I am often amused when I hear the financial pundits compare stocks and real estate as an investment. They talk about how the US stock market has historically grown at a rate of a bit over 9% and real estate has grown about 5% nationally and therefore stocks are a superior investment. They ignore a few factors, three of wich are leverage, income, and tax advantages.
1. Leverage. It is possible to borrow money to buy stock. A broker will lend up to 50% of the value of the stock. If the stock goes down too much, you will get a margin call, meaning you need to send more money or they sell the stock at a loss. Alternatively you could get leverage by purchasing an option to buy a stock. Buying a stock with leverage should not be used as a long term investment strategy and is very risky without lots of knowlege, experience and risk tolerance.
Borrowing money to buy real estate on the other hand is much less risky. Knowlege and experience reduce risk, but the learning curve is much shallower. Typically you can borrow 80% of the value of the home at relatively low interest rates. This means that your return on investment is 5 times greater. For example, if you buy a $100,000 home, you would only need $20,000 in cash. Let's assume the property goes up 4% in one year, making it worth $104,000. Your equity went from $20,ooo to $24,ooo - a 20% per year increase. This sure beats the 9% stock return!
2. Income. Some stocks have quarterly dividends which give you an income stream. These dividends are low or non-existent for stocks that tend to appreciate. To get any kind of reasonable dividend, you would have to buy a stock that doesn't appreciate, such as a utility.
Real estate investments provide monthy income in the form of rent. In my experience, this income, as a percentage of investment is greater than what you could get from a low appreciation stock.
3. Tax advantages. The best you can do with stocks, from a tax advantage point of view, is to get tax deferral. This is only if you buy them in an 401k or IRA, which means that if you won't be seeing any of that money until age 65 without stiff penalties.
With real estate, you can save quite a bit on your income tax bill. You can deduct "paper" losses even though you had a net cash gain. If you run your real estate investment like a business, you can deduct a number of business expenses. Whole books have been written on this topic, so I can only scratch the surface here.
Let me give you an example of one of the first investment houses I bought that puts this all together. I paid $90,ooo and was able to put 9000 as a down payment plus $3000 closing costs. My mortgage payment was about 450 and I charged a rent of $850. Within 2 years, the value of the home became about $150,000. Lets look at the return on investment. We will take away $250/ month from the income for maintenance, property management, and vacancy, bringing it down to $150 / month from a $12,000 investment, or 15% per year. The appreciation netted me $60,000 out of $12,000 or 250% per year. During those 2 years, I was able to save quite a bit on my taxes as well. For example, I hired my daughter to help with the bookkeeping, giving her experience and money for college, and me a write off. Do you see why it's hard for me to get excited about a 9% return from the stock market?
1. Leverage. It is possible to borrow money to buy stock. A broker will lend up to 50% of the value of the stock. If the stock goes down too much, you will get a margin call, meaning you need to send more money or they sell the stock at a loss. Alternatively you could get leverage by purchasing an option to buy a stock. Buying a stock with leverage should not be used as a long term investment strategy and is very risky without lots of knowlege, experience and risk tolerance.
Borrowing money to buy real estate on the other hand is much less risky. Knowlege and experience reduce risk, but the learning curve is much shallower. Typically you can borrow 80% of the value of the home at relatively low interest rates. This means that your return on investment is 5 times greater. For example, if you buy a $100,000 home, you would only need $20,000 in cash. Let's assume the property goes up 4% in one year, making it worth $104,000. Your equity went from $20,ooo to $24,ooo - a 20% per year increase. This sure beats the 9% stock return!
2. Income. Some stocks have quarterly dividends which give you an income stream. These dividends are low or non-existent for stocks that tend to appreciate. To get any kind of reasonable dividend, you would have to buy a stock that doesn't appreciate, such as a utility.
Real estate investments provide monthy income in the form of rent. In my experience, this income, as a percentage of investment is greater than what you could get from a low appreciation stock.
3. Tax advantages. The best you can do with stocks, from a tax advantage point of view, is to get tax deferral. This is only if you buy them in an 401k or IRA, which means that if you won't be seeing any of that money until age 65 without stiff penalties.
With real estate, you can save quite a bit on your income tax bill. You can deduct "paper" losses even though you had a net cash gain. If you run your real estate investment like a business, you can deduct a number of business expenses. Whole books have been written on this topic, so I can only scratch the surface here.
Let me give you an example of one of the first investment houses I bought that puts this all together. I paid $90,ooo and was able to put 9000 as a down payment plus $3000 closing costs. My mortgage payment was about 450 and I charged a rent of $850. Within 2 years, the value of the home became about $150,000. Lets look at the return on investment. We will take away $250/ month from the income for maintenance, property management, and vacancy, bringing it down to $150 / month from a $12,000 investment, or 15% per year. The appreciation netted me $60,000 out of $12,000 or 250% per year. During those 2 years, I was able to save quite a bit on my taxes as well. For example, I hired my daughter to help with the bookkeeping, giving her experience and money for college, and me a write off. Do you see why it's hard for me to get excited about a 9% return from the stock market?
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