I get daily Google alerts about real estate investing. Every day a couple emails hit my inbox with the top new pages related to real estate.
A lot of it is pretty useful, but almost every day I see an article that incorrectly argues that the stocks outperform real estate, but a huge margin.
Debunking the Myth That the Stock Market Beats Real Estate Investing
The reality is, articles like this one are plain wrong. It is not just a little wrong, it is dangerously wrong. Most of the people authoring this stuff have never really spent any time actually learning about real estate or real estate investments.
The stock market vs real estate investing is not an old topic to me. I argued before that stocks can’t compete against real estate…but from time to time I need to revisit it with new information.
Back in college, I developed an appreciation for numbers. I studied mostly statistics and regressions, but then when I started my Ph.D. I really solidified my understanding of other areas of math (Hey, don’t forget I left the program to get into real estate).
I realized, basic math never lies. Sure, anyone can fudge a regression with faulty data or a lack of fundamental knowledge about statistics (which is the primary cause of errors in most studies you read), but equations and their answers are accurate every time.
back on track
The article I linked to said real estate returned an average of only 4.8% in the US since 1975.
So I want to talk about capitalization rates. The capitalization rate is the return which an income producing property provides you, assuming you pay all cash and have no mortgage. A property that costs $100k and returns $10k after expenses would have a cap rate of 10%, also called a “10 cap.”
Right now, cap rates are under 6 in major metros, and a little higher in secondary cities.
Guess where cap rates were right before the recession…in the 6’s.
Now I’m not saying we are headed for a crash, that’s a topic for another discussion. The point is, rates are rarely this low except in rare circumstances.
So, owning investment property will have a cash return of at least 5-6% even in the most competitive economy.
|Amount Down||$25,000||Interest Rate||5%|
|Rate of Return||9%|
|Average Appreciation (according to TheStreet.com – 4.8% of $100k)||$4,800|
|ROI (with equity appreciation)||28.2%|
People rarely buy an investment property without a loan. It would be crazy to consider the returns on real estate without factoring this in.
When factoring in leverage, your 6% return quickly jumps to 9%. Then, factoring in appreciation as well you can see your returns jump to 28%.
Another thing, I used a conservative interest rate of 5%, though we all know the interest rates on loans are well under 4%.
Today I am officially declaring the myth dead – the stock market cannot beat real estate under normal circumstances.
The reason why returns are so high is because you get to capture all of the appreciation though you only paid one-quarter of the property value.
Though you earn a bit less each year, you invested less which leads to higher returns. The combination of these two factors is the real strength of real estate.
And now you can see that I’m telling the truth when I declare that every single property I own returns more than 35 or 40% per year.