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)