Real estate investing versus stock market

[slo]

I'm hoping that someone on this forum with more experience or knowledge regarding real estate investing can help me think through something.  I'm currently 43 and hopefully around 15 years from FI, possibly retirement.  I have the bulk of my retirement savings in a 401 k invested in low cost mutual funds.  I'm currently trying to figure out what to do with my money outside of my 401k.  I have been considering buying a rental property with a loan.  For illustration purposes, let's say the property purchase price is $125,000.  If i put 25% down, that would be $31,250.  Of course, there would be some closing costs, not really sure how much that would be?  I figured that on a 15 year mortgage with an interest rate of 5%, a 9% property management fee, property taxes, insurance, and a 10% vacancy and maintenance rate, that I would more or less break even with a monthly rent of $1225/month.  When the 15 year mortgage is paid off, I would net around $9000/year.  I know that my rental income would be taxed as income.  Can I offset the income with the costs?  My big question is:  If I invested that $31K (maybe more like $35K, if i included closing costs) into the stock market now, the future value is only $73000.  If  I withdrew 3% annually, that is only about $2200 a year.  So, after 15 years, the rental nets me about $9000 a year, and the stock market nets me about $2200 a year.  What am I missing here?  Why shouldn't I buy several rental homes?  I wouldn't put my entire retirement into real estate, but right now my net worth is around $1.4 million, with about $900k in retirement.  I'm considering buying three properties like this, investing a total of about $90-100k.  That's less than 10% of my net worth, and about 10% of my retirement.  I'd like someone with some knowledge or experience to help me with this.  I feel like I may be missing something.

[jfoxcpacfp]

slo wrote:

Can I offset the income with the costs?

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Can you clarify what you are asking, other than the obvious that your costs of the property (maintenance, RE taxes, utilities, etc.) are deductible against the income?

[slo]

The big question I'm asking is whether the real estate investment is a good idea over the long term (20-30 years) than just keeping that money in equities? Using the numbers in my OP, it appears that using the leverage of a mortgage gives me a better return than keeping that down payment in low cost mutual funds. If my math is correct it would appear that I'd come out ahead with the real estate investment. I'd like someone to chime in regarding whether I'm looking at this correctly or not.
Thanks in advance for any advice or thoughts.

[jfoxcpacfp]

slo wrote:

The big question I’m asking is whether the real estate investment is a good idea over the long term (20-30 years) than just keeping that money in equities? Using the numbers in my OP, it appears that using the leverage of a mortgage gives me a better return than keeping that down payment in low cost mutual funds. If my math is correct it would appear that I’d come out ahead with the real estate investment. I’d like someone to chime in regarding whether I’m looking at this correctly or not.
Thanks in advance for any advice or thoughts.

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Not exactly. You are confusing cash flow and taxable income. You are actually investing $125k, partly with cash, partly with a loan. I haven't tried to work out the math, but the numbers would be significantly different if you borrow $93,750 to invest $125k in the market and pay it off over 15 years. I also don't know what growth factor you're using for your investment portfolio or for the value of the real estate (which you haven't included). Are you including dividends? And so forth.

[Allonblack]

Your 10% cost of vacancies and maintenance is wildly low. The number should be closer to 50%. See bigger pockets forum for an explanation.

[The White Coat Investor]

I never understood the whole "mutual funds vs real estate" argument. Why not do both? Sure, real estate is a great thing to do with your taxable investments. Just remember that there is a certain aspect of real estate investing that is more active than a mutual fund portfolio. How you deal with that will have an effect on your returns and especially your lifestyle. There are ways to minimize that (REITs, syndicated real estate, turnkey etc) but they all cost you something compared to buying the house down the street, managing it yourself etc.

https://www.whitecoatinvestor.com/real-estate-vs-stocks-an-investing-showdown/

What you're forgetting is that you need to be a total return investor. You can take 6% a year out of a mutual fund portfolio just as easily as a real estate portfolio by declaring your own dividend. And if you decide you don't like one, you can convert to the other. I can always sell off my mutual funds and buy an apartment building. It's not like you HAVE to wait 20 years while paying down a mortgage to get cash flow.

[The White Coat Investor]

slo wrote:

Of course, there would be some closing costs, not really sure how much that would be?  ....  I feel like I may be missing something.

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Yes, you are. You might try some of John T Reed's books, like this one:

https://www.whitecoatinvestor.com/best-practices-for-the-intelligent-real-estate-investor-a-review/

Very realistic. Know what you're getting in to. There's a reason most real estate books contain a heavy "motivational" component. Because it's a lot of hard work. Not saying the hard work isn't worth it, but don't pretend it isn't there at all.

[slo]

Thank you all for your comments. Looks like I have some reading to do. WCI, I'll start with your blog posts and maybe move on to some of the books if I'm still interested.

[slo]

WCI, I read your blog on real estate versus stock market investing, it was very informative. I guess what was catching me eye is really the effect of leverage. My estimates(with plenty of assumptions) of investing around $30k now in real estate versus stocks seem to put real estate way ahead. Like I noted, it looks like in 15 years I could have $9k of yearly income in perpetuity, while I'd likely never have that kind of income from a $30k stock investment. My assumptions may be off a bit, but they'd have to be wildly off for stocks to match the real estate returns, and that really is due to the use of leverage.
You are right, there's no reason that I cannot invest in both, and I think I will, but only after some more reading. I never intended to put more than about 10% of my portfolio into RE, if I do at all. I guess I should include my primary residence anyway, where I have approximately $450k of equity now, so that tilts my portfolio quite a bit towards being a little heavy in RE already.
Anywsy, thanks for giving your thoughts.

[Zaphod]

slo wrote:

WCI, I read your blog on real estate versus stock market investing, it was very informative. I guess what was catching me eye is really the effect of leverage. My estimates(with plenty of assumptions) of investing around $30k now in real estate versus stocks seem to put real estate way ahead. Like I noted, it looks like in 15 years I could have $9k of yearly income in perpetuity, while I’d likely never have that kind of income from a $30k stock investment. My assumptions may be off a bit, but they’d have to be wildly off for stocks to match the real estate returns, and that really is due to the use of leverage.
You are right, there’s no reason that I cannot invest in both, and I think I will, but only after some more reading. I never intended to put more than about 10% of my portfolio into RE, if I do at all. I guess I should include my primary residence anyway, where I have approximately $450k of equity now, so that tilts my portfolio quite a bit towards being a little heavy in RE already.
Anywsy, thanks for giving your thoughts.

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You can get leverage in the stock market as well, it just has a different nature to it, that admittedly is less exciting than RE leverage. Just pointing it out and echoing Johanna comment about appropriate comparisons. You cant leverage the same way in the market (nor should you try!) of course. I always think of the cash flow part of it as a now or later thing. RE gives you the most per invested dollar today, while the market is more likely to give you a larger return overall, but in 30 years. So, do both and attack it from both sides of the timeline of course.

[PhysicianOnFIRE]

Investing in the stock market takes minimal effort, knowledge, and bookkeeping. Investing in real estate requires moderate to heavy effort, knowledge, and bookkeeping. I've been an accidental landlord on a couple different homes. Even with property management, it was more effort than I care to deal with for an investment. Anyone who considers rental income to be "passive" income is being generous with the term.

[Kamban]

As others have said real estate management is hands on, even when you have a property management company. Think of them as a billing company that takes 6 % but only foes for low hanging fruit and never tries to collect the last 20 %. I have had similar experiences with the management companies.

I have a couple of small town homes in my town bought mainly for having a place in a good school district should my daughter want to go that high school. And a house in FL got in 2008 housing crash as a future retirement home. All were ~$120K and bought cash. There have been periods of 6+ months when there was no renter. Over the years we have broken even or just made money. Only when we sell will we know what the gains were compared to the index funds.

My advice is to stay away unless you love to have heartburn and loves to fix things and try to find tenants and evict them.

[jfoxcpacfp]

PhysicianOnFIRE wrote:

Investing in the stock market takes minimal effort, knowledge, and bookkeeping. Investing in real estate requires moderate to heavy effort, knowledge, and bookkeeping. I’ve been an accidental landlord on a couple different homes. Even with property management, it was more effort than I care to deal with for an investment. Anyone who considers rental income to be “passive” income is being generous with the term.

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iow, a portfolio will never call you at 3am with a broken water line or leaky roof.

[AlexxT]

slo wrote:

If I invested that $31K (maybe more like $35K, if i included closing costs) into the stock market now, the future value is only $73000.  If  I withdrew 3% annually, that is only about $2200 a year.  So, after 15 years, the rental nets me about $9000 a year, and the stock market nets me about $2200 a year.  What am I missing here?

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Here's what you're missing:  Opportunity Costs!

It's not a $30,000 investment.  That's what all those snake-oil salesmen on infomercials would like you to believe so you'll take their seminars and buy their books.

Go to an investment calculator, eg

https://investor.gov/additional-resources/free-financial-planning-tools/compound-interest-calculator

Enter your down-payment as the initial sum, and for monthly contributions put in your monthly mortgage payments ( interest plus principal) .  Set the term for 15 years.  Put in your expected stock market return as the interest rate (eg 7%).   That will tell you what your opportunity costs were i.e  what your exact same investment would have been worth if you had instead invested in the stock market.

I did the math for you.  A $95,000 15 year mortgage at 5% will have monthly payments of $751.   If instead you invested the 30k down payment in index funds at 7% and added $751 a month, at the end of 15 years you would have $309,233.69.

Now, to make real estate look better, you minimized your costs and also minimized your mutual fund withdrawal rate.  Why 3%?  To make the comparison fair, you should use at least 4%, maybe even 6%.  But even at 3%  mutual funds come out ahead.   Granted, I'm not taking all the tax issues into account, depreciation, retirement accounts, etc.  But using your figures,  and quick and dirty calculations, index funds win.

As I see it, owning real estate is owning a small business.    I already have a job.

You want leverage?  I don't, but it seems that you think that's a great idea.  In that case, refinance your house and invest in the stock market.  Now you have leverage.  You don't have to invest in real estate to have leverage.

 

[NJDoc]

OK - I have to throw my 2 cents in the ring here.

I'm biased , I like real estate, but not single family home investing. I prefer commercial real estate , and I don't mean REIT's, which are stocks.

There are a million reasons to NOT buy single family homes, unless they are close and you do all the maintenance, repairs, cleaning, showing the property, etc.. Granted, many people make this model work for them, but they are the landlords, and they must be responsive to the tenants needs. Once you pull in a management company, profits get eaten up quickly. Commercial real estate when purchased alone or in a syndicate/group can be an excellent diversification to your portfolio.  Note: I said diversification, I would never put all my money in real estate, nor would I ever put all my money in stocks. That's just my opinion.

Whether or not commercial real estate beats the "market" is a very difficult statement to make. The answer is very dependent on what you buy, where you buy it, your holding period, your taxes, etc.. I have one project that has returned over 15% per annum for over a decade, and the bulk of that is tax sheltered , I have other projects that are spinning off only 7% tax sheltered per annum. Does that beat a 60/40 portfolio? Again, not an easy comparison to make as one must select one's time period, we all invest in 20 -30 year accumulation phases, so pick your time frame and you can make the data go anywhere you like.

My bottom line- I can' say real estate is better than stock investing, it is different and provides good diversification in a well constructed portfolio. Just do it right.

Oh , and leverage- NEVER leverage a core asset for investing , i.e.) your home or your 401K/IRA.