Investing in Real Estate vs Stock Market

[zetta]

I'm curious to hear everyone's thoughts on which path to take to build wealth (after you are already on a solid financial footing, no consumer debt, emergency funds in place, etc.) -- real estate or the stock market. I think either one could be done conservatively, not following a "get rich quick" approach. For real estate, I imagine this would involve building a portfolio of rental properties. For the stock market, using mutual funds and index funds.

What's been your experience with either path?

[SavedintheCity]

It is not an "either/or" proposition. You can invest in both. One issue however, it will take quite a lot of capital to invest in a large portfolio of rental properties. Therefore, you fall into the all eggs in one basket issue. Depending on how you invest, stock can offer more diversity with a lower level of capital at risk. Also, it is much MUCH easier to sell stocks than real property. Also, real property sales are subject to high transaction costs (atty's fees, brokers, inspectors, transfer taxes, recording fees, listing fees, etc) than are stocks. Stocks are generally only subject to broker's fees and capital gains taxes. It also is a different "type" of investment. Gains on investment in stocks is usually only realized upon the sale of the stock, however, rental properties provide a cash flow throughout the life of the investment (assuming you have a tenant). Stocks are generally a low maintenance investment (like $0 annually to hold it in a brokerage acct). Rental properties have a LOT of yearly maintenance costs (property manager, insurance, real property taxes, utilities, property maintenance/improvements). A lot of these costs you can net out to a commercial tenant (depending on your market). Triple Net leases have become de riguer for most commercial landlords. So if you are a new investor the learning curve for rental properties is MUCH MUCH higher for you. Whereas, stock investments (but not bonds) are much easier to understand and probably a better bet for a newbie investor.

[disneysteve]

I agree with the previous poster. It is definitely not either/or. You shouldn't put all of your money in property, but it can certainly be part of your portfolio.

Before buying rental property, think long and hard about if you want to be a landlord. Personally, I thought about it and decided the answer for me was no. I don't want the hassle. I don't have the time to be hands on and paying someone else to do everything eliminates any profit from the endeavor. So I will happily stick with my mutual funds.

[safari]

I know a guy who buys condos and rents them out. He has all kinds of problems with his tenants. People are late with their rent, or they break stuff, so he has to constantly spend money on fixing things. For example, recently one of his tenants broke a window, and then said it was already broken when he got home. It's just too much hassle. He told me he is going to sell the last two units that he owns and get out of this business because it's not worth it, even though the real estate prices went up quite a bit in the last few years. He always asks for references from tenants, and he only accepts tenants with good references, but still every third tenant is giving him a hard time. After talking to him and other people, I'll never invest into real estate.

[Ima saver]

I thought that was the way to go also, when I was younger. i purchased 3 rentals and there was always problems. They would tear up the plumbing, break windows, and just make a big mess. My dh was always having to fix things. We had a problem with collecting rent all the time. We spent thousands fixing the houses back up. Finally, I put them on the market and sold them at a big loss. Now the only real estate I will buy is vacant land. I have made a few dollars on that. No more rentals for me, ever!!

[tinapbeana]

depending on the regulations where you live, you might want to consider 'land contracts' or 'lease to own' arrangements. around here folks will fix up a house and enter a contract with a tenant interested in purchasing the house. they agree to lease it for a year or two while they get their stuff together, and at the end of that time if they buy the house the monthly rent they've paid is seen as a downpayment of sorts. if they're late, or if they don't get financing, the contract defaults to a standard lease. this way, you're more likely to get folks who will maintain the property b/c they may likely wind up owning it.

as for late renters, check your local water/electric regulations. here, for example, there are counties where you can bundle the water service into the rent and legitimately disconnect the water for any tennant 30 days late. with no water the house is deemed unliveable by the health department and 'condemned' till the water is turned back on and the folks are evicted by the sherriff's office.

[vsjhoc]

Does anyone have experience with commercial real estate? Maybe not owning Trump Tower, but perhaps some office space? You still have tenants but at least they don't live on the premises.

[kv968]

If you'd like a little of both, real estate and stock, you could always invest in a REIT. Albeit you don't own the properties themselves and it's mostly, if not all, commerical, but you get the exposure to that sector without all of the headaches.

[disneysteve]

Originally Posted by kv968

If you'd like a little of both, real estate and stock, you could always invest in a REIT. Albeit you don't own the properties themselves and it's mostly, if not all, commerical, but you get the exposure to that sector without all of the headaches.

Very true. My real estate fund (CSRSX) has had great numbers (though I'm sure the heyday is coming to an end soon).

YTD: 38.98%
1 year: 39.47%
3 year: 31.79%
5 year: 26.23%
10 year: 17.04%

Great returns and no late night phonecalls, leaky faucets or delinquent tenants to deal with.

[Duchesse]

All of the above are good posts and full of experience. I too invested in Real Estate. In a nutshell, if you can't do the repairs yourself and love doing it, forget it. REITs and the stock market, in my humble opinion are the best way to go .

[Ima saver]

I have bought property (land) and resold it and held the mortgage. That is a great way to make money. I even got one property back after the people could not afford the payments two years later, so I resold it.

[cbird01]

I have to chime in here. You always hear the horror stories whenever talking about renting properties. The truth is, most people do not know how to invest in residential properties. The property you purchase, sets up the experience you will have. Many people look for a "rental". This usually means something that needs some work or is in a cheaper neighborhood. I have 4 rental properties and the number one rule you use when purchasing is...would I live here?

Questions that raise red flags are:
Is this house boring?
Is the floor plan strange?
Is the backyard simple and boring?
Are there less than four bedrooms?

If you answered yes to any of these questions (with possible exceptions on the last one), then move on!

If the house is not exceptional, then you get low quality tenants. If the rent is on the low end of the scale, you get low end tenants. If the rent is high and house is unique, you get high end tenants.

On the four beds - people pay per bedroom. A four bedroom house costs approx the same as a three bedroom of the same square footage but rents for much more. Everyone loves the extra bedroom. Don't buy a three bedroom.

If you follow these rules, you do not have problems. Believe me, I have done it for 10 years. I guarantee these stories of people with problems did not follow these rules and they are the unhappy landlords.

Appreciation. Compare stocks to rentals. Investment amount $20,000 over 20 year span.

House: Let's say a conservative 5% appreciation rate(near historical value). It appreciates on FULL VALUE of house $200,000. At 5% rate that equates to a house value in 20 years of $530,659 or a profit of $310,659

Stocks: A generous 10% return. It returns profit off of the initial investment of $20k. At 10% rate that equates to a final value of $134,549 or a $114,549 profit.

Now you may say...what about maintainance? I never did my own maintainance but did find a good handyman at a fair price. Over a 20 year period your cash flow will acutally add to this profit considerably as rents ALWAYS go up. By the end of my 10 year period I was cash flowing $700/month on a house I purchased in 1996 for $95,000 and renting for $1500 when I sold it in 2005. New owner is now renting it for $1700.(did some upgrades before I sold)

Location is the obvious wildcard in this. I firmly believe in renting to college students. However this is in Tempe Arizona, where the majority of students are rich California kids that are clubbers. I would NOT do this at my alma mater Michigan State University where they are inside for 6 months of winter and mostly throw keggers (i know what they do). I have never had damages at the end of lease that was not covered by a security deposit in 10 years, 2 houses. My other house was in a highly desirable family neighborhood and had the most georgous backyard that sold any renter, which I rented to young professional just out of college and families. Young children do more damage than college kids(if you follow the rules! low rent = low quality), but it is still covered by your security deposit.

Sorry for the long post, just needed people to see the good side since you only hear from the people with horror stories.

(oh, I did not even mention the tax benefits...all those years of positive cash flow and I never once showed a profit on my taxes - it gets eaten up by loan interest which your tenant pays and depreciation...thanks uncle sam!)

[Broken Arrow]

Thank you for sharing your experiences cbird01. Those are very valuable insights indeed.

I'm of the opinion that there is no such thing as a "magic bullet" in investing. If there was, we'd all be doing it. Conventional wisdom on any type of hard commodity investing, be it real estate or precious metal, is to do it only as a part of your portfolio. Because they are not without their cost and risks.

That is not to say that there won't be some who will come out ahead of the game. Nor does it mean that people couldn't enjoy focusing in on certain types of investments. I know someone who is, as he himself puts it, "a slumlord" and the joy he derives from it far outweighs any hassles involved. I, on the other hand, would not be interested in this type of investment.

My most sincere apologies if I once again seem too critical, but I don't think your numbers are entirely accurate? For example, even though (property) tax and maintenance was mentioned, it was not factored into the overall net worth calculations when compared to an equivalent stock example.

I would imagine that, all told, stocks are just as competitive, requires a lot less work, and can be better diversified against volatility than simply owning properties for rental. But here, I also admit my bias towards simply owning controlling interest rather than getting my hands dirty.

In any case, I think the best stance to take is to give the Pros and Cons of such an investment, and let individual investors decide which way works best for them.

[cbird01]

Originally Posted by Broken Arrow

My most sincere apologies if I once again seem too critical, but I don't think your numbers are entirely accurate? For example, even though (property) tax and maintenance was mentioned, it was not factored into the overall net worth calculations when compared to an equivalent stock example.

Yes I did simplify. Obviously the home example is much more complicated than the stock example. However, as I mentioned at the end, my example for the rental is actually UNDERestimated. Over a 20 year span the combination of positive cash flow and tax benefits far exceeds taxes and maintainance and even insurance/management/vacancies. This is not the case in the shorter term (1-5 years) due to lower cash flows prior to rent increases or for a poorly chosen property. I have made a fairly complicated spreadsheet that evaluates a real estate investment over its life cycle in a detailed way(uses amortization charts, computes IRR and covers all expenses - my version of fun )

That said, a stock investment can certainly outperform a real estate investment. A real estate investment is more "hands on" and much less liquid so that is a consideration for many. I do stand by the notion that the "headaches" can be almost eliminated with proper strategy. I have not had a phone call or even thought about my rental properties since August when I rerented 2 of them.

I wouldn't do one without the other though...and you must have a "slush fund" for real estate to cover short term vacancies and larger expenses that are one time.

[cbird01]

Boy is my face red. What kind of engineer am I. For those of you who previously read my numbers from previous post I appologize. I was using the wrong spreadsheet that was adding a yearly investment of $4,000 a month to both scenarios.

So the real numbers have been edited above and in reality the scenario is much better. A house appreciating at 5% over 20 years makes $196,110 more (2.7 times as much) as a stock investment at 10% over 20 years.

Even at 3% appreciation vs 10%, the house will make $26,673 more than the stock investment over 20 years.

So if you believe that homes will appreciate at 5%, I will challenge you to see if it is not worth considering. Maintenance and management is not going to overcome cash flow(Rent-PITI payment) and tax breaks to the tune of $196,110. On the contrary it should increase the profit. Worst case scenario it will be a minor negative.

There is a key to this argument that is overlooked in real estate investing by many - LEVERAGE

[kv968]

Originally Posted by cbird01

There is a key to this argument that is overlooked in real estate investing by many - LEVERAGE

I think the key missing in this argument that's being most overlooked by many who want to venture down this road is TIME. Cbird you've certainly done your homework and then some when it comes to investing in and renting real estate and I applaud you for that. It definitely can be done. However, I have a feeling (and I could be wrong) that a lot of people who are looking to jump into the real estate and renting market think of it as just buying a home on the cheap, renting it out so the mortgage is covered and then selling it at a huge profit a couple of years down the road. Again, it can be done but not without some real in-depth research and knowledge of the market. All of which takes a great deal of time which I don't think the average investor realizes or has to offer. Heck, I know many people who don't have the "time" to even find out what their financial advisor has them invested in let alone learning a little bit about it themselves.

[mom-from-missouri]

The majority of my stock has gone down since 9-11. But, I can tell you that farm land around here was $700 an acre in 1998 when my husband bought this farm. We just purchased some land ajoining it for $2000 and acre and that was a GOOD DEAL because the neighbor sold it to us without an agent. On down the road, less than a mile its going for $2700 an acre. DH is wishing he had bought more in 98.

[cbird01]

I will agree with you there kv. There is a big learning curve. I had one property that was high on the headache scale, so I sold it after 5 years. I purchased it prior to knowing the criteria I outlined. It ended up being high on the headache scale, so I sold it. It was still profitable for me, but now I know what to buy to avoid the headaches and time that it sucks up. That is a skill that is not easy. Some real estate agents have it but most do not understand it either so you need to rely on yourself.

Another little known strategy is a great way to "ease" into investing and takes advantage of something that few people know about.

Buy a house that is unique and rentable and live in it. Preferably within 4 miles of a major university or in a school district that everyone wants to be in. After you have lived in it for two years, rent it out. Rent it out for 2.5 years and then put it on the market. Why you ask? If you sell a house that was your primary residence for any 2 out of the last 5 years - drum roll - you can keep the profits TAX FREE. You need to close escrow prior to the 3 year aniversary of moving out of your home, that is why you start marketing it at 2.5 years.

If you have a high tolerance for moving, you can do this every two years. Use that tax free money to buy more houses or as most people on these threads like..more mutual funds or stock investments of your choice. You also have the benefit of much more favorable lending terms for an owner occupied home.

How is that for a tax free investment?

This obviously has a little more risk due to the fact that real estate could stay pretty flat over a five year period. You can always continue to rent it out in that case. Real estate profits are always tax free if you roll them into purchasing another investment property (1031 exchange)

[JBinKC]

Even though I have profited from both I am going to have to say real estate probably is a better bet.

You can't live in a stock. Another criticism of the stock market is the recent slowdown in new breakthrough technological innovations (i.e. new products and or industries which drives prices higher. Why do think why Apple Computer continues to go higher?)

[Rich_Rico]

Interesting points! Cool