EP #19 - Rental Properties vs. Stocks: The Ultimate Investment Breakdown
May 06, 2024Episode 19
Jacob Sandoval & Michael Magno
In this insightful video, Jacob delves into the age-old debate between investing in rental properties versus stocks. Through a comprehensive seven-round comparison, Jacob breaks down key factors such as appreciation, cash flow, level of effort, volatility, leverage, liquidity, and tax benefits. Even though there is a "winner", Jacob emphasizes the importance of aligning investment strategies with personal goals and offers a balanced perspective, revealing his own portfolio strategy. Don't miss out on valuable insights into building wealth and achieving financial freedom!
In this insightful video, Jacob delves into the age-old debate between investing in rental properties versus stocks. Through a comprehensive seven-round comparison, Jacob breaks down key factors such as appreciation, cash flow, level of effort, volatility, leverage, liquidity, and tax benefits. Even though there is a "winner", Jacob emphasizes the importance of aligning investment strategies with personal goals and offers a balanced perspective, revealing his own portfolio strategy. Don't miss out on valuable insights into building wealth and achieving financial freedom!
Here's the sad reality. Most people are never going to achieve financial freedom. And that's because most people are either spenders or savers spenders spend every single dollar that they make. So even as they make more money over time, they just spend more money over time. So they're never getting ahead and savers are the opposite where they do save money, but they're only saving it in their bank accounts where they're getting 0. 1 percent interest and inflation is even higher. Eating away at their nest egg. And so the vast majority of the population are either spenders or savers. But in order to achieve financial freedom, you need to be an investor, somebody who allocates their capital effectively so that their money is growing over time. And since you're watching this video, I'm guessing that you're an investor or you want to be investor, which is great, but it still begs the question, Jacob, what am I supposed to invest in? Well, since the dawn of time, the two most popular investments have been, real estate and stocks. And in this video, we're going to pit these two investment vehicles in a head to head battle to determine which is the best investment vehicle for you. So let's hop into it. The first thing we need to do is establish a clear criteria. How are we going to compare these investments? against one another. And so there are seven factors or seven rounds in which we'll compare stocks versus real estate. The first is appreciation, which investments values expected to increase more over time. The second is cashflow, which is the better investment vehicle for producing cashflow. The third is level of effort, which investment is going to require more work to manage. The fourth is volatility, which investments price is going to fluctuate the most over time. The fifth is leverage. Can I borrow money to purchase this asset? And we'll explain why that's important. Next one is liquidity. How quickly can I turn this investment into cash? And then last but not least is tax benefits. So without further ado, let's hop in to round one round one appreciation. Stocks are famously known for their consistent price appreciation over time. Over the past 30 years, stocks have appreciated at a rate of 10 percent every single year, which is really good growth to paint that picture with numbers. If you invested 10, 000 into the S and P 500 30 years ago today, that investment will be worth 164, 000 assuming you invested all dividends, which is not too shabby in that same 30 year period, real estate has appreciated at a rate of 10%. Of 4 percent every single year. So less than half the returns of the stock market. So stocks are the clear winner, right? Not so fast. This assumes a very, very big thing, which is you actually can achieve the average annual returns of the S and P 500, which studies show that 94 percent of us fund managers 50. Unable to match the returns of S and P 500. So it's no surprise that everyday investors like you and me get nowhere close to the returns of S and P 500 when it comes to our stock investing portfolios in a money with Katie episode, she breaks down a study that shows most stock investors are only achieving around a 5 percent average annualized return, which is a lot closer to the returns of the real estate market. Now, even though it's a lot closer, if you have the discipline and you're an index fund investor, then you should be able to get close to the returns of the S and P 500, which is much better than the real estate market. So I'm still going to go ahead and say, stocks take round one appreciation round to cashflow while appreciation is an important aspect of building long term wealth over time. In order to achieve financial freedom, you 2 income, which takes cashflow. So which investment vehicle is more effective at generating cashflow? Stocks or real estate. Let's start with stocks. Let's say we invested a hundred thousand dollars into ticker symbol VOO, which is the ETF for the s and p 500. The dividend yield for VOO is around 1.5 to 1.6%. So if you invested a hundred thousand dollars, you'd be generating 15 a hundred to$1,600 a year, or roughly$130 a month, which is not a lot of cash flow. You can't really live on$130 a month. So how does real estate compare? Let's say we took that same 100, 000 and paid all cash for a single family house in a nice, clean, working class neighborhood in Cleveland, Ohio, for example, and yes, those do exist. So, let's say we bought that house and since we made sure that it satisfies the 1 percent rule, that house rents for 1, 000 a month or 12, 000 in rental income annually. Now, 12, 000 isn't our cash flow. We still have to pay rent. Factor in our operating expenses. And to keep this very, very simple, a good rule of thumb is rental properties have about a 50 percent operating expense ratio, which means that for this particular property, our expenses would be 50 percent of 12, 000 or 6, 000. So our net operating income would be. 6, 000. And since we paid all cash for this property, we don't have any debt service. So 6, 000 is actually our net cashflow. If we take that 6, 000 divided by the 100, 000 that we used to buy the property, then our cash on cash return is 6 percent or 6 percent Yield, and that is much, much better than the 1. 5 percent to 1. 6 percent yield we got in the stock market. And so this very simple example exemplifies how much more effective real estate is at generating cashflow. And that's why real estate has been one of the more popular financial freedom vehicles because of how effective it is at generating cashflow. So for this round, it's not even close. Real estate is a much better Cashflow generating vehicle than stocks. Before we move on to round number three, I want to talk about something very important. A lot of real estate investors are purchasing properties that are actually losing them money. And that's because they didn't know how to analyze the property properly. To help with that, I built a free rental property calculator and deal analysis guide that you can get for free by heading to the link in description below. Round three level of effort, which investment vehicle is easier, which is going to take a lot less work to invest in this vehicle and manage that vehicle over time. And this one spoiler stocks are the clear winner with technology these days. Anybody could be a stock market investor. You can download an app. Click a few buttons and boom, you're a stock market investor. And the barrier to entry is so much lower as well. You can invest in stocks with fractional investing these days for as little as 1. You can even automate your investments so that, you know, every time you get paid, you're investing in the stock market and remove yourself from the process entirely. And then on top of that, once you do invest, you're pretty much done just because you invest in Apple stock doesn't mean Tim Cook, the Apple CEO is going to call you up and expect you to do anything. So stocks are completely passive in that regard. Real estate on the other hand is. Not passive whatsoever. First, the barrier to entry is, is much, much higher, right? Even for a hundred thousand dollar property was, which is extremely affordable. You still have to put 20 to 25 percent down, which is a lot of money for most people. And even if you do have the money, you have to pick a market. You have to. Find a realtor. You have to know how to analyze that the property is going to cashflow. You have to do inspections. You have to manage the property once you actually acquire it. And so there's a lot more work required in real estate. And this is one of the myths about investing in real estate is that it's passive income. It's not passive at all. But as investors, we also have to ask ourselves. Why things are the way that they are. If anybody can be a stock market investor and not, everyone's going to put in the work required to be a real estate investor, which investment vehicle do we think that there's going to be more opportunity in there should be more opportunity in real estate because there's a lot more work required to be a successful real estate investor. But that aside, stocks are clearly the easier investment, the more passive investment. And if you don't have a lot of time to dedicate to investing, then maybe stocks are kind of the better option for you. And I want to be clear here. I'm talking about rental. Properties and operating a rental property business. There are a lot of investments that are in the real estate space that could be as passive as investing in stocks. For example, you can invest in REITs, you can invest in real estate syndications. Um, you can invest in crowdfunding platforms like Fundrise. So there are equivalent passive investments within real estate that you can make. But I'm talking about rental property specifically and for rental property stocks are a lot easier, so they win the level of effort round and take round three. Round four, volatility. What is volatility? Volatility is. The tendency of the investment vehicle to fluctuate in price over time. So everyone's appetite for risk is different, but generally speaking, the less volatile investment, the better, because something that is up in price one day or down to price another day. And for there to be large swings in the investment that could lead to suboptimal decision making. That's. A lot of the reason why people can't achieve great returns in the stock market because they buy high and they sell low, there's a lot of emotion involved. And so the stock market is generally known to be a very volatile investment. And the reason why that is is because anybody could be a stock market investor, and it's very easy to transact in the stock market with just a few clicks of a button. So there are millions of trades that are happening. Every single minute of every single day all around the world. And so that level of frequency can cause huge swings in price of the market. Because think about it, you know, uh, bad news drops in the economy, you know, bad things happening in the world, Elon tweeting, whatever Elon likes to tweet, and that can cause huge swings in the price value of the market. Kind of the stock market. And so the stock market is known to be, you know, a much more volatile investment. When we take real estate, for example, real estate, it takes much more work to buy and sell real estate. So there's positive friction in that regard, which results in real estate values being a lot more stable than the stock market over time. And so that is why real estate is a clear winner of this round, the volatility round. So now we're heading into round five with real estate winning two rounds and stocks winning two rounds. Round number five is. Leverage. What are we talking about when we were talking about leverage? Leverage is your ability to borrow money, to purchase the asset. When we're talking about stocks, you're effectively talking about borrowing money to buy more stocks. And this is referred to as trading on margin. And while some people are able to do this successfully, it's a more advanced strategy And it can be really, really risky, right? Because of the volatile nature of the stock market. If you're trading a margin and the stock market tanks in value, you can suffer from what's called a margin call, which is absolutely no bueno real estate. On the other hand, it's a lot more commonplace to be purchasing real estate with leverage or debt. Banks will typically lend up to 75 to 80 percent of the home's value for you, the investor to purchase that asset. And the 30 year fixed rate. Loan is an amazing product, which is, you know, the secret weapon of the investor, because that means that your debt payments are going to be fixed over the entire life of the 30 years. And as your revenue is increasing through rent increases, your cashflow is going to be increasing over time that allows you to service the debt and still be profitable. Whereas in the stock market, you're kind of banking on the appreciation, which is a lot more speculative in this respect. Leverage is the superpower of real estate. It really amplifies the returns of real estate and it makes it the clear winner of round number five. So real estate takes the leverage round. Round number six is liquidity. How easy is it to turn the investment into cash? And this one's not even close. Stocks are effectively as good as cash. You can sell your stock with a few clicks of a button. And within a few days, you can transfer that into cash and have it hit your bank account. Real estate on the other hand is a very illiquid investment. It could take weeks, even months to sell your property and turn the investment value of your real estate into cash. And so this one's not close stocks take the liquidity round and we are tied. Three rounds to three heading into the final round. In the last round, we're talking about tax benefits. And if you live in the U S taxes is going to be likely one of the largest expenses you'll incur in your lifetime from an investment perspective. Taxes can also greatly alter the returns of the investment. And so let's break down the impact of tax benefits on stocks versus real estate. Starting with stocks. When you sell stocks, you're going to pay capital gains taxes. And the rate of the capital gains tax is going to vary depending on how long you actually held that stock. If you held the stock for more than a year, you'll pay a lower capital gains tax. If you held it for less than a year, you'll pay short term capital gains tax, which is a. A lot higher, and you'll also be taxed on any dividend income that you receive. So that's kind of it from a stock perspective, not a lot of tax sheltering happening with stock investing real estate on the other hand is a completely different animal entirely. Now I am not a CPA, but my CPA refers to real estate as. Tax free wealth, because the fact of the matter is, is the IRS wrote the tax code with real estate investors in mind. And there are a lot of deductions that you can take like depreciation and mortgage interests that allow you to shelter more of the money that you're making. In real estate from the U S government and pay fewer taxes. You can also do things like 1031 exchanges, which allows you to defer capital gains tax that you would have paid by investing in more real estate. So this one is not even close. Real estate is the runaway winner. It is the much more tax advantageous asset class when compared to stocks. So real estate wins. The seventh and final round. And the total count is real estate won four rounds and stocks won three rounds. So real estate wins this investment head to head battle. So there you guys have it. The investment head to head battle is complete and real estate was victorious. To recap the results, stocks won the appreciation round, the level of effort round and the liquidity rounds. And real estate came back and won the cashflow rounds. The volatility rounds, the leverage round and the tax benefit rounds. So real estate is the winner for today's video. But at the end of the day, just because real estate one, it all depends on you as an investor. What is most important to you? Maybe you're young and you have a long time horizon and all you care about is appreciation. In which case, maybe stocks is the right investment vehicle for you. Or, you know, maybe you're trying to achieve financial freedom or you're nearing retirement and you have to care the most about cashflow and volatility, in which case real estate is going to be the better investment for you. For you, for me personally, I have a balanced portfolio of both stocks and real estate, because I like the strengths of both investment vehicles. And I use that to kind of counteract the weaknesses of the other. And so at the end of the day, investing is very personal and you have to be very strategic about what is most important to you and act accordingly. I hope you guys found that video helpful in the next video, we'll be breaking down how much you need exactly to be financially free and the answer might shock you. So make sure to hit that like, and subscribe button so you can catch the next one. Um, Also very excited to be launching my six week comprehensive real estate investing bootcamp, where I walk you step by step on how to identify a cashflow and rental property and acquire that property. So if you want to hang out with me and learn about real estate investing, you can join the waitlist for rental property investing in one on one my course by heading to the link in the description below. And if you're on the waitlist and you'll be the first to know exactly when the course launches. So I hope to see you guys there and that's all I have for you today. So I'll see you guys in the next video. Peace.