So often, I will hear people asking the question, “What provides a better return, investing into real estate, or investing into stocks?”
But, that kind of comparison really can’t be made. First of all, it’s a loaded question. Are we talking Johnson & Johnson stock or Tesla? Are we talking about single family home rentals or are we talking about commercial buildings?
Let’s ignore the fact that this is an extremely broad question, and just assume we are making the comparison between the S&P 500 and single family home rentals. We’re also not going to dive into any specific geographic market data, but instead focus more on the types of return that both asset classes produce.
S&P 500 Index:
If you own the S&P 500 index through funds that track the index, then you get paid returns in two ways.
1. Appreciation– The S&P 500 is made up of a pool of large company stocks. When those companies do well through growth of revenue, then the value of the equity share you own appreciates. Meaning, the value of your piece of the pie increases.
2. Dividends– Each company in the S&P 500 pays a different dividend amount. This is similar to an interest note, where the company is paying you a specific percentage in exchange for the amount of money you provided them by buying a share of the company. When you own the index fund, the blended dividend rate streams out to you, the investor, in proportion to the shares you own of the index fund.
Really, what you need to know is that there are two ways to make money owning “stocks”. Appreciation and dividends make up your total return on investment.
Rental Real Estate (Single Family Home):
When you own a real estate investment, it’s not as linear. There are the traditional returns on investment, like we just spoke of. But, there are also a few other forms of return that you may not have considered.
We’ll start with the most assumed, and then work our way down the list.
1. Appreciation- As you might expect, real estate generally appreciates over time. Recently, we have experienced a huge housing boom in real estate markets across the country. Some as much as 45% in just a few years! However, broadly speaking, 3%-5% long-term annual return rates are more normal. That being said, with careful considerations, some markets far exceed these normal return rates.
2. Rental Income- This is more similar to the dividend example above. When rented out, you receive a return on your investment through rental income. And, when rented out for an amount above the mortgage and expenses, you are positively cash flowing.
3. Depreciation- Each year you own your rental property, you can to depreciate a portion of the house. Basically, depreciation is a tax deduction for the cost of purchasing the home, divided out over a period of 27.5 years. So, each year you get a portion of the depreciation to offset your income and equate to a return on taxes.
4. Amortization- When you get a mortgage loan, you have principle and interest to pay. A certain portion goes to each, typically with increasing payments to principle as the life of the loan goes on. Every principle payment is increasing your equity position in the house and therefore increasing your return on investment. The best part is, your tenants are the ones buying you more equity stake in the home each month.
As you can see, the returns for the S&P 500 versus real estate investments just can be compared. This is because there are additional types of returns for rental real estate that just can’t be translated over to the stock market.
There are many reasons to own both types of investments and diversification is also an important element to successful investing. But, the returns within real estate have significant diversification and that is a huge benefit to owning real estate investments.
If you need any help analyzing the returns of your investing strategy, don’t hesitate to reach out.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
All investing involves risk including loss of principal. No strategy assures success or protects against loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
Asset allocation does not ensure a profit or protect against a loss.