Real Estate v. Stocks? The $86,000 Choice

A famous real estate investor once said, “The best investment on Earth is earth.” Hyperbole? Maybe. But not by much! Investing in real estate is one of the quickest ways to (legitimately– ha!) build lasting wealth. As I noted in my previous post, Are You House Rich?, an overwhelming percentage of wealthy people invest in real estate by owning their own home. And many also own separate investment properties, and have made their riches doing so.

Yet, the typical American does not own investment properties. Rather, many Americans lack investments altogether, and those who do invest tend to invest in mutual funds and individual stocks.  While those investments certainly have their place in a well-balanced investment portfolio, the average yields from investing in the stock market often pale in comparison to returns from investing in real property, even accounting for periods of down-turns in the housing market.

I think two key reasons many people aren’t investing in real estate are: 1) they don’t truly understand just how beneficial real estate investing can be, and 2) they don’t understand how to do it. Hopefully, this post and subsequent postings will help. I’ll also be offering more detailed educational resources on how to invest in real estate this fall, so look for those later.:)

On average, the stock market yields 10% return on investment (ROI). However, by investing in rental properties you can more than double your investment with 109% ROI. By flipping homes—that is buying, renovating, and selling a property within a 12-month span– that return can be more than 400%! Sound too good to be true? Let me give you an example:

Let’s say you have $20,000 to invest. I know, I know—you may be wondering how you can come up with that kind of dough. We’ll cover that in next week’s blog post. For now, suffice it to say that it is not as hard as you may think.

If you invest that $20,000 in the stock market– either through mutual funds or a balanced portfolio of individual stocks—and you have an annual return of 10% (again, the average annual return), you will have $22,000 after a year—your initial $20,000 plus the $2,000 you earned.

However, if you take that same $20,000 and you use it for a down payment on a recently-built (to keep repairs low) $100,000 rental property, charge $1,000 in rent monthly, and have $600 in monthly costs–mortgage payments, insurance, and repairs– you will earn $4,800 in rental income ($400 cash flow per month for 12 months).  You will also probably realize appreciation, or, the increase in value of the home. That’s 5% on average, so that’s worth $5,000 in our example. And you will have paid down your principal by $982.41 (assuming a 30-year mortgage for $80,000 at 6% interest). By the way—these types of calculations are easy to do with all the online calculators;  I used Bankrate’s Amortization Schedule Calculator for this example. Lastly, if you buy a distressed property—foreclosure, short sale, or estate sale– with built-in equity (as I firmly believe one should do), you can also add that in. I regularly see distressed properties with at least 10% built-in equity. So, in our example, if $100,000 represents 90% of the fair market value of the property, that would mean the property is worth $111,000, which equates to $11,000 built-in equity. Add the rental income, appreciation, and equity, and your $20,000 investment has generated $21,782.41. That’s a 109% ROI!

Now, if you think that’s pretty impressive, take a look at investing through flipping homes. Take that same $20,000, and instead of stocks or rental properties, use $10,000 for a down payment on a distressed property worth $120,000 but selling for $80,000, and use the other $10,000 to renovate it (we’re assuming here that this property needs mostly cosmetic fixes like painting, new carpet, and updated fixtures). After renovating, if you indeed sell the property for $120,000 minus closing costs of $8,000, you will have made $22,000 with your $20,000! That’s an ROI of 110%! Now, here’s the kicker: that cosmetic flip should not take more than about a month to spruce up, if that.  Assuming a month’s time for rehab, two weeks on the market before securing a buyer, and six weeks in escrow before closing, your flip will be complete in three months.   If you rinse and repeat, you are earning $22,000 per quarter or $88,000 over the year. ROI on your initial $20,000 investment is 440%!! And that’s if you only continue flipping one house at a time. Your earning potential grows exponentially as you reinvest your profits (which, I suggest you do)!

As you can see real estate can be a real wealth-building machine. The difference between investing that $20,000 in stocks for a year and investing it in flipping homes is an astounding $86,000! Imagine that year after year…

Of course, this example does not address ALL of the potential hiccups and profit depressors. In that way, it is somewhat of an oversimplification, as any quick example would be.  So no, I haven’t factored taxes into the equation. No, renovations will not go perfectly smooth each time. No, you won’t always sell for exactly what you list for. And, yes, it may take some time to find a “flippable” property. But, fundamentally, the premise remains the same—investing in real estate provides a much greater opportunity to build wealth very quickly in a very short time-period.

Now, back to that threshold question you may have asked yourself—how do I come up with $20,000? Look for next week’s post for discussion on funding. And if you missed last week’s post, please go back and read Are you House Rich: Why Homeowner=Millionaire-in-the-Making to understand how just being a homeowner in and of itself is putting you on the path to wealth!

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