Buy & Hold Real Estate Investing vs. Buy & Hold Stock Purchases

[Chris Mackey]

Hello,

I am new to this forum and real estate investing. I have been doing some reading and feel that real estate could potentially help me reach my goal of financial freedom so that I have more time to spend with my family. 

After giving the idea some thought, I also felt it was a good idea to review my current stock investments, their performance over the last few years, and the overall stock market return since inception to see which strategy (stock vs real estate) would be the most beneficial option for passive wealth generation. At the end of the day, I want to make sure I am making the best possible decision for my family.

The S&P 500 return since inception is in the 10% range without adjusting for inflation. I feel this is a good benchmark to use to compare to investing in buy and hold real estate. 

With that said, I have ran some different scenarios and feel as if I am missing something when comparing the 2 strategies.

Below is what I came up with.

A recent property deal (a small apartment)  I used as a comparison was this:

Purchase price: $140,000

Approximate value: $155,000

Reconditioning: $5,000 - $10,000

Down Payment: $35,000

Annual Appreciation: 1%

Approx. Positive Monthly Cash Flow: $225 (after deductions for principle, interest, insurance, tax, HOA, 10% of rent for maintenance, 5% vacancy)

The numbers over 30 years I came up with were as follows:

Property value at 1% appreciation: $209,000

Mortgage balance: $0

Positive Cash Flow Accrued: $81,000($225/mo x 360 months w/ no add for rent increases. Not sure best way to figure that)

Initial Cash Investment: $42,500 with upfront reconditioning costs

Using the above numbers my investment would give me all the equity ($209,000) plus the 30 years of positive cash flow ($81,000) for a total worth of $290,000.

I realize I am not factoring the tax benefits, but I am not sure of a good way to do this.

Stock Market Investment:

Initial Cash Investment: $42,500

Rate of Return: 10%

Value After 30 Years: $741,600

As I said, I feel as if I am missing something. I feel that there shouldn't be such a large gap between the two returns ($741,666 vs $290,000).

What am I not factoring?

[David Thompson]

There is a strong mentality out there as to what is best and then that is the only option considered.  It's rather interesting thinking because as @Andrew Johnson astutely points out, you are using assumptions and those factors often are based on history not what will actually happen.  Any financial education around investments typically involved a balanced approach and concepts of diversification. Some stocks, bonds, real estate, etc.  Certainly most folks are probably over weighted in stocks simply because their 401Ks at work and IRAs are geared, marketed to that asset class.  Why is that? Because large financial institutions make a boat load on fees and spend that on marketing.  Pickup any financial magazine and see how overweight articles are on stock funds for instance and annuities (insurance companies) and devoid of real estate.  You will not see many articles touting self-directed IRAs as much because Wall Street loses their fee opportunity.

Another thing to think about is not just performance but your tolerance for risk.  Beta is a measure of volatility and one component of risk.  The beta on the U.S. stock market is 1.0.  The beta on MF apartments is .8, self storage .5 and mobile home parks .3.  The historical performance on the latter assets classes also have outperformed stocks on a risk adjusted basis.  Common sense leverage in these asset classes are the norm and hence often leads to outperformance.

Although the historical norm for stocks may be 10%, most wise stock investors out there think that where the market is today, less than 10%, like 7% may be more in the cards for the next 10 years.  So your time horizon also needs to be taken into consideration.  For your model, 1% appreciation on real estate seems quite low.

Re: taxes, if held in a taxable account and using current tax laws, you have a lot of deductions each year (property taxes, interest on your mortgage, depreciation, etc) that can make real estate a very tax efficient investment so your true after tax return may be higher than a stock account depending on if you are using indexing or trading frequently.