Comparing Note vs. Stock Market Returns and Cash Flow

[Brian M.]

Hello everyone,

I'm a long-time reader of the Bigger Pockets forums and have just created my account to become more engaged in real estate related discussions. The forums have many amazing individuals with extensive experience in a variety of areas and I certainly look forward to connecting with the community. 

I'd appreciate your assistance in comparing note returns with those from the stock market. I'm considering diversifying and holding some re-performing notes in addition to rental property and stocks and am trying to determine the respective ROI and cash flow of these investments over a 5 - 10 year window. Let's make some assumptions here so we can operate with the same set of variables.

• Stock market returns compound 7% annually in our test case and no funds will be withdrawn during the test period
• Stock market withdraw rate will be 4% annually at the end of our test period
• Re-performing notes each have the same set of metrics:
  
  • Annual IRR = 11%
  • 30 year period of performance
  • Cash flow is continuously reinvested in new notes at the end of the year (Dec 31st)
  • The notes will not become delinquent or be paid off early during the test period
  • Note servicing costs are ignored for this analysis
• Our test period is over 5 years
• The cash invested will be $200K for each option
• Taxes are ignored for this analysis
• Our goal:
  • Determine final cash flow for both investments
    • This will be the "safe" withdraw rate that does not require principal to be withdrawn
    • For stocks, it will be assumed to be 4%
    • For notes, this will be the annual cash flow - return of investment capital (let me know if you think this is the wrong statistic to use)

Stock Investment Option

Future Value: 200,000 * (1.07)^5 = $280,510

Future Cash Flow (safe withdraw rate): $280,510 * .05 = $14,026

Note Investment Option

Average ROI = ( (total payments - note price) / (note price) ) / period of performance

Total payments = 200,000 * .11 IRR * 30 years = 660,000

Note price = 200,000

Average ROI = ( (660,000 - 200,000) / 200,000 ) / 30 years = 7.67%

This means that the difference between 11% IRR and 7.67% ROI is the return of capital each year which equals 3.3%. These are the average ROI and return of capital values over the life of the loan. If we are to use a compounded value for annual return, it would be the 7.67% ROI because this will take into account the return of principal and prevent "double counting" of the principal from the original 200,000 note purchases and the annual purchase of new notes with cash flow.

Future Value: 200,000 * (1.0767)^5 = $289,403

Future Cash Flow (safe withdraw rate) = $289,403 * .0767 = $22,197

Conclusion

Based on this analysis, cash flow for the note investment would be higher by $8,121 annually after 5 years.

Question

Do you think this analysis was done correctly? If not, what elements am I missing / calculating incorrectly?

Thank you for your assistance!

Regards,

Brian