Investing in Real Estate or the Stock Market
Real Estate Wins!
So you want to invest some money and you are not sure if it should be in the stock market or in real estate, keep reading. For this blog I am specifically talking about investing not buying the house that you want to live in. Owner occupant purchase of real estate is a vastly different endeavor then that of an investment purchase. I am writing this with the assumption that the reader already owns a home and is looking to better their financial situation with an investment
Let us start with some basics:
If you only have a small amount of money and/or you are not very good at saving it up to be a larger amount, small incremental investments in the stock market is likely your best play. For those that are not good at saving you can still create wealth and be heading in the right financial direction. If you have some money saved up and can make a down payment on real estate, you will likely be better off purchasing a house and renting it out. As for what I consider to be a reasonable amount of money you will need… well 25% of the purchase price you want to buy in is a great place to start.
You don’t need 25% of the purchase price for the purchase but it is the best way to go. The main reasons for saying this is that it reduces your risk of loss. If those that purchased speculative or investment real estate in the last housing boom would have put 25% down then we almost certainly would have not been caught in the situations we kept seeing and hearing about (which is another blog post in itself). When you put 25% down you reduce the mortgage to a level that will help, making the payment from the rents received much easier. There are many points to how this helps.
Most obviously 25% less principal to make a payment on is a big deal. Another reason 25% down is crucial is that you will automatically save yourself the cost of private mortgage insurance (PMI). Once you put a minimum of 20% down, reaching 80% loan to value (LTV), you will not have to pay the extra expense of mortgage insurance. This can easily be a $150 per month savings. Lastly, the vast majority of lenders will not make an investment loan with less than 25% down.
For many, an even larger hurtle to overcome is for your first investment property you will need to be able to cover the mortgage expense of both houses (the one you live in and the one you wish to purchase). There are ways around this but that is a topic for another time and another blog post. Lending regulations change all the time and many lenders, especially smaller ones may have a product that can get around this but as of the time of my writing this blog, this can still be a tripping point for many.
So, let’s get to the meat of the math that shows you why real estate beats the stock market. Depending on what source you use you will find that the stock market has increased somewhere just under 1900% since 1968. Even if we use this large number, real estate still wins. Here is the math. If you were so blessed as to have $20,000 in 1968 and you placed it in the stock market you would have approximately $380,000 today.
If you were to take that $20,000 and invest it in real estate in 1968 even if it was just bought a single property, you would have an increase of just under 1100%. This is a much smaller return, and stocks pay dividends, etc. Yep, totally true! So real estate is a big looser. Nope! The way real estate wins is that you have a much larger vehicle for appreciation.
As we have seen above with that $20,000 dollars you could have purchased a property worth $80,000 (that would have been quite the home back in 1968). Sticking with the 1100% increase, that home would be worth $880,000. Not too shabby! Now of course there are lots of costs that go with home ownership and those are not factored into this simple equation. Still, we are talking about better than double the value. Oh, and this is an investment property! SOMEONE ELSE HAS BEEN PAYING THE MORTGAGE ALL THIS TIME! Also, it has been payed off since 1998 and a big cash cow for the past 17+years! REAL ESTATE WINS!!!
So if you are not tired of the math up to now let’s take it one step farther. If you were a savvy real estate investor and this fits better into the reality for most of us, you likely would have taken that $20,000 and purchased four houses putting $5000 down on each one. This gets you the same total appreciation, but would have done something you hear said is important for investing in stock, diversify your risk. Sure it is all in real estate but an extended vacancy will not hurt the budget as it would with all your eggs in one basket. The last, almost unseen, benefit to this strategy is that those $20,000 houses would be worth $220,000 today, the current median home price in the US. This makes them the most likely and easiest to rent and keep rented and the most likely and easiest to sell if financial difficulties were to happen.
The last point that needs to be made is this: Lets assume for easy math, that those four houses had an average rent of $1000 of the 18 years since they were paid off. That is $4000 a month, 12 months per year equaling $48,000 per year, times 18 years equals an astounding $864,000!!!! That should easily cover the cost of repairs and probably any dividends that the stocks would have paid you
So, yes, real estate wins!
Oh, and did I mention the most astounding part of all this? Banks will line up to lend you 3/4 of the money to invest in (buy) a historically appreciating asset. No one is going to give you $80,000 to put in the stock market!
If you have any questions about this topic I would love to talk with you, feel free to contact me!
*** Please note, this is just meant to be informative, all facts and figures are assumed to be true and accurate but there can be differences in all values stated depending on the source material used.