Why is real estate a better investment?

[Ben Bartels]

I feel silly asking this question, but my wife and I have been struggling to compare our investment options. Obviously, BP forums/podcasts/blogs/etc. indicate that real estate is a good way to go. It sounds like a 15% annualized return is pretty realistic. Dave Ramsey suggests investing in high-performing growth-focused mutual funds. He suggests that a 12% annualized return is realistic.

At first glance, real estate seems like a no brainer. It's the higher percentage. However, when I try to figure out exactly how I hit that 15%, I'm stumped. I haven't found a good example to convince myself of how it works.

Suppose I invest $25K into mutual funds and get Dave's estimated 12% over 30 years. At the end, I'll theoretically have close to $900K.

Now, suppose I take that $25K and purchase an investment property worth $80K (with $5K for closing costs, loan fees, etc.). Let's assume it triples in value over 30 years, so at the end, I sell it for $200K. Let's also assume I cashflowed $300/month, so that's another $108K over 30 years. I know I'm missing rent increases, depreciation, tax benefits from paying loan interest. Is there other stuff I'm missing, and can those things really add up to an additional $600K to make real estate the better investment?

I'm sure there are resources out there to explain concrete examples, so it's absolutely fine to just link to something rather than coming up with your own example. I haven't found anything yet that actually goes through the numbers though, and without actually going through an example, I don't understand how those additional benefits from real estate can make it a better investment. Thanks in advance for helping me figure this out!

[James Free]

Sitting in a single property and getting 15% over 30 years is quite hard, actually. The benefit of real-estate investing is using leverage, and in your scenario, most of your 30 years is spent with very little leverage. You're also doing the math in a way that suggests that as you collect your cash-flow, you'll let it sit in a bank at 0%, whereas your mutual fund option is reinvesting (compounding) every penny earned. That's not a fair comparison. You could put the cash flow in mutual funds as you receive it, or you could use it as down payments for more real estate. To fairly compare the two investment classes, you need to be reinvesting gains from both.

Of course, actually getting 12%/year in mutual funds is also very hard. 8% is a more realistic number, and beating 8% in real estate is a lot easier than beating 12% is.

Finally, there are the tax implications. Your equity investment will incur capital gains taxes at the least, and possibly income-level taxation if certain politicians have their way. With real estate, there are ways to realize gains tax-free, which has a substantial impact on total return.

I encourage you to look into getting more realistic numbers for each of your scenarios. In the real-estate case, consider rolling your gains into more/larger properties over time and cashing out your equity with refinances.