Main Stream Financial Publications Get it All Wrong

Main Stream Financial Publications Get it All Wrong

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.

Quick Sidetrack

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.

Digging Deeper

Price $100,000 Cap Rate 6%
Amount Down $25,000 Interest Rate 5%
Yearly Income $6,000
Interest Payments $3,750
Profit $2,250
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.

By | 2016-11-28T01:29:56+00:00 August 22nd, 2016|Categories: Investing, Real Estate|Tags: , |5 Comments

About the Author:

An investor that reached financial independence at the age of 30, Eric has been seen on Forbes, Trulia, WiseBread, TheStreet, and other financial publications.

5 Comments

  1. Rob @ Money Nomad August 23, 2016 at 10:08 pm - Reply

    Great post and good to hear! As someone who’s casually playing with both of these strategies, I do consistently feel like real estate is more secure — the challenge is just that it’s usually more difficult to get into. Of course, there are services like Fundrise, but other than that you usually have to invest a substantial amount of time into real estate, while the stock market is rather hassle free. I’m certainly investing more of my own money into real estate, but it’s a slow transition. Thanks for the inspiration!

    • Eric Bowlin August 23, 2016 at 10:44 pm - Reply

      Real estate is definitely hard to get into and stocks are far easier to invest in. Real estate is really hard to get into if you’re a Nomad! For the location independent, I might suggest finding people who syndicate deals rather than being the primary owner.

      I think a solid portfolio is balanced based on the person – stocks have a role to play in that along with real estate. I think it’s most important to invest in SOMETHING, rather than nothing.

      I just find it frustrating that major organizations pop out information about real estate without telling the whole story.

  2. Nathaniel Cook September 2, 2016 at 5:11 am - Reply

    Aren’t you forgetting a few things in the chart above, like insurance, property taxes, repairs and capital expenditures? That $2250 profit can quickly turn into $0. (Heck property taxes alone in some areas could be more than that.) Granted, you still have the equity…but that’s about it. I understand that we want to keep examples simple but can we at least be realistic? Oh, and interest rates are "well under 4%" only for property you live in, not for investment property…unless I’m just using the wrong banks.

    • Eric Bowlin September 2, 2016 at 10:50 am - Reply

      Thanks for your comment. Let me quickly explain what "capitalization rate" is since you must not understand it.

      Capitalization rate is the rate of return after ALL expenses, which includes taxes, repairs, cap ex, insurance, and everything else you didn’t mention. It also assumes you paid cash for the property so it’s before any finance expenses.

      6% roughly the national average on property right now. That is because major metro areas are at 5% while secondary markets are up at 7 or even 8%.

      You’ll also notice I used 5% interest rate in my calculations to be conservative. Every single one of my commercial loans are at or under 5%, so perhaps you are using the wrong banks. Yes, that’s commercial loans, not personal loans (which most small investors are using, and come with lower interest rates).

    • Eric Bowlin September 2, 2016 at 10:53 am - Reply

      Thanks for your comment. Let me quickly explain what "capitalization rate" is since you must not understand it.

      Capitalization rate is the rate of return after ALL expenses, which includes taxes, repairs, cap ex, insurance, and everything else you didn’t mention. It also assumes you paid cash for the property so it’s before any finance expenses.

      The national average cap rate on investment real estate is around 6% right now. That is because major metro areas are at 5% while secondary markets are up at 7 or even 8%. Metro areas have much more volume so they bring the whole average closer toward them.

      You’ll also notice I used 5% interest rate in my calculations to be conservative. Every single one of my commercial loans are at or under 5%, so perhaps you are using the wrong banks.

      So though people can get 4% loans, and I have some under that, I used very conservative number in my analysis. And Yes, that’s commercial loans, not personal loans (which most small investors are using, and come with lower interest rates).

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