Real estate and stocks. These two asset classes are almost synonymous with investing. Although there are a lot of investment products out there, none are as popular as stocks and real estate. When people talk about investing, what they literally mean is buying either stocks or real estate.
That’s probably because real estate and stocks are the most relatable asset classes for most of us. It is easy to understand real estate because we are used to the concept of buying or renting property. Stocks are also easy to understand because we see the products of the companies we invest in every day.
But when you get ready to start investing, which of these two options – real estate or stocks – should you give preference to? The answer will depend on your personality, goals, personal experience, financial circumstances, and, of course, the potential returns from each investment.
In this post, we will compare the returns from rental real estate versus the returns from stocks. The analysis is specifically for rental properties. The distinction between rental properties and non-rental properties is vital because the returns on a real estate investment completely change when you factor rent into the equation. Check out this article to learn more about rental terminology.
Returns of rental property versus stocks
To make it easier to understand, we will use case scenarios to explain the possibilities when investing in each of these two asset classes.
Investing in stocks
For this comparison, we assume an 8% yearly return for stocks, including dividends. This is a realistic return because it is what stocks have averaged historically.
Let’s assume that I put $14,000 in the stock market and leave it there for 30 years to earn an annual return of 8%. At the end of the period, the investment would have grown to $140,877. I would then have to pay tax on that money. If the tax on that earning is $16,666.70, that would knock the money I have down to $124,210.3.
After thirty years, my profit on that initial investment of $14,000 would be $110,210.30. That is $140,877 – $16,666.70 (tax) – $14,000 (initial investment) = $110,210.30 (total profit).
Investing in rental properties
For the rental property, let us assume I invested $11,500 as a 20% down payment on a property. I then paid a further $2,500 in closing costs to bring my total investment to $14,000. Assuming a tenant in the home pays $550 in rent, and I have a 30-year mortgage on the property at the fixed rate of 4%, my monthly mortgage payment would be $216.
My other costs would be $33/month on property taxes and $33/month on insurance, plus 8% of the collected rent to the property managers ($44/month). My total monthly costs would be 216 + 33 + 33 + 44 = $326/month.
If I deduct 5% for those months when the unit is vacant, 5% for maintenance, and 6% for general expenses, I end up with $550 – $326 – $88 = $136.
My monthly return on that property would be $136, which is just a little over 10% of the initial $11,500 I invested. Over the course of 30 years, that amount would sum up to $48,960. At first glance, this is less than the $110,210.30 I could make if I invested the same amount of money in the stock market. But this is not the complete story about rental property returns.
Given that the initial $11,500 I paid to buy the property was only 20% of the house’s value, the property would actually be worth $57,500. After the 30-year period when the house is completely paid for, I would have added a further $46,000 to the $48,960 I made, bringing my total return to $94,960. But this is still not all the potential return on the property.
If you add the 3% yearly appreciation in the property’s value, the value of the home climbs from $57,500 to $144,325. That’s how much I would get if I sold the house, and it does not include the $48,960 I made from rent over 30 years. This calculation, which is based on realistic figures, is a clear example of how an investment in real estate could trump a comparable investment in stocks.
Other reasons to invest in real estate
The other reason to invest in real estate is that it gives you the kind of control you could not get with stocks. As a real estate investor, you have an array of investment strategies to choose from. You can choose to invest in residential properties or commercial real estate. You can also go with a long-term or short-term investment strategy.
Furthermore, real estate offers the opportunity to grow your investment portfolio at a faster rate. Using borrowed money to buy property gives you the chance to earn returns far above what is possible if you were using your own cash. Instead of raising cash every time you wanted to buy a new home, you could use your existing property to expand your portfolio.
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