I have invested in both real estate and the stock market and I believe real estate is hands down the better investment. Even with the stock market increasing significantly, I am making more money on my rental properties and they allow me to retire much earlier than the stock market. The conventional thoughts are that if we invest enough money for a long enough time in the stock market, we should have enough money to retire without much risk. The problem is how long it takes to invest and how much money you have to invest in the stock market to be able to retire. With real estate, you can retire by investing much less money over a much shorter time if you do your homework and spend the time needed to choose great properties. I have invested in both the stock market and real estate. and I am a strong believer that real estate is the best way to invest your money and retire early.
Real estate has many advantages over the stock market; being able to leverage your money, cash flow, tax breaks, appreciation, and the biggest advantage is you can buy real estate below market value.
Why is it hard to retire by investing money in the stock market?
Traditional investment models encourage us to invest in the stock market because over time the stock market always goes up. I was taught this in college, and I invested in the stock market before I became frustrated because it took so long to make my money grow. When I plugged my current level of investing into retirement calculators, I was shocked at how much and how long I would have to invest before I could retire with the stock market.
The kicker was I had to guess when I would die with the retirement calculators to see how much I needed to invest. I also had to guess what return on my investment I would get. Hopefully, I do not live too long or underestimate the return on my investment or I would run out of money in retirement. I knew there had to be a better way to invest than to play a guessing game with my future.
How did I discover the benefits of investing in real estate versus stocks?
I have been a real estate agent since 2001 and I knew many people invested in real estate, but I never dug deep into the advantages of investing in real estate. When I became disappointed with the time it would take me to retire by investing in the stock market. I read as many books as I could on the best ways to invest, and real estate kept popping up as a great way to build wealth.
Real estate provides cash flow while the stock market does not
When you buy rental properties, you should focus on the cash flow they produce. I like to see cash flow of at least $500 per month (after expenses) on my rental properties and that is from an investment of around $30,000. That equals a cash on cash return of about 20 percent on the money I invest. That is a 20 percent gain I see in my pocket every month, not a paper gain.
The cash flow from rental properties keeps coming every month as long as you own the property. That means if you buy enough rental properties to provide the monthly income you need to live on, you can retire and never worry about running out of money in retirement! 11 rental properties (I now own 16) provided me over $63,000 in 2014 based on my cash flow calculator.
Some stocks will provide dividends that produce cash flow, however, those dividends are not going to add up to a 20 percent return. You may see a 20 percent return on your stocks, but it is a paper gain that won’t be realized until you sell the stocks. Remember real estate will also appreciate over time just like stocks will, plus you make money on the cash flow.
How can you get such great returns on rental properties?
One reason rental properties can provide great returns is they can be bought below market value. I am a real estate agent and I see properties sold below market value all the time. Some houses are distressed sales like short sales or REOs and the seller just wants to get rid of them. Other properties need many repairs or an estate is selling a house and they want it sold quick. I buy my rental properties at least 20% below market value on top of making sure I am making a 20% cash on cash. That means if I buy a $100,000 rental property, I will gain at least $20,000 in equity as soon as I sign the papers. Here is an article that describes how my rental properties have increased my net worth by $600,000.
Assuming it takes me $30,000 to buy a rental property, I have made a 66% return on my money (on paper) as soon as I buy a rental property. I don’t like to count this money since it is only a paper gain, but if I ever sell the home or refinance it, that is money in my pocket. One downfall to real estate is it costs much more to sell a house than it does to sell a stock. On the other hand, if you are buying properties below market value, it more than makes up for the extra costs.
For more information on investing in rentals, check out my book: Build a Rental Property Empire: the no-nonsense book on finding deals, financing the right way, and managing wisely.
You can leverage much more money with real estate than you can with the stock market
Another great advantage to investing in real estate is I can buy a $100,000 property with $30,000 in cash (that includes closing costs and repairs). I have to put 20% down, I usually spend at least $7,500 on repairs, and I spend a few thousand on closing costs and carrying costs before the home is rented. By being able to put less money down on a home than the actual cost of the home, the advantages of rental properties are multiplied.
Interest rates are still extremely low on real estate and I pay about 4.5 percent on a 5/30 ARM. In my area, my 16 rental properties rent from $1,200 a month to $1,600 a month, and my payments including taxes and insurance are $400 to $600 a month.
It is possible to leverage some money with stocks by buying on margin. However, margins can be called due when stocks decrease in value and you can’t get a 30-year margin! Margins also will not let you borrow 80 percent of the value of a stock like you can with real estate.
What are the tax advantages of rental properties versus the stock market?
Rental properties have another huge advantage over the stock market when it comes to taxes. Rental properties can be depreciated over time, which means the initial cost of the structure of a rental property, repairs and improvements can all be depreciated. The IRS will allow an investor to deduct the depreciated value of the structure from their taxes over 26.5 years and less for improvements. If the structure is valued at $100,000, then $3700 can be deducted from your taxes every year. That is not a $3,700 savings in taxes, but a deduction meaning you would save $1,100 if your tax rate is 30 percent. I do not count the tax savings in my 20% cash on cash return for rental properties.
Rental properties pay themselves off over time
When you leverage rental properties you have a mortgage on the property, which scares some people. But when I calculate my cash flow I include paying the mortgage payments every month. Every month the mortgage is being paid off slowly by the tenants who are renting the home. On my loans, about $1,500 a year is being paid off every year. I don’t count the equity pay down in my 20 percent cash on cash return, I consider it a bonus!
Do rental properties take more time to manage than stocks?
One downfall to rental properties is they take more time to manage. You can buy a stock and forget about it, but you can’t forget about a rental property. It also takes work to find a great deal on a rental property and to educate yourself about what a good deal is. You can also hire a property manager to take care of your rental properties, which will greatly reduce the amount of time and work you have to put into them. It takes more work to buy rental properties than it does stocks, but I think the work is well worth the returns. If you think real estate is riskier than the stock market I would disagree. Just like the stock market, real estate has historically always gone up and if you don’t have to sell, you won’t lose money.
How have my rental properties done over three and a half years?
I have purchased 16 rental properties since December of 2010. I estimate it took me about $330,000 to buy those properties, but I refinanced two of my rentals which gave me back about $50,000. My total out-of-pocket cost for these rental properties has been about $280,000, which equals a 21 percent return on my money. I made over $60,000 in cash a year from my rentals, which does not include mortgage pay down, tax advantages or appreciation. My net worth has increased over $600,000 thanks to my rental properties, but that is only a paper gain. If I had to sell my rentals I would have to pay selling costs, which would be around 5 percent, since I am a real estate agent. The value of my rentals is 1.85 million dollars and 5 percent of that is about $93,000. If I were to sell all my rentals I would make about $500,000 from appreciation, buying below market value and making improvements through repairs. If I divide that return over the 3.5 years I have owned my rentals, my returns are over 51% a year. That does not include the cash flow I am making!
The stock market has increased 61 percent over the same time period I have invested in rental properties. The 61 percent must be divided by 3.5 years to come up with a yearly return which would be a 17.5 percent yearly return. That is a paper return and you would have to sell your stocks to realize that gain, plus you are most likely making very little in the way of dividends or cash flow from those stocks.
It is clear to me why I choose to invest in real estate over the stock market. If I plug in numbers into a retirement calculator, I would have to invest $90,000 a year into the stock market in a tax-deferred retirement account at 7 percent interest rate to produce $60,000 a year in retirement income. The worst part is I would have to invest that $100,000 every year for 10 years and I could only retire for 20 years (I would run out of money at 65 if I retired at 45)! That $60,000 is not even adjusted for inflation and you bet money is going to be worth a lot less in 10 years. Investing that same amount of money into real estate, it took me three years to reach the same amount of income and that income will last for life, increase with inflation and increase as my loans are paid off.