EP #6 - Real Estate vs. Stocks (Part 2)

In Episode 6 of the Financial Freedom Fighters podcast, Jacob and Mike delve deeper into the ongoing debate between real estate and stock market investments. Building on the insights shared in the previous episode (Episode 5), they reiterate the importance of personal financial goals and risk tolerance when making investment decisions.

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Transcript

Nancy: 0:00

This is the Financial Freedom Fighters Podcast

Jacob: 0:13

So we are two rounds to stocks, one round to real estate, and we are going to round four, which is volatility. Mike, I will pass it over to you. Talk about volatility for me with respect to stocks and real estate.

Mike: 0:28

Yeah, so volatility is obviously something that a lot of people want to try to avoid um Like you said you had some In your own portfolio where you got scared and sold off and, you know, we've all done it, right? We've all done it. So yeah, so the volatility piece is obviously anytime you're investing, You have a chance to lose money, That's why it's called an investment. So that's the biggest thing that we need to people understand is yeah, you're investing your money. And, you know, it may turn negative, it's, it's possible, but if you, you stick with the strategies and you continue to educate yourself, you can mitigate a lot of that risk, So volatility, I mean, you know, stock market volatility, uh, it really depends to how involved you are. I think, I don't look at the stocks every day. Like I just don't. if you look at it every single day, oh my gosh, um, did you see the Dow today? The Dow was down 2%. Okay, cool. And it'll be up 2 percent tomorrow. And, you know, so there's that volatility. Um, so in the stock market to me, you just have to, you got to get through the noise. There's a lot of noise. The political environment affects it. The Fed affects it.

Jacob: 1:38

Yeah. So my perspective here is. to kind of define what we're talking about here, volatility is just the degree of variation in an investment's price over time. How much does this bounce? Up and down, And mike touched on this but so much can move the stock market so much market sentiment politics the weather What elon tweets a bunch of different stuff, right? a bunch of different stuff can affect what actually moves the stock market which makes it It's basically impossible to predict short term what's happening. What's going to happen with the stock market is so many variables, And so there is a lot of volatility in the stock market, just a lot because of all the stuff that can swing it. And to speak on another point, we said it's so easy, right? And stocks actually won this round. It's so easy to transact stocks. You can just pull up your phone. and that's good in one sense, but it's also bad in another sense because that accessibility Makes it so easy for there to be swings in the market because people can buy and sell at will and One thing we know about ourselves as human beings is we're emotional creatures. We buy and sell we don't make rational decisions all the time And so there's a lot of transacting at a high volume and there's a lot that can shift the market So stocks are really really volatile on the flip side of that We said, again, it's not easy to buy a house. It's not actually easy to sell a house either, right, Mike? You've been on both sides of many transactions. It's a journey to do that. You can't just decide, hey, I want to sell, and you can just do it instantly. You can't do that. There's a process. You need to find the right buyer, or you need to find the right property. You need to do due diligence. We talked about how to buy a rental property last couple of episodes, and so there's a whole journey to buying. And that actually is built in stability for the price of real estate because you can't just emotion panic, sell your house. You can't really do that. You have, you have to go through so much work to do it. So there's a safety net that there's a safeguard there. And you said this, Mike, it's easy to hold onto a property for a long time because there's just so much work in listing it. And that actually is a good thing in this case, right? This is a good thing in this case. So if we look at it from that lens, I think it's. It's very clear, very clear that real estate is the winner of this round. And depending on which stage of your financial freedom journey, you're in volatility might be really, really important to you. If you are a retiree or nearing retirement, you do not want to mess around with volatility. let's just think about an instance where, you know, all your money was in the stock market and the stock market takes a huge, huge hit. All of a sudden a huge portion of your kind of nest egg is gone. And so. So depending on where you're at in your career, in your financial freedom journey, volatility might be really, really important. And in this case, 2008, notwithstanding real estate is the more stable investment. So I think clear winner, in my opinion, real estate takes round four. We are now tied two to two stocks, two real estate, two. Moving in around number five, Mike, I'll pass it to you round. Number five is leverage

Mike: 5:03

leverage is a very important piece of the real estate investing. puzzle The ability to be able to borrow against that asset and buy it. You can buy 100, 000 property with 20, 000 and that's a very, very powerful tool for people to be able to leverage because it gives you the ability to spread out and scale better, you know, scale more, let's say, you can buy 100, 000 worth of stock You can take that same 100, 000 and potentially buy like a million dollar property like where you live with 10 percent down as a primary, primary residence. And the returns you're going to see are going to be, they're going to be completely different because of the leverage piece, right? Because your, your appreciation is continuing on a million dollars. Not 100, 000. So that's why the appreciation can be very, very powerful.

Jacob: 5:55

If you bought a hundred thousand dollar property, you put 20 percent down, right? So you're at 20K. That property appreciates 10%. So that's 10, 000, but that's a 50 percent return on your investment, right? Cause you only put 20, 000 down. So leverage amplifies returns. As Mike was talking about, we're in the stock market. You know, you only getting 10 percent on what you invested, So leverage amplifies returns, but important to note leverage also amplifies losses as well,

Mike: 6:24

Yeah. That, and that becomes, people's risk tolerance, right? how averse are they to risk? Because obviously if you have vacancy, you still have a mortgage to pay. And that's where, you know, people will come at us like, Oh, it's dead. It's bad. Yeah, it can be. But done properly. And I'm not saying that you should over leverage yourself, right? You need to take out loans on that. You can actually afford to pay, right? Cause you will have, eventually you will have vacancy. So that's the other piece of it. Yeah. You can also get yourself into trouble, right? Um, so that's where you have to just be careful. And, and not take on more than you can handle as the investor.

Jacob: 7:04

Absolutely. Absolutely. And so. I'll kind of round us out on this specific piece with respect to leverage, but you can leverage in stocks. It's called margin trading, So some brokerage accounts, uh, or some brokerages will allow you to borrow money to purchase stocks. It is very, very risky, very, very advanced. And you should just have caution when you're doing that, because in the aforementioned round stocks are very, very volatile. So if you borrow money to trade stocks and the stock takes a big nosedive, they're going to call that margin loan due real quick, And so you're putting yourself in a bind. If you're trading on margin because of the volatility on the flip side, a bank all day, every day, if you are a qualified borrower, they're going to put 80 percent up 75 percent up to allow you to buy that property all day, every day. That's commonplace. and we have to take a step back and ask ourselves, why is that the case? Why would a bank, you know, willingly give me 80% of the purchase price of the property and I only have to put 20%? Well, one, obviously the bank makes a ton of money, right? You're paying interest on that, and if you actually run the math, or if you look at an amortization schedule, The bank is getting a ton of money back and they're getting a lot of it upfront because interest is front loaded. So they make sure they get that return for themselves. Um, and then it switches more to principal pay down. But that aside, even if you, for example, foreclose. On the property. You can't make those payments. The bank is still pretty confident that because they only put up 80 percent and they were collecting interest, they're still pretty confident that they can turn around, sell it and get out relatively unscathed or still make a profit. Now they don't want to do that, right? Cause they're not in the real estate business, but they view real estate as a. And so that's why they're willing to put up that 80 to 75%, right? So again, another feather in the cap of real estate from that respect. And then lastly, I want to touch on this concept and you, you kind of hinted towards it, Mike, but there's a lot of talk about real estate being good debt, And I don't know where you sit on listener on kind of the, the, your relationship with debt, Mike talked about Dave Ramsey and, and, and, and, A lot of people are very anti debt and I think that's, you know, that's a fair philosophy to have for a lot of people for sure, but in the real estate investing space, it's referred real estate is referred to as good debt. And why is it good debt? Well, for me, I think real estate is good debt because it is backed by a cash flowing asset that the income generated by the property is enough to cover the debt service. To me, that's what good debt means is that the asset is paying for itself. Now you have vacancies and things like that, et cetera, et cetera. But in general. It's going to pay for itself to me. That's good debt. And when you trade on margin for stocks, you're not getting that you're 100 percent banking on the appreciation of the property to eventually be able to kind of pay that margin loan back. So you're very much just dependent on the appreciation, which is more akin to gambling, in my opinion. But if you know that this property is going to cover the debt service to me, that is. A healthy amount of risk to take because that is, you know, a much more stable proposition to put a tenant in there, to have a cashflow, to pay the debt down. And, you know, I feel okay with that. I sleep fine at night knowing that that's the debt that I have. all that to say round five leverage goes to real estate, right? So we are five rounds through, and I believe stocks took round one, real estate took round two, stocks took round three, real estate took round four and five, so we are three rounds to two real estate is edging out stocks right now. We are moving to round six, and I think that this one is a pretty straight forward one for one. Mike. It is liquidity, liquidity. Mike. So let's talk liquidity. Not much to talk here. But, uh, what are your thoughts on liquidity for this round?

Mike: 11:11

Yeah, I mean, liquidity obviously is for, for those who, you know, may be new to this and they're learning, you know, liquidity means how quick can we convert that asset to cash? it's pretty easy for me to go sell that stock I just bought on my app, right? I open my phone, I go in there, I hit a sell, it tells me the price it's going to sell it for me, the boom, done. And that money is back into my account as cash and then I can transfer it out and I'm done, right? I could sell everything in my my robin wood account when they open when the markets open on monday And I could have cash in my bank account by the end of the week, you know That's, that's pretty quick, right? Whereas, you know, houses, that's a little bit tougher. That's a little bit tougher. Um, there's a process that has to go to sell a property, right? You got to enter into a purchase agreement. You have to have an agreed upon price and contract. You have to do title work. That takes time. I think everyone would agree that the stocks are pretty easy, easily liquid versus real estate. I mean, it is easier in today's with technology in today's world. It is more liquid than it used to be, but I still, as a real estate guy, I would still lean, um, that the stock market is more liquid.

Jacob: 12:25

Yeah, absolutely. I think this one is pretty straightforward, but we'll, we'll talk a little bit more about why this is important. Why is liquidity important for me? What it comes down to is it's flexibility, If you have a good amount of liquidity, you are more positioned to one capitalize on opportunities that might present itself, Let's say a smoking hot deal comes onto the market, right? Mike, you send me a deal. 12 percent cash on cash return off market. We need to act fast. If I don't have any liquidity, I can't act on that. I can't take that deal down. And I gotta be Mike. I'm sorry. I'm not liquid right now. I gotta pass on it. My wife actually jokes with me all the time because I don't like to have a lot of liquidity in terms of cash. I don't like to hold a lot of cash. For me, it's cash feels like it's burning a hole in my pocket. And unless I'm saving up for a down payment, I don't like to hold a lot of cash. So I always am either putting it into a deal. Or I'm just putting into the stock market. So pure liquid cash. I don't have a lot of it. I don't have a lot of it. My wife always jokes with me. And she's like, I'm gonna buy you a shirt that says, I'm not broke, I'm illiquid. that's her running joke. And I, I, I always get a good kick out of it. But anyway. Liquidity is good because that's flexibility. So one, you could take advantage of opportunities that present itself, but two, you can also get yourself out of a bind. You know, what if something happens and you actually need to come up with liquidity, like you have an emergency medical expense, for example, or you have something that, you know, you need to help your family with, you need to have that liquidity to be able to do that. but all that to say is liquidity is flexibility, both in emergency situations, but also to capitalize on opportunities. Stocks offer you much more liquidity than real estate. And that is, I think, round six for stocks. And so Mike, we are approaching the seventh and final round and we have had. A pretty even battle here between stocks and real estate. We are tied three rounds to three. So the seventh round is going to be the deciding round. And the round is tax benefits, tax benefits, and disclaimer here, quick disclaimer, Mike and I are, neither of us are CPAs. I have my degree in accounting actually, but I did not take the CPA exam. And so we are not tax professionals. This is not tax advice. So. Take all of this with a grain of salt and talk to your tax professional, but Mike Brown seven tax benefits. Let's talk about it.

Mike: 15:06

This is one of the things that I think gets passed over. The most to the new investor, because all the new investors hear about is cash flow and cash on cash return and ROI and IRR and reserves and everything, right? The tax benefits of real estate, if anyone hasn't been paying attention, the way that the tax code is written in this country, it's to the real estate investor slash business owner. period. Like this is literally the knockout punch. This is Mike Tyson, you know, knocking out whoever, right? Um, the tax benefits are unparalleled and you know, once again, we aren't professionals. So we're going to leave that up to your professional CPAs to help you with. But I mean between a depreciation, bonus depreciation, segregation studies, I mean, there's just a million ways to offset. Income, but still get cashflow. Remember, that's the kicker, right? You get cashflow and then you have paper losses. So you end up not paying any taxes potentially on those gains on that cashflow. Um, you know, so for those people out there who aren't in real estate yet, You know, those, that's probably one of the most powerful tools of real estate investing are the tax benefits.

Jacob: 16:45

Yeah. Yeah. So like Mike said, this is definitely the knockout punch, uh, for real estate. If we're talking about real estate versus stocks. So to just touch on stocks really quickly, there, there are not a lot of tax benefits when it comes to stocks. In most cases, you are going to be subject to capital gains tax when you sell a stock. If you hold a stock for less than a year, that capital gains tax is going to be a lot higher. For example. I was fortunate enough to buy AMC at a very, very low price before the kind of Reddit craze, WallStreetBets craze, and that jumped up a ton, and obviously I was elated at that because I bought a ton of shares at 2 and it jumped up to like 30 or 25. And so I dumped it, obviously, and that next year I had a pretty big tax bill because I sold it after only holding it for a couple of months. And so that is, I paid 50 percent taxes on that. So that hurt, but obviously it is what it is. That's how the tax code is written. Now to put things in perspective, Mike alluded to this, but I always find that this is the part of real estate investing that for the beginning investors, actually pretty hard to understand, or pretty hard to wrap your head around. They think it's a scam or they think it's a loophole, but those are all the wrong ways to think about it because as you alluded to Mike, this is the way the tax code is written. This is the letter of the law with respect to the IRS and the tax code. So this is not illegal. This is not loopholes. This is just how it's written. This is how the law is written. And so to make it tangible. And again, we are not tax professionals, but to illuminate, right, let's say that you have built up your real estate portfolio, you've been at the grind, you've been acquiring rental properties, you've held them for a long time, and you get to this place where you finally have that portfolio that's generating 10, 000 a month in passive income, that entire portfolio, so you're doing 120, 000 a year, you could be in a position that you are paying very minimal tax. On that 120, 000 a year. Is that fair to say, Mike, that you can be generating that much income, you know, a six figure income, right? Which is a lot of money for people. You can be generating a six figure income and you will be paying pretty minimal taxes. Now you juxtapose that with somebody who's making a six figure active income salary, who's going to be paying a lot more in taxes to the government with that active income. And so just to put a more. of a point on it. This is why when the wealthy say they do not pay taxes, it's probably because of businesses and it's probably because of real estate and they are taking advantage of the tax code. So. All of us, all of us, right? We shouldn't get mad about that. We shouldn't get mad about that. We have to understand the game that's being played, and over time, we have to allocate the wealth that we're relying upon to be more tax advantaged over time, right? It's just a smart thing to do. We should be shifting the income that we rely upon From active to real estate because there's inherent tax advantages and the tax advantages are going to allow us to what to invest more, Mike, and to generate more return, which is going to generate more tax advantage. And so all this to say is that you have to understand the tax code and you have to. Really take advantage of it, not take advantage of it, but understand it and implement it and follow it to really amplify your wealth building journey. And in this case, there is no comparison. Real estate is hands down the most tax advantage investment class and definitely more tax advantage than stocks. And so this one is the knockout punch, Mike, like you said,

Mike: 20:50

Yeah. The, the biggest thing I try to explain to people is just, you know, understanding that there are just so many advantages. Um, you know, the, the depreciation piece is one that people often, they just are, just kind of can't. Wrap their heads around. Right. And for whatever reason, that's still don't know to this day, but the IRS allows you to depreciate your properties or rental properties for 27 and a half years. Don't know how they ever came up with that, but basically you can take one 27th of the value of the building. You can't depreciate land. Okay. And that's literally straight. Subtract it from the income. Of the, of the, of your gross income off the property. So, um, you know, you, you have a property, let's say it's worth, the building's worth a 270, 000. So one 27th would be 10, 000 and you had 10, 000 in income. You can just, it just kind of wipes itself out. You know, they're just very dumbly putting that together. But

Jacob: 21:54

no, exact, exactly. And so you can get to a place. Ladies and gentlemen, where you're making 10, 000 real dollars in profit and you are just completely wiping it out with 10, 000 of a paper lost. Right. Because you're building is not losing value. It's not losing value. That's the misconception and misnomer of depreciation here. It's not losing any value. It's just one of the benefits of real estate. And there are more advanced things you can do to kind of really stack the depreciation and pull a lot of that depreciation forward. But we won't get into that. Another thing that's a kind of specific to real estate, Mike, and you are well versed in this is the 1031 exchange. I don't know if you want to talk about the 1031 exchange.

Mike: 22:36

yeah, absolutely. We can talk on it for, you know, for a couple of minutes here. Um, you know, the 10 31, uh, tax deferred exchange is what it's called. Uh, and it's very romanticized out there in the, in the world of real estate investing, and a lot of people don't understand what it is, but it's a way for the real estate investor to sell a property. And then take all the gains and reinvest it into a different asset in real estate and just continue stacking properties. And that's how the wealthiest of the wealthy in this country have been executing it for a long time.

jacob_pt_2mp4_fixed: 23:08

Yeah. Yeah, absolutely. And I have not executed a 1031 exchange, but I'm sure I will use that tool in the toolbox at some point. And luckily I have you, Mike, to kind of walk me through that process with the experience that you have. But for the beginning investor listening out there. I read a book, an earlier book, and I think it was Rich Dad, Poor Dad, but Robert Kiyosaki, in that book, he talks about how he turned one house, one single family house, And through a series of 1031 exchanges, that single family house turned into a large apartment building, basically, is the example that he used. Because he continuously rolled the proceeds of the sale to be the down payment, like you were saying, Mike, for a larger property, and he just kept on doing that, so eventually the proceeds rolled into this large apartment building. That Robert Kiyosaki then owned, and it was directly attributed to owning that small single family property, which is mind blowing to actually think about, right? And that is just a powerful, powerful concept. So, if you're just continuing to reinvest the gains from real estate and continuing to take advantage of the tax advantages, like the 10 31 exchange, like depreciation, you can capitalize and roll. These would be tax expenses into bigger and bigger deals, but it's important to note as well, Mike, these, you are deferring the taxes. You are kicking the tax liability down the road, but even then still really wealthy people figure out a way to get out of that as well. And they pass down that to their heirs. And when their heirs inherit it, they inherit it at a stepped up cost basis. And then that liability. Is effectively wiped out because they're inheriting it at that new basis. And again, not a CPA talk to your CPA before kind of executing on this, but all this to say, there's just such strong tax shrinks when it comes to real estate that's why I think the tax benefits piece definitely is like we said, Mike, the kind of knockout blow with respect to real estate when being compared to stocks. So I'm going to bring us home, Mike, to kind of wrap up the episode. We compared stocks versus real estate. We had a spirited debate. We try to maintain objectivity when comparing these two kinds of investment classes and where we got to is stocks. One, the appreciation round, the level of effort round and the liquidity round. So if those three aspects of an investment are really important to you, stock shine. In those particular aspects, appreciation, level of effort, and liquidity real estate. However, one, the cashflow round, the volatility round, the leverage round, and the tax benefits round four rounds to three. So if those particular aspects of investment. Are meaningful to you, then real estate shines in those aspects, but what Mike and I want to kind of emphasize here is that there is no best investment, right? There's just the investment that is right for you. In your personal situation, so you have to listen to this episode and you have to take all this information and you have to apply it to your personal situation. Where are you in your financial freedom journey? Where are you with your risk tolerance? What attributes of an investment are the most important to you? Do you want to prioritize cashflow and low volatility, or do you want to prioritize rapid appreciation? And do you want to be as passive as possible? You have to critically ask yourselves these questions as an investor, not just as a real estate investor, but a stock market investor, as an investor. As a whole, because these critical questions are going to allow you to devise the strategies that are going to propel you towards financial freedom and I'll be up front, right? The majority of my career before investing in real estate, I was dumping a lot of money into the stock market. And today. The allocation of my wealth is about 70 percent stocks and 30 percent real estate, but me consistently asking myself the question of where do I want to be and what are my goals? I know that I want to retire in less than 10 years and now I look at my portfolio. And I say, Oh, I need to index more heavily into cash flowing assets because that's going to allow me in 10 years to step away from my job if I want to. So now my strategy is more heavy real estate and I want to get to an asset allocation that's closer to 50 50 in stocks and real estate. So I'm kind of diversifying in that way. But that's a part of me evolving and adapting my strategy, continuously asking the questions and having a goal and having a North star. And so just ask those questions of yourself and think critically about what you want, but anything, any kind of closing thoughts, Mike, on, on this topic?

mike_pt_2_fixed: 28:34

I, think it's important for people to understand, like everyone else, everyone's in different points in their journeys and it's important for them to, to really figure out what the, what the goal is. Um, and like you, you put it very, you know, you very succinctly, right? Like you have a goal. It's 10 years. I want to work optional life. Right? So you have to really look at, well, how am I going to, how am I going to achieve? How am I going to be able to achieve the kind of cashflow I need to make that happen in the next 10 years? And really, I mean, it's going to be heavily, heavily real estate. Cause you just don't get the compounding effects. you know, into those, those things that we talked about, cashflow, debt, pay down, leverage and the tax benefits. Right. Um, you know, so that's where it really, I mean, it just really becomes, Oh, once again, I don't want to bang on stocks because once again, I open my phone right now and I have a pretty hefty chunk of change that people would be like. Wow. That's a lot of money invested in stocks. And I do, I do that with my extra cash, you know, extra money that, you know, want to dabble a little bit, right. Um, have some other, other things, but you know, for the most part, I think we've, we really hammered home what the power of the real estate investing is for people, um, which is kind of what we were talking about. I mean, but that being said, I mean, it's, it's, it's different for everyone. So

jacob_pt_2mp4_fixed: 29:56

Absolutely. And look, we are huge, huge real estate people, but we both have exposure to the stock market. So there is no rule that says you have to purely be invested in stocks or purely be invested into real estate. You can do both, but just think critically about what makes the most sense for you and your personal situation. And devise a strategy that's going to get you to your goals, plain and simple. And so we hope this episode was helpful. This was fun for me to do personally. I just love thinking about this stuff. I love thinking about the, the best ways to kind of allocate capital, the best ways to kind of generate a return. And it's all in effort of achieving that financial freedom that we are all pursuing, that we're all going after. And so we hope this episode was helpful for you today. This is the financial freedom fighters podcast. I am Jacob. You can find me on all socials at Cashflow Saga and my website CashflowSaga. com. You can find Mike at Realtor Michael Magno on all socials. This is episode 5. We will see you guys for episode 6. That's a wrap.

mike_pt_2_fixed: 31:12

See ya.