As you may recall that a few weeks ago, I asked whether I should buy an investment property in this housing market given that I didn’t even own a primary residence yet. There were quite a few very insightful comments left by my readers and first of all, I’d like to thank you for all your kind responses.
I haven’t decided what I should do yet but I went to see an investment property with my coworker over the weekend and it got my blood pumping because he ended up putting an offer in for one of the properties we saw. Here are the details:
- 1411 sq. ft, 2 stories town home
- 3 bedrooms / 2 bathrooms
- $187 per month HOA
- $2000 per year mello roos (basically like property taxes, only non-tax deductible)
- 1.03% property taxes
- $1,500 a month rent can be expected for the property
- My coworker offered $170,000 for the house
The agent told us that there were already a few offers higher than $170,000 for that particular property, but my friend still has a chance to get it since he can pay cash for it while the others all needed a loan.
Witnessing this got me thinking much more about the investment property idea I’ve been kicking around so I did some calculations comparing the return on buying this investment property versus using the $170,000 to buy a dividend paying stock, say Altria (MO).
Assumptions
Since we cannot predict the future, there are some assumptions made. I listed them below
- The housing price and the stock price of Altria will stay the same. I know this is not realistic but trying to predict the appreciation of these two investments is like trying to guess the lottery so let’s keep it simple.
- I assumed that 5% of the time, the house will be vacant. My coworker told me that he knows of an agency that will help find him a tenant for 3% of the first year’s rent, so I used 5% since tenants won’t move in immediately. (I suspect the vacancy rate assumption is on the low side but let’s use it for comparison purposes)
- Since the positive cash flow generated by house cannot be put back into the house, I am adding the same amount of money into my investment of the townhome each year. In reality, I can use the proceeds to invest in something else.
- I’m not including any house maintenance and repair charges into the investment property. I’m assuming that my coworker can fix everything himself and nothing needs to be purchased.
- The investment property is actually one hour away. I’m assuming that there will not be a need to drive there and no gas expenses will need to be incurred.
- There are no taxes involved in the comparison. In reality, the rent you receive from your investment property need to be taxed each year, as do the dividends.
- The rent and dividend is going to stay the same. Again, this is not true in reality. Judging by history, Altria’s dividend increase is much better than rents, but there is always the risk in any given stock to lower their dividend.
- By assuming $1500 rent per month and 95% occupancy, I took out $2,244 of HOA per year and $1,751 per year of property taxes for a total gain of $13,105.
- I took Altria’s dividend as 6%, and had it compound quarterly since that’s what happens in reality if you reinvest the dividends
| Time Frame | Town Home | Altria (MO) | |
| Current | $170,000.00 | $170,000.00 | |
| 1 year | $184,005.00 | $180,431.80 | |
| 5 years | $235,525.00 | $228,965.40 | |
| 10 years | $301,050.00 | $308,383.10 | |
| 20 years | $432,100.00 | $559,412.70 |
Discussion
Before I did the calculation, buying a townhome made a lot of sense since the monthly check from the investment property is much more than the 6% that I would get from Altria’s dividend. As you can see though, buying the stock turns out to be much better in the long run because of the magic of compound interest.
Buying a stock and living off its dividend also seems to fit my quest of finding passive income. Those that have investment properties know that maintaining a house is definitely not considered passive income. Repairing the property, dealing with the occasional bad tenant and needing to do all the paperwork of having an investment property make these types of investments an active one.
Taxes
Taxes were not part of this calculation. As mentioned, rental income needs to be taxed each year, which would eat into the gain. On the other hand, dividends (for now) are taxed at 15%, much less than the taxes on a rental income.
Property taxes on the townhome is however tax deductable. So depending on your situation, you might get a few hundred dollars back each year for the townhome (the money can be used to pay for the repairs)
Pride
There is no question that owning an investment property gives you much more satisfaction than owning a stock because you actually see the house that you own. This factor might convince you to buy an investment property regardless of what the numbers tell you but I rather have more money in my pocket.
Flexibility
Owning a stock is much more versatile, which can be a good and a bad thing at the same time. It’s good because you can use the funds in case of emergencies, but if this means that you can just wake up one day and decide to sell a stock and buy another stock that you feel is hot at the moment, then all the gains can be wiped out in an instant.
Risk
Houses can be destroyed, set on fire and so forth but they are in general a safer investment than betting on any one company. I picked Altria because they have a good track record but you should never put all your eggs in one basket.
Appreciation
In the calculation, there was no mention of appreciation. Although much of the decision will depend on which asset increases in value quicker, there is really no way to tell what will happen in the future. Altria has historically performed much better than any investment property but if we get another housing bubble, who knows?
Leverage
This calculation is based on having cash for the whole investment property. The biggest advantage of investing in real estate is the ability buy a house with little money down. Even with the increased loan standards, we can still buy a property with only 25% down. This gives us tremendous leverage. This comparison is not intended to look into this, and will be discussed in a future article.
What do you think?
Many of you have no doubt made the decision between owning a stock and buying an investment property before. What made you pick one over the other and why? What were the results? My coworker, myself, and the rest of the readers who are trying to decide between the two would really appreciate your feedback.
{ read the comments below or add one }
Why not do both? I agree that dividend stock is easier to manage. But, dividend returns won’t match the monthly returns as rent. Be selective when buying a property making sure your ROI is a certain amount, say around $400 per month. Keep all of your properties that you have lived in that you have owned, and rent those out when it’s time to buy another primary residence. Save the money that you do earn with dividend stock and use the money for the down payment on the next property. Depending on your goals, two rental properties should generate enough additional income in your retirement years to live comfortably especially if you can get at least one rental paid off. I also think it is good to have some (good) debt such as mortgage interest, property taxes and depreciation to help with federal income taxes. With other income sources such as social security, IRA distributions, 401(k)’s, and pensions, the write-off’s from owning rental properties are huge. If you don’t want to manage your properties, hire a management company to do it. You can write off that expense as well. I hope I have triggered some thoughts and ideas. Good Luck!
Damn did you end up investing in altria? Looking at it now, it would’ve been an awesome decision
I’m definitely a stock dividend guy. I rent an apartment, and I would think my landlord makes money off of me. I am interested in rental income at some point, but I just don’t know how to get started. Real estate is harder to be successful in I would say. It would be quite fulfilling though to know that I’m offering affordable housing to people while making a modest profit.
The recent price rises for homes here in CA is ridiculous. A house across the street rose from $360000 to $425000 over a few months. Idiots rushing in and paying way above their pay scale again.
Tenants can be a real nightmare. We lost $42000 in repairs due to lost rent and damages. Drug users. Previous tenants failed to report a shower leak that attracted termites – another $7000 damages. Constant plumbing issues etc
You forgot house insurance costs. Over 20 years rising yearly (my experience) could be another $600^ x 20
Buy stocks with dividends. Those can also increase as with MSFT recently from 22 to 27 cents (if I recall accurately).
With the benefit of hindsight, your call on altria was very good indeed
My husband is convinced that if he had cash to pay off our 4 rental properties, he would. He would then make them all part of an LLC (to reduce the risk of being sued by tenants if something happens at the property). He believes that his equity is preserved because the homes could at least sell for the current home payoff amount + commissions), and that all the rent (less expenses) would be all profit. What I’ve learned with real estate it that your profit (like stocks) is still so unpredictable. This year on one house we spent nearly 4K because of a plumbing backup. Two months later the tenant moved. It cost $4000 in painting and other repaires. It took 4 months to get a new tenant. And we had to rent for $150 less that what we previously received in rent. This house is only 7 years old! Because of our income level and the fact were’re considered passive investors, we get no tax breaks on all of the expenses throughout the year. We simply carry the loss. They add up, but we can’t apply them until we sell. I wish we could sell all of the homes, but my fear is that we would only get what we currently owe on them and overall will have taken a bath in costs. In comparision, when I look at my 401K, I’ve seen losses, but its still way above my total investment. Long story to say I perfer mutual funds!
Your discussion was very interesting. We are in a unique situation that many in the real estate investing community say will never happen again in our lifetime. Stocks historically have been a better investment because of the compounding of interest from dividens (I am starting to learn about stock). I suggest seeking out a wholesaler when buying a real estate investment. You can can a much better deal.
i love the picture:)
Altria is in the business of giving people cancer. A house provides shelter and safety to other humans. Buy the house, and sleep with a clear conscience.
First, I wouldn’t touch stocks or bonds because, I understand too little about it and I don’t have enough cash to play with which means for me putting an egg into a basket which could be a gamble.
On principle, one should only buy investment in form of property in the best neighborhood. It’s better to buy a come down property in an expensive suburb at a low price than buying any new property in a new or fashion suburb at a normal price. Fashion comes and goes.
One should never buy by a river, close to a lake or ocean, where landslides could occur or in a dip where water can collect during torrential rains nor on unstable grounds.
When buying new property it’s important that insurance has been taken out by the builder or construction company to cover building errors which might show up later.
Otherwise, find out if you can have a rental contract accepted for 6 months only based on some personal rental conditions. That way you have some idea of what sort of tenant you will have.
It may be wise to discuss this with a real estate lawyer.
I like the stock. You forgot to add in the additional risks of real estate. Tenants moving out, repairs and you cannot sell a house as quick as a stock
That’s sound great.
RENT YOUR STOCK AS YOU RENT INVESTMENT PROPERTY?
I like the comparison. If are not a handyman, an investment property especially a house can create a havoc in the middle of night when tenant start calling for trouble i.e., water pipe burst in kitchen on a winter night.
I would like to add another dimension to your analysis. Treat stocks as investment rental property. Sell a covered call(what I call rent the stock) on MO for every two months. At present, it is generating a return (rental income of 1.5% every month) while you will be entitled to receive dividends as well.
For more discussion, please visit:
http://optionsforstocks.blogspot.com/
Mello roos? Sounds like a type of cookie. 😉
I think Joe has a touched upon a good point. For me personally, I don’t want to have to deal with all of the hassle of investment property, especially after just viewing what Professor Schiller said about housing prices over the past century.
If one is seeking diversity through real estate, REITs would seem to offer a much easier approach.
MoneyNing,
I’d stick with the stock. Here’s why…
I’m not cut out to be a landlord, and if Altria (or whatever stock) took too much of a hit it’s easier to minimize my losses and sell it. Real estate is a fickle beast, and not as easy to sell when things turn south.
Here’s an idea: why not split the difference and invest in a REIT, or REIT index like Vanguard’s VNQ? REITs (like the underlying real estate) have taken a hit and are selling at a discount. They pay a hefty dividend, and you can let someone else be landlord.
Real estate investing is usually promoted because of the leverage and because you have more control (i.e. you can remodel the kitchen, etc).
I think that it ultimately comes down to what a person is more comfortable with.
A lot of people think stocks are risky, and they feel that property is more substantial.
I personally feel more comfortable investing in stocks, and I feel that my trading system gives me control, because I’m not just buying and holding.
Another thing to be aware of with real estate is that the costs like property taxes go up while, once you buy a share of stock, you do not have to keep paying for it.
Maybe it is not a concern in California, because of Proposition 13, but here in the Chicago area, the property tax on my house has gone up from $7,233.58 for tax year 2003, to $10,783.46 for year 2007.
That is a 49% increase in 5 years, or 8.3% per year.
oh – I should add that when I sold the rentals, I carried the land sales contracts on them at 11% and am using those proceeds to fund my stock purchases.
There were just too many expenses you left out of the rental side of things. And figure at least 10% vacancy, and at least 1% per year for repairs. And some deductions: Your travel to and from the rental is tax deductible, as is your depreciation.
You could get a renter who turns it into a drug house and you loose your investment in the cost of clean-up. Your stocks could fall thru the bottom… No way to predict the future as you said.
I have done both. Rentals in my earlier years when I had the stamina and energy for it and could take the worries. Now I am all about stocks…. diversification of stocks so not all eggs are in one basket.
Why go thru all the mental and physical stress of having a rental, when the money just rolls in from the stocks in the form of dividends? Much easier… it just appears magically in my portfolio without my having to lift a finger. But you are right – there is not the same ‘pride of ownership’ in stocks as there is in having a tangible rental property.
MN,
That’s a very interesting discussion. Buying a single property for $170K does have a lot of concentrated risks associated with it. The main reward is that if you can find someone to manage the property and take care of fixing stuff for a management fee you could theoretically achieve a higher monthly income faster because of the leverage factor. The way I am calculating it however, your mortgae will be around $1200 month plus you have 187 HOA + 167 mello roos monthly + $146 prop tax monthly. The total comes out to $1736/month. Your rental income is $1500/month if it is rented all the time ( you will have vacancies). What happens if the property requires you to change the roof for 5K-6K or do some other major rehabilitation/upgrade/upkeep.
In my opinion if you are not cash flow positive you shouldn’t purchase the property.
If you still want to dabble in Real Estate, you can purchase a stock in Realty Income, which pays a monthly dividend and currently yields 6.50%.
But you still have to be diversified and should buy at least 30 income producing stocks across different sectors.
With your assumptions, I do no understand why you would not finance it. With that you get the beauty of leverage. You get a renter paying off your mortgage, while you can still invest the rest of that money that you didnt invest in the house in the stock. Not to mention, any appreciation in the home is appreciation on the vaule of the home, not on your actual investment in. If you feel confident in it being rented 95% of the time I feel financing it is the way to go. Just my $.02.
Defintety buy the stock. It’s so much more flexible. A couple years ago, my husband got into an accident and we lost half our income in a flash. Thank god that we have stocks and bonds. Otherwise we would’ve been kicked out of the house during that tough time.