EP #5 - Real Estate vs. Stocks (Part 1)

In Episode 5 of the "Financial Freedom Fighters Podcast," Jacob and Mike debate the merits of stocks versus real estate, providing valuable insights for budding investors. They compare both options in terms of appreciation, cash flow, and the level of effort required. Stocks win on appreciation, but real estate takes the lead in cash flow, highlighting its potential for generating steady income. However, stocks are praised for their ease of entry and low level of effort, making them an accessible choice for many. This episode offers a balanced perspective for listeners as they determine the right investment strategy for them on their journey to financial freedom. 

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Transcript

Nancy: 0:00

This is the Financial Freedom Fighters Podcast

Jacob: 0:13

What's up everybody. This is the financial freedom fighters podcast. I am your host, Jacob Sandoval. I am here with my co host, Mike Magno. How you doing?

Mike: 0:24

I'm good, Jacob. How are you?

Jacob: 0:26

I'm good. I'm good. There's a heat wave in California right now. It was 94 degrees. And I don't know about you, Mike, but I'm not an extreme weather guy. I don't like extreme cold. I don't like extreme hot. I like 65 to 75. I like that 10 degree variance and that's where I live all day and that's where I'm happy. So 94, it's a little bit too hot for me. I don't know. I don't know about you.

Mike: 0:50

Yeah, I, um, I'm with you. I don't like the extreme heats. Um, you know, we get obviously all the weathers right in where, in, in Northern Ohio here. Um, I know in where you live in the Bay Area, it stays pretty consistent year round, uh, typically. Um, in that zone where you like it. Um, so yeah, it's, it's tough. I know this week we've had a beautiful, we've had a beautiful end of the summer and the beginning of fall.

Jacob: 1:19

Nice. we have another fun topic for you folks today. Mike and I are talking about Stocks versus real estate. It is an age old debate within the investment community. And today Mike and I are going to try to bring a very objective perspective. Obviously Mike and I are both real estate investors, but prior to being a real estate investor, I was predominantly a stock market investor. And so I have a decent amount of experience there. And Mike also does a little bit of stock investing as well. So we are going to kind of pit these two investment vehicles against each other. And we're going to have a round by round type of debate on the merits and the weaknesses of each investment. And so, Mike, do you have anything to say before we kind of jump into the episode for today?

Mike: 2:15

yeah, I, um, I like this, um, this. Topic today for us to discuss, cause I think that's, um, a lot of people who want to get into real estate, that's where they have a lot of their wealth currently is in the stock market and they want better returns, right? They want the power of leverage. So there's, you know, there's obviously we're going to debate all the pros and cons to both, both strategies. Um, but I think it's an interesting topic to talk about on our, on what we're doing. You know, putting it, putting out this, this particular type of content that, you know, that you and I chose to do. And I think it's, um, you know, I think it's a good conversation to have for people. So I'm excited.

Jacob: 2:57

Yeah, absolutely. So, if we take two steps back, there are a few different types of people with respect to their finances and the relationship that they have to money. There's one set of people who are what I'll call spenders. They spend basically everything that they earn, you know, this is the paycheck to paycheck population. And this is the reality for a lot of Americans. Uh, I think the latest stat is 60 percent of Americans Mike live paycheck to paycheck. So there are a lot of people that sit in this bucket, And you're never going to get ahead if you're kind of stuck in that mode of spending everything that you make. So that's one segment. Another segment is what I'll call the savers, Mike, who are doing a little bit better than the spenders, but the extra money that they have, they're just putting it into their bank account or effectively putting it under their mattress, Where their earning basically no interest 0. 01 percent on their money. And they're never going to get ahead as well, right? Because you touched on it last episode, Mike, but. The value of your money is decreasing over time. So there's the spenders and they're the savers. And if you hope, to achieve financial freedom, you have to shed these identities, the identity of the spender, the identity of the saver, and you have to shift your mindset to be the mindset of an investor. Somebody who allocates their capital to efficient investment vehicles that are going to earn them a return that is going to allow them to achieve financial freedom. But then the question becomes, what do I invest in? the two investment vehicles that have withstood the test of time are stocks and real estate. Those are the two biggest investment vehicles. So Mike and I are going to jump into which investment vehicles are better. We're going to have a nice fun debate. It's going to be a seven round fight between stocks and real estate, and each round is going to be based on a different criteria. So Mike, let me run through the criteria really quickly, and then we'll kind of jump right in. The first criteria is appreciation. How much will the value of this asset increase over time? So that's round number one round. Number two is cashflow. How much cash will this investment generate cashflow number round? Number three is level of effort. How much work is this investment going to require on my part? The investor that's round number three, round number four, volatility. How much is this investment? It going to move up and down over time, Round number five is leverage. Can I borrow money to purchase this asset? round number six is liquidity. How easily can I turn this investment into cash? And last but not least is tax benefits. So that is seven rounds, seven rounds, and we are going to pick a winner for each round and we'll kind of assess and regroup at the end to talk about the merits of both. And so let's jump into round number one, Mike, let's jump into round number one. I'm going to kick us off. Round number one is appreciation, appreciation. So stocks are famously known. For achieving an average annual return of about If you put your money in the S and P 500, which is the 500 largest publicly traded companies in the U S if you put it in that index, you would be getting around a 10 percent return on average over a long period of time. If you look back at any 30 year period in history, that is basically what the return would be, which is a really, really strong return to kind of put real numbers on that. If 30 years ago from today, you invested 10, 000 into the S& P 500, 30 years ago, you put 10, 000 today that would be worth 165, 000 approximately. So you put 10, 000 in, it grew at a rate of 10 percent per year. 30 years later, it is 165, 000, not too shabby. Not too shabby of a return. So that is the typical kind of appreciation of the stock market. Now, what about real estate? What about real estate? If we look at the average annual increases nationally, price appreciation of homes. If we look at that same 30 year period, the average appreciation is roughly 4 percent in that same 30 year period. So less than half of the returns of the stock market. Stocks are the clear winner, right? Ah Hold on. Hold on. Not so fast. Not so fast. There's a really big assumption that's being made when you make that comparison You're assuming that you can actually achieve the same returns as the S and P 500 index. That is a massive, massive assumption. Here's an interesting stat. 94 percent of US fund managers underperformed the average returns of the stock market. So Mike, these are big shot wall street guys whose sole job it is to beat the S and P 500. It's their sole job. So they spent all day, every day, trying to beat the S& P 500. 94 percent of them failed. 94 percent of them failed. So what chance, realistically, does the mom and pop investor, you, Mike, picking stocks, me, Jacob, just like picking stocks, what chance do we have to actually beat the S& P 500? Pretty slim. Pretty slim. And there's also the component of emotional selling. I have made so many bad calls with respect to stocks. I bought it at the height. And then I sold it at the crash, And so many investors make that same mistake because it's an emotional game. So the pointed stat here, I heard this on the money with Katie show, another personal finance podcast. And she said that the average return for the typical investor is actually 5%. So not the 10 percent of the S and P 500, about 5%, half of that. And so. It is much, much closer than it looks if we're just talking straight appreciation, But if we just want to very simplify this, let's say straight appreciation stocks still edge this out, but it's a lot closer than you think because of the emotional selling component, because of the fact it's really hard to actually achieve the returns of the S and P five 500. So it's a lot closer. But I'm calling this one for stocks because this is what they're famously known for is appreciation and knowing that stat actually researching that has actually forced me to shift my stock investing strategy. Mike, I was a stock picker before I thought it was real slick and I thought that I could see things that other fund managers couldn't see. And I just stopped all that. I stopped all that. I only invest in index funds. Now I've just, I've come to grips with it that I'm not, I'm not good enough. And so I only invest in index funds now because I do want that 10 percent return because it is very solid so i'm calling stocks take round one mike, but i'll pass it over to you What are your thoughts on kind of the appreciation component?

Mike: 10:17

Yeah. Appreciation obviously is a, is a huge piece of what people are looking for in their portfolios, whether it's in real estate or in the stock market. Um, I think the hardest thing too, for the stock market investor. It's holding onto it for that long. It's much easier to hold onto a piece of real estate for 20 or 30 years than it is for you to hold onto that hundred shares of Apple stock. You know what I mean? So, um, so it makes it much more, much more difficult. Um, you know, and then we'll have people, you know, you have people come to us and say, well, what about forced appreciation in real estate? And I mean, there's, there's other ways to accelerate the appreciation. And then if you look at markets like California versus Ohio. Well, obviously you guys have appreciated how much higher rate over the last 30 years and we have But then and in the reverse, you know, you live in San Francisco Bay Area Your guys's prices are down this year ours aren't so it you know It's tough, but they both, you know, they both are gonna offer you appreciation It's what you do with that appreciation once you get it and that's where I think you know real estate will well ultimately You know, went out in total, I think, um, through our conversation today. But, you know, there's certainly, I mean, if you look at like what NVIDIA is doing this year, right. Uh, I mean, it's, it's nutty. I mean, it's, it's up like 200 percent this year, you know, for those people who bought NVIDIA, you know, 18 months ago or two years ago when it was at the bottom and have held and have held on long enough, right.

Jacob: 11:53

Yeah, absolutely it is important to kind of weigh all factors and it's not always that black and white, but we'll say stocks take round one, right? Edges it out, but stocks take around one appreciation stepping into round two. I'll have you kick this round off Mike, but it is cashflow. Okay.

Mike: 12:11

yeah, so cashflow, you know, for the, for the real estate investor, how do we define cashflow? So, you know, cashflow is obviously the money that you get at the end of the month above and beyond all your expenses. And then also, I also categorize in some reserves as well, which is actually still cashflow, even more cashflow, but you know, for the, for the investor, they want to set aside some money for expenses that you're going to ultimately, you, you will have, right. So, you know, in terms of the different types of areas to invest in and real estate, you know, people come to like my area for that cashflow, Um, and you may, at the end of the day, get two or 300 per month, 400 per month. In cashflow. And that money is after principal, interest, taxes, insurance, your property management expense, and then whatever reserves that you set aside, you know, I personally, I just set aside 10%. That's just my own personal thing. Um, so you've got that. And while Cash, some cashflow does exist in the stock market. It's only in the stocks that offer you some type of dividend and the yields on those stocks are much lower in terms of percentage basis. You know, the, uh, what is it? Real, realty income, right? Like people love that stock. I actually own some, it has a huge dividend yield of, I don't know, 4 percent and they pay a monthly dividend, which is cool. But unless you own 1, 000, 000 of that stock, you're, you're not getting a ton of cash flow from it, you know? So that's where I think, you know, the cash flow would, would certainly go into the real estate, um, side of the, uh, the ledger.

Jacob: 13:52

Absolutely. Absolutely. So completely agree there while appreciation is a major component of building long term wealth, ultimately cashflow is what pays the bills. Cashflow is what allows you to escape the rat race. It's what allows you to achieve financial freedom because you can't pay the bills with appreciation, right? You, you alluded to this earlier, Mike, but you have to do something with that appreciation eventually. Yeah, absolutely. To achieve that financial freedom. So cashflow is King in the financial freedom world and hands down, hands down, real estate is a much, much better cashflow vehicle. So I'll just throw in some specific numbers here to add color to the point that you were making Mike. So let's take that same S and P 500 investment vehicle, right? And let's say we had a hundred grand. We have a hundred grand to dump into something. And let's say for the savvy stock market investor, they're not trying to beat the market cause they know that they can't. And so they put it all into the S and P 500. The dividend yields that Mike was talking about for the S and P 500 is 1. 6%, 1. 6%. So on an investment of a hundred thousand dollars, you will have annual cashflow of about 1600 bucks, right? So a little over. 100 a month for 100, 000 investment to Mike's point. That's not a lot of cashflow. That's not a lot of cashflow. You can't even pay for Barry's bootcamp on a monthly basis with that. And so not a good cashflow vehicle, the S and P 500. Let's take that same hundred thousand dollars. And let's say that we're going to buy a property in Cleveland, Ohio. I think people will be pretty shocked, Mike, but you can buy. A three bed, two bath house cash in a decent working class neighborhood for a hundred grand. You can keep me honest here, Mike, can, can you do that?

Mike: 15:55

it's certainly possible, right? You, I could go, I could pull up the MLS right now. I could find us probably four or five properties in and around the neighborhood where I invest. We could find a property somewhere in the 100, 000 range that I could go out tomorrow and put a tenant in there for 1, 100.

Jacob: 16:31

So let's, let's run that scenario. Let's, let's be conservative even Mike. Let's say we, you hook up with Mike Magno and you say, Mike, I have a hundred grand. I want to buy a property cash in a decent neighborhood, three bed, one and a half bath or two bath. And I want to buy in cash. Let's run the numbers on that. So Mike is going to obviously find you something that is going to fit the 1 percent rule. And the 1 percent rule says that The house has to rent for at least 1 percent of the cost of the property. So for a hundred thousand dollar house, it needs to at least rent for 1, 000. That's the type of property that Mike is going to suggest to you. It probably, like he said, we'll be a little bit more 1100, 1200, but let's be conservative. Say we can do it for a thousand. So that's 12, 000 in annual income, which is great, but we're not factoring in our expenses just to do some quick math. Let's say that our expense ratio is 50%, Mike, right? 50%, which is pretty. Typical. I would say pretty typical. So now we're down to 6K in annual income and because we bought this property in cash, Mike, we don't have any debt service. We don't have any debt service, right? So now we're doing 6K a year on 100, 000. So that is the cash on cash return. that is effectively the yield. That's the dividend yield for this property, 6%. Right? And this is an average deal. An average deal that we're finding, bought in cash. So, that is what we're talking about. That's 500 a month. On that same hundred thousand dollar investment, and you can do better than that, A 6 percent cash on cash return, a 6 percent yield is good, especially in this market, but it is not out of this world, a home run deal by any stretch of the imagination. And so to compare that to the stock market cashflow that you're going to see, there's no competition here. There's no competition. And Mike did allude to this, right? There, there are sophisticated dividend investors and there are dividend strategies. But when it comes to your average investment, real estate in the cash flow realm is always. Always going to beat the stock market. And that is why real estate is kind of regarded as the path to financial freedom, Because eventually you're going to need to turn whatever wealth you have into cashflow to leave the rat race and Real estate is the most time tested vehicle to, to be able to achieve that. So I think round two easily goes to real estate. So we are at one and one. Stocks took round one, real estate took round two. I will jump us into round three. And this one is level of effort, Mike level of effort. And so what do we mean by level of effort? There's a couple of things that we're talking about here is one, how much work is this going to take? How much work is their investment going to require? From me, the investor to research it, to acquire it, to manage it, and to, you know, do all the things, do all the things. So that's one element of it. How much work. And then the second element of it is. What is the barrier to entry? How much is exactly actually going to take to get into this investment? So there's two kinds of elements to this. And I think this one is pretty straightforward in my opinion, but we were talking about this Mike, but you can open up your Robin hood app, click a couple of buttons and, uh, you're, you're a bonafide stock market investor, right? You're a bonafide stock market investor. And just because you bought that Nvidia stock, or just because you bought that Apple stock. Tim cook, the CEO of Apple's not going to call you up and, uh, ask you to make a couple of decisions on, uh, what Apple's supposed to be doing for their Q4 plans. Right. They're not going to, they're not going to ask you that there's, there's no work required and you can be a part owner in Apple for as little as 1 probably even less right with fractional investing right now. So barrier to entry for stocks is super low, literally requires no work. You might do some research and you probably have to manage your emotions with the stock market. But. No, one's going to be expecting you to do anything once you become an owner of that stock and I'll pass it over to you, Mike, but that's not quite the case with real estate.

Mike: 20:40

Yeah, no, you make some really great points there with regards to how easy it is to literally buy stocks nowadays, right? You can just open your app, deposit some money and boom, you're, you're a stock market investor. Real estate, not the same way. And why is that? Well, typically it's much more expensive, right? We just talked about a hundred thousand dollar property, which, you know, in, in today's world with the, when the average home price in America is over 400, 000, a hundred thousand dollar property seems like a steal, but still a hundred thousand dollars. So, you know, for those people who don't have a hundred thousand dollars, they're going to have to leverage the purchase. And in leveraging that purchase means going to a lender and borrowing almost all of the money, right? You're going to borrow on a single family home, non owner occupied investment property. You're going to borrow 80%. And then how does the bank underwrite you? Right? So they're gonna check your credit They're gonna check your bank statements. They're gonna check your income. They're gonna check your tax returns They're gonna look at all these different aspects of you Cause they're investing in you as well. So it's very, very difficult, right? Then on top of that, you have to talk, you have to find a target market, right? Um, you know, for you, Jacob, you live, you're in San Francisco right now and I'm sitting in, you know, suburban Ohio, right? Suburbia. And for you to invest here, you have to find people that you know, like, and trust, obviously, you know, you and I have become friends and we've invested together. And, but that didn't just happen overnight. Right. So for the, for that person who's going to invest in real estate, unless you're investing in your local market, where you can actually physically go see and touch these things, you have to rely on that trusted network of people. So that takes some, some time and energy, right? And then on top of it, we talked, we talked about it in the last episode, right, the whole inventory, just where the market is today. It's very difficult to find properties that are going to meet all this criteria. That we've laid out. you know, it's time consuming, right? Like you have to search for deals. Your agent has to search for deals. You have to talk about the deals. You have to, look at all the numbers of the deal. Does it make sense? it's a much more strenuous process than opening up your cell phone and click, click, click. Okay, cool. I bought some stocks.

Jacob: 23:02

And, and you didn't even touch on Mike, the property management aspect of it. And even if you get a property manager, it's very important to know that you're still going to need to manage the manager. You're still also going to need to make a ton of decisions. One of the tenants in my triplex is consistently consistently late. She pays late fees every single month. And I'm like, what is going on with this? I get a message from my property manager says, Hey, this person is on social security. They only get one paycheck per month and it happens on the 15th. So they're consistently late because they just don't have enough money on the first. To be able to make that payment on because their paycheck comes on the 15th. Can you allow her to move her due date to be closer to her payment date? And obviously I said yes, knowing the details of this, but this is just an example of some of the kind of inquiries you're going to get for your property manager. And sometimes there's going to be bigger things. Sometimes there's going to be bigger things. And so. Just to say, Oh, I have a property manager. I don't have to do anything. There will be days. There will be entire months where I don't talk to my property manager at all. And that's not abnormal. But then there's going to be weeks where you talk to them every other day. Just depending on what's going on with the property. And that's just something if you were. You have to know that this, there is work involved, even when you do have a property manager. So I'm sure you have stuff to say on that too, Mike.

Mike: 24:28

Yeah. I mean, uh, you know, we've talked about it on previous episodes, property management, I've said it time and time again, I'll say it till, you know, I don't do this anymore. It's the most difficult piece of this puzzle. You know, I personally can right now I manage my own properties and I'm going to do that for now. Um, and it saves me some money. I don't have a huge portfolio, uh, but eventually I'll probably get away from that and I'll be working with a property manager and experiencing those same things that you experience. Um, I'm dealing with it. I'm dealing with it today. Uh, one of our tenants is late with the rent. So, you know, it happens It's not the best thing in the world, but we'll we'll work through it.

Jacob: 25:08

Yep. So to kind of round this out and I'll say one more point, because I think it's important. We are talking about rental property investing versus the stock market. There are investment vehicles within real estate that can be as passive as As the stock market, for sure. I'll throw out a couple real estate syndications, You can invest in these private syndications where the syndicators, a group of people are raising a bunch of money and you're taking down a big deal together. Right. And you're a limited partner and LP in this deal. So that's an example, you can invest in REITs, right? Real estate investment trust. and that actually transacts exactly like a stock. And then there's crowdfunding, right? Before I actually jumped into real estate investing, I looked into things like Fundrise and things like that. there are options in re to be exposed to real estate that are more passive. But what Mike and I are talking about, which is what we do is active investing, active investing in real estate. You are actually the owner of that property and you are operating that property. So just want to clarify that point. And when we're talking about. Active real estate versus stock market, a clear winner in this case is stocks. So stocks take round three quite handily.