Back in 2007, I covered an article in Money Magazine that was interesting to me – Stocks vs. Real Estate. It’s fifteen years later now, and I thought it was worth revisiting now that we sold an investment property. Now it’s time to invest that money in the stock market.
Before I get to that new stuff, let’s review what Money Magazine and 2007 Lazy Man thoughts were:
May’s Money Magazine tries to answer the Stocks vs. Real Estate question. I had thought that real estate would come out as the big winner. I know that real estate has been trendy of late, but I had it as the favorite due to the value of leverage.
Money Magazine declared stocks the winner, but I think they glossed over the leverage factor. For one, they took a two-year timeline for the real estate and deducted many one-time costs. That didn’t seem fair to me. So to the right, you’ll see my attempt at running the numbers in my spreadsheet.
For this example, I assume the investor has $40K to put to work. I assume a 10% (for better or worse) gain for stock picks. I also took a cue from my early physics classes and ignored friction – in this case; it’s the cost of buying stocks. The “Real Estate” column assumes the investor puts 20% down, allowing them to buy a $200K home and pays 10K in closing costs (closing costs from the article). The “Real Estate AC (after costs)” factors in a 6% sales commission (though I believe this can be less), paying off the mortgage, $3,600 in preparing the house for the sale (sourced from Money Magazine), plus the original 40K investment.
I’m not sure that my chart is accurate. I’ve edited it several times, realizing a couple of errors. However, each of the charts showed the same trend. Real estate seems to outperform in the short term, but at some point in the 25-30 year mark, the 10% return of stocks takes over the leverage of real estate. However, if one were to lock in real estate gains at year 8 (around $125K), the person could use the profits to buy three more $200K homes, getting more and more leverage. Leverage can be dangerous as a loss can spiral just as much in the negative direction. Nonetheless, it still makes me think that there are a lot of general gains in real estate.
If you plan to go this route, remember that it’s not a get-rich-quick scheme. In today’s real estate market, I believe you should be prepared to hold onto a home for a minimum of 6 years (while being prepared to hold for ten years). Trying to fix up and flip a home within a year opens you up to short-term price pressures and fixed costs. You should also be aware of other factors mentioned in the Money Magazine article apply. One important thing to remember is that a home is not a very diverse investment. Another is that real estate investing takes a lot of work while investing in stocks is relatively quick and easy.
That was the whole article. I miss the pithy 2007 style of blogging. For the most part, it seems to stand-up well today. Of course, it might be more challenging to buy a $200,000 home than it was back then.
With fifteen years of wisdom, I’d say I should have put more attention into the last few lines of that article.
- Investment property is NOT a diverse investment
There are ways to make investing in real estate more diversified. You can buy a REIT, which trades like a stock. Or you can do crowdfunded real estate like Crowdstreet and Fundrise. Those weren’t around in 2007.
We all know what happened in the next 12-24 after I wrote that in 2007. The market crashed, and the property I bought for around $275,000 suddenly became worth $175,000. It took years for it to recover. In 2012, we purchased another property for $95,000 and sold it for $200,000. We used that money and did a 1031 exchange into another property now worth $300,000.
One condo lost nearly a hundred thousand in a few years. Another gained a couple hundred thousand in a decade. Those are extreme examples, but they are two of the properties we owned.
- Owning stocks is a LOT easier than managing a rental property
About 97% of the time, managing a rental property is easy. It’s the other 3% that’s tough.
The real estate approach is more difficult, but I feel that you have more control over the results. I’d like my kids to have the life skills to be able to fix up an old dump and flip it for profit. I never learned those skills, making being a landlord more difficult. My friend, Carl at 1500days.com has executed some excellent live-in home flipping profits. It’s amazing to take one of your biggest expenses (your home) and turn it into a profit.
Let’s take the case of the property we just sold. We sold the property for $385,000 – close to the Zillow Zestimate. The Zillow Zestimate said that we should be able to get $2375/mo. in rent. We would need to do some updates, but that’s a reasonable number. That’s an annual income number of $28,500. Let’s assume that there was no mortgage on the property. All we have for expenses are property tax, insurance, condo fee, and maintenance. If it wasn’t a condo the condo fee and maintenance would be combined. All those numbers add up very close to $1,000 – so we’ll keep things simple and say that expenses are $12,000 a year.
The profit on a $385,000 investment is $16,500 or about 4.2%. That’s not a great return. It’s better than I can get with most dividend stocks, but the stock market usually grows more than 4.2%, and I don’t need to be a landlord. While I never ran these numbers specifically when I sold, I knew I wasn’t getting great value. Our situation was a little more complicated because we still had a mortgage, so our monthly gain was building the equity towards owning 100% of that $385,000 property.
There are likely better properties out there that would return more. Perhaps there’s a property that’s $250,000 and rents for $2,000, making the numbers more favorable for investors.
I think it’s hard (maybe impossible) to answer the stocks vs. real estate question because the specific details matter. If you do real estate poorly (pay too much, can’t maintain the property, pick lousy tenants, etc.), you would be better off with some index funds. If you can do real estate right (live-in flip, buy at a low market, have a tremendous price-to-rent ratio, etc.), it will probably beat the stock market. And it should, especially if you are putting in the extra work.
I’m left with the same conclusion that I had before. It seems that real estate is great if you are young and can put in the work. As you get older, maybe it’s best to cash out the equity and let the passive income from the stock market work its magic.
(Original version of this article published on: Apr 19, 2007 at 05:55)
I do agree. Real Estate is more complicated than stocks. I love investing in stocks (ETFs, Mutual Funds) because it is easy and convient for me.
Real Estate takes more time and risk. With stocks if you feel you are losing money, you can quickly get out. RE is not that simple to get out.
I’m commenting on this blind, since I haven’t read the article. But is the article comparing actual real estate investing versus owning a home? They aren’t the same thing. If I own a rental home, the monthly rents plus the depreciation, as well as the equity growth usually provide returns of 13% or higher for the long term, and sometimes much higher – with somewhat less risk.
Lazy Man says
Moneymonk, it’s true that you can get out of stocks quicker, but I might say that’s a bad thing. This would be against the buy and hold strategy.
Silverbax, I have forgotten some of the Money magazine article, but I think their logic was to apply to both cases even if they aren’t the same. I ignored all cash flow issues (both positive and negative) of the real estate situation. I have an investment property now that’s cash flow negative, which I hope will be cash flow positive in the upcoming months. This article ignores that and focuses on just the appreciation of the property, which I believe is close to 5% per year. I’ve seen it quoted as high as 6% long term.
Diversify, Diversify, Diversify for long term
leverage leverage leverage to get rich form other people’s money.
Do both. I own a 4 family apt building, and I own stocks. The building is cash flow positive, yet runs a large tax loss due to depreciation. Wow, this one apartment building has been a major boon to our finances. Our Federal Tax owed plummeted.
I am tempted to buy a 2nd one, but realize I must build up a sizable pile of equities first. Plus, the building does take some of our time. I am comfortable with our time committment now, but wonder if we could handle a 2nd one.
The only problem with real estate projections is the numbers you get to work with are completely gameable. Most numbers you will find will be from the NAR or home builders or mortgage broker associations. All of them have vested interest in people thinking appreciation is higher than reality. A quick example is the stat that shows median house prices have roughly gone up about ~5% the past few decades. Too bad it doesn’t account for house size — the median house in 1960 was 1200 sq ft, the median house now is 2500 sq ft. Factor that in, price appreciation seemingly matches inflation — which is not too surprising because the limiting factor controlling house buying is (1) income and (2) credit.
I don’t know if I agree with making leverage a judgement factor. While I realize it’s much easier to be more highly leveraged with real estate, leverage can be used for any kind of investment. I think Money magazine too quickly dismissed the use of options to leverage yourself in stocks just because you could lose everything, but that’s not really any different from borrowing 300,000 with downpayment of 20,000 and then having the house drop 20,000 and be left with nothing in equity. If anything options are safer than pure leverage play since you can cap your loss. Not to say I endorse the use options to make such a maneveur, but rather leverage isn’t the best criteria to differntiate stocks and real estate.
I see various articles and blogs address this from time to time. It’s interesting and provides some additional information with which to make a decision, but there are lots of assumptions that can make the analysis go either way. Particularly when the analysis is for a general situation rather than a specific purchase decision. Real estate markets are so regional, plus what assumptions are used for taxes, interest, inflation, appreciation, maintenance, remodels, etc.
Most of these articles address homeownership vs. renting and I think that decision is (should be) dominated by the local market and the individual’s desires. I suspect that based on nationwide averages (or means), the best financial decision (mathematically) is to rent. However, I don’t think it is a huge difference and if you like gardening, projects around the house, etc. then buying makes sense. If you don’t like mowing the lawn, maintenance etc. then rent and invest the difference. After all, isn’t the reason we save and talk about returns so that we have the financial freedom to buy or do things we enjoy?
Real Estate Guru says
Well if you like to park and pray, go ahead and invest in stocks and bonds. If you want to take true control of your financial freedom, take the time and risk to invest into the real estate market. You can invest with less risk than the stock market, plus you can make a lot more faster than the stock market. If stocks and bonds are so good then why are IRA’s down 2 trillion dollars. There is only one thing that there is a limit to, and that is real estate. There is only so much of it, and someone is always buying.
Adventures In Money Making says
hey, i just posted on this too!
what was it about great minds thinking alike? ;-)
If your stock gave off dividends wouldn’t you re-invest those? similarly you need to consider the rental income for real estate too. after 30 yrs, the house is free and clear so you should consider the rents as a dividend. assuming you bought in California and the rents are 0.06%/mo of the value of the house, you should consider 6% as the annual dividend off the future value of the house.
anyway, like you i think the article isn’t accurate.
I am currently working on the ultimate housing buy vs rent spreadsheet where every factor ever brought up in these buy/rent arguments is modelled. When done, we can finally settle this issue once and for all! (Once and for all = some specific location, some specific time in history, possible direction of stock/housing markets, etc, etc, etc.)
BTW, most landlords historically considered 10%/year as the target number for rental income. 6% is borderline unsustainable. And some coastal areas of California are seeing as low as 3% as the annual rent:price ratio — I’d like to see somebody attempt to push 3% as a good buy number.
Lazy Man says
MossySF, while I agree that real estate prices should be close to inflation, I think it’s definitely harder to buy a home now that it was for my parents – even one of the same size and quality. That would suggest that it’s not just inflation. I’m comfortable saying that it’s appreciating 5% without too much gaming – that’s just 1% more than inflation, but it’s more due to the leverage.
Dong, I will say that I don’t know much about options investing. However, I think Money magazine was afraid of leveraging stocks because they swing so wildly. They did mention the ability to use margin accounts, but again, I don’t see it as being an overall successful strategy. One more thing, you can’t live in (or collect rent from) your leveraged stocks.
Lazy Man, you may be looking at previous generation through rose-colored eyeglasses. I remember it was damn tough to buy a house for my parents. They spent years saving up — got up to about 10% when they received a small inheritance to get to 20%. Then they spent easily 40% of their income on the payments. So while we think “oh it must have been easy to buy a 100K house back then”, getting the 20K required was a tough job when salaries were 15K-20K. Nowadays, it’s probably about par to getting 5% on the typical house today. Except that means with the higher home prices due to easier credit, the banks are making much more off the monthly payments.
Which actually comes back to the matter of inflation. Perhaps both you and I are right — 5%-6% could be accurate now because that’s true inflation after you factor in the money supply expansion from looser credit standards. Previous lower inflation numbers were based on 20% down tighter credit. This means the typical inflation X% factor perhaps should be applied to other asset classes. If you thought stocks were 10% (3.5% inflation 6.5% real return), that 2% inflation for housing is probably there bumping up stocks to 12%. Example, people can borrow much more money leaving much more money to put into either the stock market (more demand pushing prices up), spending the money (more cash for companies improving results) or putting it into savings (more reserves for banks to lend even more money). I suspect we are in a global credit bubble that’s pushing up returns on all asset classes — housing, stocks, bonds, commodities so the only real way comparison is to base it on historic real returns.
Lazy Man says
I guess what I mean by it being easier for the previous generation is that they typically bought homes with one income and a shorter work week. Society has changed and there are many more dual-income families. That means more money nowadays for many families. I think housing prices have risen to match. Perhaps it’s like how if you have a big house, you always buy enough stuff to fill it up.
The question is an important one, but I have never been convinced that there is a “right” answer to it.
The number of express or implicit assumptions in any comparison is huge and that makes it easy to “prove” or “disprove” whatever conclusion the writer wishes to reach or to reach a conclusion of dubious worth even when trying to be as objective as possible.
As an example, one of the problems with analysis is finding the right comparison. It is easy enough to take a well recognised index as a proxy for investment in stocks (factoring in dividends)- you can always invest in an index fund to achieve the benchmark return. However, finding a sensible proxy for property is a lot harder. National or even regional average data for sale prices of real estate are not meaningful because, as individual property investors, we will be investing in specific properties in specific (local) markets.
I concluded that an investor can do very well out of an investment in stocks and can do very well out of an investment in property.
That said, the analysis is still well worth doing as it forces me to think about what makes a good investment. My retirement plan calls for investment in both equities and real estate.
Nice try, but homes don’t appreciate at anywhere near 5%. You conveniently chose a time period to calculate the average appreciation that includes the biggest housing bubble in the history of the US, skewing the reality. Sure, if you buy at the beginning of a boom and sell at the top you could stand to make a major profit, but how do you know you are at the beginning of a boom? And then you take the risk that you sell to late, after the boom takes a downturn. And even if you magically do everything right you no longer have a house and since all home prices have gone up you end up spending all of the money you earned to get into another house.
Lazy Man says
The 5% was a number that I pulled from a reading a long time again, but that data went as far back as the 1950s. I think that catches a lot of datapoints. Also that data was 5-6%, so I took the conservative estimate. The Money magazine article quoted a return of 8.6% from 1974-2004 (http://money.cnn.com/galleries/2007/real_estate/0704/gallery.stocks_v_realestate.moneymag/index.html). By taking 5%, I think I’m sufficiently compensating for this “bubble.”
Why not do both – leverage a home into equities? I am planning on paying off our house the next couple years, because I can’t itemize deductions and I think equities are priced too high. After the prices of equities corrects, I plan on re-borrowing against the house and plowing it into foreign/domestic index funds.
David Bethoney says
If we are comparing stocks vs. real estate and leverage, real estate clearly wins this battle. There are so many more variables to answer the stocks vs real estate question though like short term vs long term investment, costs, taxes, effort, volatility, diversification and so on. The sad news for all you real estate investors is stocks win most of these battles (stocks are easily diversified, less effort and subsequent issues and less cost). If you are looking for the long term investment and we look at historical data, stocks crush real estate in performance. If we compare short term performance, real estate far outperforms stocks.
Main Line Real Estate says
To me real estate is by far the better investment. Stocks, well you have to know exactly which ones to buy and exactly when to sale.
Lazy Man says
Main Line Real Estate – Mutual Funds and Index Funds are included in the my definition of stocks here… I’d say that real estate is more difficult because you can’t diversify unless you go with REITs. REITs are more like stocks, you don’t seem to get the 5-1 leverage that you do with a typical mortgage.
The best thing about a real estate marketing script, whether it’s targeting FSBOs, expireds, or whatever you choose, is that they’ll help you save you time while making money.
How is your Donald Trump status these days? Money Magazine is correct. They tout stocks for the long run and the S and P 500 handily beat real estate as the better investment since November 2000. A meager 2.8 percent average annual gain. It is rare for such a dismal decade. But it still beat rentals in most markets.
Nice post, I’d like to add that… It is important that you diversify your investments as much as you can. Remember the old saying: do not put all your eggs in the same basket. Instead of buying a quantity of stocks from the same company, look for other investments. However, you should also learn when to strengthen your positions when you find a great investment.