mortgage within a couple of years was significantly less than rent. If hadn't sold it I and stayed there I'd probably have a paid off mortgage this year. Now the $15,300 which was probably closer to 17K after closing cost etc. would have increased 1132% and be worth $192,400.  However, that pales next to the property which has increased by 8% a year for the last 30 years and Zillow says in now worth $1, 523,000. Other than buying Apple stock I think you'd be hard press to find a stock investment which would come close to that property.  (I should add there isn't anything special about the property other than being in the heart of Silicon Valley.

It's also worth noting that I've been following this property for 30 years, and the rent vs sale price has always been in the 4-5% range. In fact, the poor rent-price ratio is one of the reasons I was never tempted to keep the property.

There is no question that real estate is a lot more work than buying an index fund. In fact even though rental properties are only about 7%, I probably spent almost as much time dealing with them as I do my portfolio of 40+ individual stock, MLPs, and ETFs.

[mr_orange]

I buy $80,000 houses for $30,000 to $38,500 and fix them up.  After fix-up costs are included in the purchase price, I'm paying $47,000 to $55,000 for an $80,000 house.

That's an pretty good rate of return even before I rent them out...

And there are a lot of them like that in my very good rental property area, too.

This.

To be fair this is not really purely "investing" though and it requires at least some labor and business management.  Even if you account for your labor at some bill rate on these projects and include that in what you count as your contribution real estate will beat the pants off of what "stocks" (I assume this is confined to index funds for this discussion) delivery long-term.  The best way to return an optimal amount on the equity you contribute is to sell immediately and then repeat the process.  Many people choose to NOT do this and to generate cash flows instead so that they can later avoid working. 

[totoro]

Am I the only one who finds it annoying when people make assertions without enough factual information to run the numbers and compare?

Please post detailed financials and you'll get a detailed response.   

[mr_orange]

From the OP's original thread comment it is apparent that he intends to hold the projects indefinitely and generate yields from them.  What is unclear is what "real estate" means.  There are literally thousands of different ways to profit from real estate just like there are with investing in other vehicles.  Thus doing a detailed comparison is impossible given the lack of information. 

However, I will make the assumption that he is referencing residential real estate held as a rental.  If you use this as an example you'd need to know what type of rentals are available in his deal flow and use an IRR calculation with the discount from the going-in discount being realized at the reversion cash flow.  The project would presumably generate positive cash flow during the hold period as well if it was purchased correctly.  A general rule of thumb is to try to get at least $100/door/month in positive cash flow; or $1200/year.  If you find the right project and can force appreciation by rehabilitating it or finding a situation where you can purchase equity at a discount in a distressed sale you'll have red meat from day 1. 

In this situation the cash flow patterns will look like:

Year 0 - (Initial Investment)
Year 1 - $1200
Year 2 - $1200
.
.
.
Year N - $1200 + realized equity from initial purchase and forced appreciation + appreciation + quantity of loan amortized

This assumes a fully-amortizing loan and that the property is not part of an exchange to avoid recapture taxes.  If you run numbers like this you'll probably find that the real estate DOES under-perform index investing because the leverage is no longer enhancing the small real yields from the project in the latter years.  This is because the investment was held long past the optimal sell year. 

People generally don't invest in real estate in this manner.  They generally hold it for other purposes or exchange to larger properties.  The real estate also helps with taxes if you do it properly.

Anyway....yeah, this thread is impossible to address in the abstract.  Comparing one single type of real estate investing under one set of holding period assumptions to investing in index funds forever is a futile exercise IMO. 

[totoro]

Yes.  And in Canada if you are investing in RE you don't just wait and pay down the properties and leave your money unleveraged.  You borrow against the equity and invest it again, whether through stocks or RE.  Interest on the borrowing is tax deductible.   Without analyzing a specific situation who knows what is going on that is lowering the ROI - or not.

[mr_orange]

Yes.  And in Canada if you are investing in RE you don't just wait and pay down the properties and leave your money unleveraged.  You borrow against the equity and invest it again, whether through stocks or RE.  Interest on the borrowing is tax deductible.   Without analyzing a specific situation who knows what is going on that is lowering the ROI - or not.

Yup....borrowing against the property again is not a taxable event and you could increase the leveraged yields in this manner too.  We have to assume that the loan amortizes normally though given the way this thread was set up ;-)

The capacity to get nice leverage with real estate and not have the equivalent of margin calls is one of the main great features.  If you remove this feature then the benefits aren't as good.  The original analysis failed to account for appreciation, depreciation, and amortization and didn't give any analysis of when the cash flows would need to be realized to support whatever the investor was trying to support. 

[Miss Prim]

I'm not a financial wiz, but I do like those rental dollars coming in every month!  I think of our rental property as diversifying our portfolio.  I do have some REIT exposure also. 

The best money from renting has come from our basement apartment which basically costs us nothing because we have to heat that space anyway and our renter loves it so much here (4 acres) that he will take care of our chickens and dog while we are on vacation and he mows the lawn for fun!

                                                                                      Miss Prim

[Bobberth]

I'm not going to do any math to work this out as I don't care to convince anybody, but what has been grating on me since first reading this is the comparing of buying real estate at full value for income to being aggressively invested in 100% stocks and saying that stocks are better. It just doesn't feel right to me. Buying nearly anything for the sole purpose of income now will provide lower expected returns than something purchased solely for growth. It's like comparing the returns of stocks and bonds and claiming, hands down, that stocks are better. Not necessarily, they are meant to do totally different things. Maybe comparing a 60/40 portfolio to rental real estate or the investing of $80k for a $100k property, or buying more properties with the rental income, or buying in a high growth market with low or negative cash flow are better comparisons.

Looking at 30 years of compounded growth in stocks, by math, the vast majority of that growth comes in the last 10 years. If you work diligently in real estate (reinvest rents, use leverage, buy right, add value, pull out equity etc), in 10-20 years most can probably create enough income to retire on. So there are 10-20 years of opportunity costs lost to building that stock nest egg to create that ultimately bigger income with stocks. I started by buying my first rental nearly 7 years ago. Yes it was quite the opportunity with the housing crash but if I added up the purchase prices of all the properties I have bought (purchase price, not actual cash/downpayments I put in) and would have invested it at the absolute bottom of the stock market, using the 4% withdrawal rate, I am making more income on my rentals right now. As the stock market keeps going up, at some point that will change and in 2039, after 30 years, I could no doubt kick myself for not investing everything in stocks instead of real estate. But at that point, I will be retired for at least 9 years (probably much sooner) and have assets and income that theoretically keep up with inflation so I will probably be too busy to really worry about how much I could spend if I would have chosen just stocks.

But you have to remember, rental real estate is a business, not an investment. So it's very tough to compare to stocks.

[Roland of Gilead]

Oh, one more thing.

I don't buy $100,000 houses that are worth $100,000 and rent them out.  That's crazy talk.

I buy $80,000 houses for $30,000 to $38,500 and fix them up.  After fix-up costs are included in the purchase price, I'm paying $47,000 to $55,000 for an $80,000 house.

That's an pretty good rate of return even before I rent them out...

And there are a lot of them like that in my very good rental property area, too.

This has some real risk if you do not know what you are doing and can fail even if you do (repair costs could spiral because of unknowns)

I would equate it to being able to pick undervalued individual stocks, which also involves risks and can fail, but if it succeeds, delivers returns far better than 10% a year.

Buying a $100k house for $100k is a better comparison to buying a stock index.  Buying a $80k fixer upper for $30k is like buying Apple for $95 the other day when it flash crashed.

[mr_orange]

Buying a $100k house for $100k is a better comparison to buying a stock index.  Buying a $80k fixer upper for $30k is like buying Apple for $95 the other day when it flash crashed.

The reason that this statement is incorrect is because the real estate markets are not efficient like the stock market generally will be.  There are not hoards of investors setting the market prices correctly on a femto-second basis.  Distressed sales happen all the time as do sales to investors that are offering far less than what other buyers would offer. 

In this type of environment it is far easier to identify mismatches between price and value than it is in markets with supercomputers trading out any inefficiency at light speed. 

[matchewed]

Oh, one more thing.

I don't buy $100,000 houses that are worth $100,000 and rent them out.  That's crazy talk.

I buy $80,000 houses for $30,000 to $38,500 and fix them up.  After fix-up costs are included in the purchase price, I'm paying $47,000 to $55,000 for an $80,000 house.

That's an pretty good rate of return even before I rent them out...

And there are a lot of them like that in my very good rental property area, too.

This has some real risk if you do not know what you are doing and can fail even if you do (repair costs could spiral because of unknowns)

I would equate it to being able to pick undervalued individual stocks, which also involves risks and can fail, but if it succeeds, delivers returns far better than 10% a year.

Buying a $100k house for $100k is a better comparison to buying a stock index.  Buying a $80k fixer upper for $30k is like buying Apple for $95 the other day when it flash crashed.

I'm not sure if that's a total fair comparison. IMO any particular real estate market is has a greater level of inefficiency while buying a blue chip on a dip is doing it through a very efficient market.

[freeatlast]

I bought two small rental single family homes in a less popular part of Seattle and paid cash. They were both estate sales and I fixed them up. I generate about $20,000 a year after property tax on a total investment of $365,000. That's 5.5%. My 401k which is also valued in the $300k range is nowhere near 5.5% this year and from time to time goes negative.  I have a long term income stream I can count on and my homes have appreciated by at least $70k in FMV in a year. 

I haven't done a spreadsheet or anything. I haven't determined the benefit of the deferral in taxes either.

It sure feels like my rentals are the better bet.  I have an income stream I can use NOW and the principle has grown. I also have a tangible asset that I know won't go belly up. As my company will soon be laying people off, I sure am glad I have those rentals.......

[meadow lark]

Asset allocation.  I think of rentals as similar to bonds.  Even if they do underperform stocks in a particular period, they have been steady, so far.   So, my 403b is 100% stocks, and my diversity is my rentals.  I'm at about 75% equities to 25% real estate.  Also, there is quite a learning curve.  I would make better choices now in properties, but  that is because I learned by buying my first properties.

[andyp2010]

If you're talking armchair investment vs armchair investment.

Realistically, it's not that difficult to make some really decent money, maybe a few hundred thousand just by pushing around paper with commercial real estate.

I'm more into the slower returns of residential. I put in $50k 2.5 years ago. It's now have over $400k in equity on four different houses.

Oh, one more thing.

I don't buy $100,000 houses that are worth $100,000 and rent them out.  That's crazy talk.

I buy $80,000 houses for $30,000 to $38,500 and fix them up.  After fix-up costs are included in the purchase price, I'm paying $47,000 to $55,000 for an $80,000 house.

That's an pretty good rate of return even before I rent them out...

And there are a lot of them like that in my very good rental property area, too.

Essentially the above. Show me a set of shares that can do that, without being tinpot penny stocks.

[SnackDog]

The real return on US Large Caps the next 30 or so years is going to be way closer to 5% than 10% CAGR.

As several people have demonstrated, real estate business is hard work but can yield financial independence much sooner than passive stock investing.  If you really are that good at real estate investing, quit your job and do it full time.  Keep your leverage maximized and your cost minimized.

[Roland of Gilead]

Essentially the above. Show me a set of shares that can do that, without being tinpot penny stocks.

Tesla is a tinpot penny stock?

[TomTX]

   I think one of the key points in all this discussion is at what monthly rent vs purchase price ratio does real estate beat the market (assuming historic rate of return for the market)?  Seems to me its a little bit, (or maybe a lot) above 1.0, but somewhere below 2.0.

This is a good point. Why type of return is needed in real estate to beat a 8% market return?

Real estate is always at the local level. It might not make sense to buy in some parts of the country, but it does in others. The market is going to be at the national level and more standard.

Rule of thumb for decades has been that monthly rent should equal or exceed 1% of the property value. MMM posters have gotten purchases where monthly rent is 2% of property value (purchase price anyway.)

Getting $1000/month on a $150k property is truly shitty.

[2527]

If you know what you are doing, real estate allows you to exceed market averages.

But a real estate holding will eventually go past its prime (the neighborhood goes out of fashion, the building gets old) whereas a diversified mutual fund (especially an index fund) will always reflect what's current.

Stocks are much much easier to handle as you get older and much much easier to pass on when you die.

[totoro]

If you know what you are doing, real estate allows you to exceed market averages.

But a real estate holding will eventually go past its prime (the neighborhood goes out of fashion, the building gets old) whereas a diversified mutual fund (especially an index fund) will always reflect what's current.

Stocks are much much easier to handle as you get older and much much easier to pass on when you die.

What neighbourhoods are you buying in that go out of fashion within your lifetime buying window which is probably 30 years max?  In my experience desirable areas have become more desirable.

As far as old buildings, again, your buy and hold window is probably 30 years max.  You need to budget for O&M/repairs and buy strategically.  Land appreciates and buildings depreciate, but most buildings have longer than a 30-year lifespan. 

Stocks are easier to manage when you get older but RE has been a faster way to accumulate wealth to retire imo.  Strategic buying is way easier with RE.