Real estate vs. Stocks long term: stocks win by a landslide?

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SimpleLife
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Real estate vs. Stocks long term: stocks win by a landslide?

Post by SimpleLife » Mon Oct 19, 2015 6:17 pm

​I've been running the numbers and although real estate has been very attractive to me with leverage (I own 3 properties), running the numbers even with leverage real estate is not as attractive in the long run, because although you are earning higher CoC returns on leveraged real estate, the reality is the asset itself is eventually deleveraged once paid off, and it didn't appreciate in value as much as stocks would have over the same period. Over time, the advantage of leverage is removed, and you're left with an asset that barely kept pace with inflation. Even Seattle has been at 3-4% over the last 20+ years when averaged.

If I buy a 100K house that appreciates 3% over the long run (per study by famed economist who called the last crash, Robert Shiller), in 30 years I have 242,726 dollars. Not only is this a petty return, since it just keeps up with inflation, I got to pay for all kinds of repairs during that time. And it was a job, getting called after hours, dealing with BS, etc. To top it all off, I faced potential lawsuits during that time.

Even if I Buy the house with leverage, due to the low appreciation rate, I'm still not earning that much. When you compare it with stocks:

100K invested in an index fund that earns 10% a year over 30 years, gives me: 1,744,940.22

To make it even worse, a 4% safe withdrawal rate for the actual value of what my assets would be in these two scenarios, I'm making about 900K a year in SWR eligible funds, compared to a paltry fraction of that with my real estate, which is ultimately a job. Even if we continue with the numbers for the above two scenarios, you are making $20,391 a year in profits after expenses (all rents and expenses adjusted for inflation of 3%) from the house being rented out, compared to what I could be making with the stocks $69,797

Am I wrong here? Was initially thinking real estate was the way to go, and it has certainly been good to me buying during the downturn, but I think I may be better off cashing out and putting 500+K to use in the market. Maybe not now, with the run up, but DCA over time.

Gilberto de Piento
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Re: Real estate vs. Stocks long term: stocks win by a landslide?

Post by Gilberto de Piento » Mon Oct 19, 2015 7:37 pm

I don't have an answer but I'm curious about stocks vs. real estate too. For me there's some appeal in doing both in the hopes that if one tanks the other will still be working.

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Ego
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Re: Real estate vs. Stocks long term: stocks win by a landslide?

Post by Ego » Mon Oct 19, 2015 8:13 pm

Somebody here used to post about this all the time. Anyone remember who that was?

Dave
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Re: Real estate vs. Stocks long term: stocks win by a landslide?

Post by Dave » Mon Oct 19, 2015 8:24 pm

Here are a few thoughts that quickly come to mind. I do not think these are going to 100% accurate, but I believe they are generally true.

1. Real estate returns are much more subject to price risk, since your purchase price drives the entire payoff structure. Although the mortgage is paid off over time, the original purchase price determines your basis, whereas in stocks you average in over time and are less subject to that angle of price risk.
2. Real estate returns can be higher in situations where you do buy at a good price, as you are using a relatively safe form of leverage to drive large returns.
3. Interest rates play a role in the payoff structure of real estate returns. If you both get a low interest rate and get in at a good price, I would think real estate returns can challenge stock returns.
4. If we hold populations static, theoretically the price of real estate should match inflation and not a ton more. It is not a productive asset in the sense that it is a business. I have no data to support this, but I would be very surprised if an efficiently priced real estate asset purchased without leverage would yield the same returns as a business. IE, rents <= the "normal" business return.
5. Outside of activity managed stock investing, the time involvement is significantly lower than real estate investing. In silly textbook economic terms, you could theoretically take this extra time you save by stock investing and go earn a wage that probably surpasses your return on time for real estate investing, unless you have very large amounts of capital.

With all that said, a big part of investing is being psychologically aligned with your investing strategy, so it is possible that real estate investing is in fact best for you.

In response to your situation, I think you did a pretty great job of getting low-priced real estate assets at a low interest rates, and have probably enjoyed strong returns. I would be surprised if you continued to get those sorts of returns for the next 30 years on future real estate purchases, so my intuition is that investing in equities will probably do better over the long-term.

bibacula
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Re: Real estate vs. Stocks long term: stocks win by a landslide?

Post by bibacula » Mon Oct 19, 2015 8:28 pm

According to Robert Shiller, real estate has appreciated by inflation plus 0.8% (less than 1% real return).

Shiller has calculated a real return over 6% for stocks over the past century.

While future returns will be different than past performance, I believe that stocks will easily outperform real estate over the next century, too.

Houses are good savings vehicle for people who pay off their mortgage over 30 years. They own an asset that keeps up with inflation.

For people with the discipline to save, stocks will almost certainly be a better lifetime investment (50+ year time span).

George the original one
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Re: Real estate vs. Stocks long term: stocks win by a landslide?

Post by George the original one » Mon Oct 19, 2015 9:04 pm

If you're only holding real estate for price gain, flipping, then you don't get real good returns. Rentals, on the other hand, allow you to skim the profit above the expenses (purchase price, property taxes, interest rate, repairs). Make sure you're allowing for that in your calculations!

Also, if you're only talking about primary residence, then you need to allow for the rent avoidance you achieved in addition to resale value.

I think you're also comparing apples and oranges with the $100k home appreciating to $242,726 in 30 years. That's more like constant dollars rather than nominal dollars? I mean, seriously, the $110k home I bought in 1997 is $250k today and that's only 20 years (I sold it in 2005 for $180k, next buyer bought for $245k in 2007, so they got screwed for buying into the hype and the market price has just now returned to what they paid for it). Another example is the house my parents bought new for $20k in 1968 is now a $240k home.

Now, I personally don't like to invest in real estate, but that's because it's an illiquid investment and my temperament is not suited to being a landlord.

susswein
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Re: Real estate vs. Stocks long term: stocks win by a landslide?

Post by susswein » Mon Oct 19, 2015 10:26 pm

1)By comparing the returns of real estate to the stock market you're comparing 2 asset classes with widely differing risk profiles. Housing prices don't (historically) have nearly the same volatility as the stock market.

2)As someone else said here, you're also focusing only on the final market value of the real estate and ignoring the income it generates while you own it.

3) You're also skewing the ROI by ignoring the leverage that comes with real estate investing. You can't compare buying a $100,000 house to investing $100,000 in the stock market. Buying a $100,000 with a 30 year mortgage will probably cost you $10,000 down, so in actuality your $100,000 real estate investment will buy you 10 houses, not 1.

SimpleLife
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Re: Real estate vs. Stocks long term: stocks win by a landslide?

Post by SimpleLife » Mon Oct 19, 2015 11:07 pm

susswein wrote:1)By comparing the returns of real estate to the stock market you're comparing 2 asset classes with widely differing risk profiles. Housing prices don't (historically) have nearly the same volatility as the stock market.

2)As someone else said here, you're also focusing only on the final market value of the real estate and ignoring the income it generates while you own it.

3) You're also skewing the ROI by ignoring the leverage that comes with real estate investing. You can't compare buying a $100,000 house to investing $100,000 in the stock market. Buying a $100,000 with a 30 year mortgage will probably cost you $10,000 down, so in actuality your $100,000 real estate investment will buy you 10 houses, not 1.
You can't buy investment property with 10% down like that, they require 25% down and have hefty fees. Have you ever bought real estate investment property?? At best you'd buy 3 houses after 25% down and the fees. That is worth 728K, less than half what they same amount of money would have been invested in stocks. Stocks still beat real estate. Even with income generated, on a leveraged asset, stocks STILL beat real estate. Sorry, your 10 properties with 10% down is unrealistic.


Again, as I said, stocks still out perform a leveraged real estate investment. Do the math, it doesn't matter whether you pay cash or leverage. Even if you only put 25% down you are still left with the same value once the mortgage is paid off and stocks pay dividends too. At the end of the day, cap rates and coc return don't tell you the real numbers. When you consider what the asset appreciates by over the long term, it doesn't matter if you put 25K down or paid 100K cash, you are still left with the same net worth and income I posted above, which is a paltry comparison to the same investment in stocks, regardless of if you put 25K or 100K in. If you put 25K in stocks it would still be worth almost TWICE what the same investment in a leveraged real estate investment would be. I've posted this on several forums and all I've gotten so far are illogical, emotional arguments about how I'm missing key points about leverage or how I don't take into account something that I clearly stated I did take into account (reading is fundamental), how it makes people feel safe, or how real estate is "good 'nuff". I've yet to see a single person be able to present a valid, logical argument against the actual numbers above. Higher net worth by a factor of 7 on net worth, and an income of almost 13 times what a similar investment in real estate would provide, regardless of it's leverage, with less risk of lawsuits, and less work. The fact of the matter is, in the long run, stocks (index funds specifically) outperform real estate. The numbers don't lie, and they are based on countless studies.

The factors that determine your gain are the capital you start with, the interest rate, and the length of time invested. Even with leverage, over a long period of time, real estate loses because of the low gain. Actually, my numbers above are generous. Historically over the same length as the stock market, real estate has returned .8%.

susswein
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Re: Real estate vs. Stocks long term: stocks win by a landslide?

Post by susswein » Tue Oct 20, 2015 1:29 am

SimpleLife wrote:
You can't buy investment property with 10% down like that, they require 25% down and have hefty fees. Have you ever bought real estate investment property?? At best you'd buy 3 houses after 25% down and the fees. That is worth 728K, less than half what they same amount of money would have been invested in stocks. Stocks still beat real estate. Even with income generated, on a leveraged asset, stocks STILL beat real estate. Sorry, your 10 properties with 10% down is unrealistic.

I've bought multiple real estate properties with 10% down. While a commercial loan for a larger property does indeed require a larger down payment, duplexes, triplexes, and 4-plexes can be bought with a residential mortgage with lower down payment requirements.

I'm not saying that real estate is a better or worse investment than the stock market, just saying that the analysis you presented was flawed.

IlliniDave
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Re: Real estate vs. Stocks long term: stocks win by a landslide?

Post by IlliniDave » Tue Oct 20, 2015 4:55 am

I don't think you can say stocks win hands-down every time by comparing averages because real estate markets vary wildly by location. If you can get into the right market at the right price you can make a lot of money with real estate. Highly leveraged real estate is probably one of the easiest ways for an investor to be driven into bankruptcy though because of the ongoing cashflow requirements coupled with less than ideal liquidity. Owning investment real estate also quickly becomes a business and/or an occupation unto itself. I think holding a portfolio of both financial investments and manageable real estate with manageable debt levels (to me that means debt-free but others would argue differently) presents a nice diversification. I will probably never go there because I don't want to do the work, and I'll be deliberately steering clear of dynamic real estate markets to lower the cost of my own housing. I've already got 35% of my net worth tied up in real estate which is more than I like, though I hope to have that down to 20% once I make my ER transition. But I've always thought that in the future if a house came up for sale down the block from me or something, that I'd consider it if the price was right.

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Re: Real estate vs. Stocks long term: stocks win by a landslide?

Post by Chad » Tue Oct 20, 2015 5:38 am

susswein wrote:1)By comparing the returns of real estate to the stock market you're comparing 2 asset classes with widely differing risk profiles. Housing prices don't (historically) have nearly the same volatility as the stock market.
As a side note, holding a diversified stock portfolio for roughly 30 years or more has very low risk. Per Jeremy Siegel states, "...it's less than bonds." He doesn't mention real estate in the podcast, but over this time frame I bet the risk for holding all these assets is really low.

Ritholtz interviews Siegel. He states the above in the podcast:
http://www.bloomberg.com/podcasts/masters-in-business/

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Re: Real estate vs. Stocks long term: stocks win by a landslide?

Post by jennypenny » Tue Oct 20, 2015 6:03 am

Some factors that aren't being considered in the OP ...

--You're only talking about a specific part of the real estate market (rental homes if I'm reading correctly), not the entire real estate market.

--You're only looking at results based on a narrow range of overall investment money. Someone with a net worth of 10mil who invests 2 of that in real estate might invest in different types of real estate and have very different results.

--Based on the example above, that person is also diversifying in a way that's more beneficial than a person with a net worth of a million or less who's got half of their net worth invested in real estate.

--You're assuming the investor is equally proficient at assessing both markets. Someone who's terrible at assessing stock value but good at assessing real estate value would presumably do much better in real estate. Related ... someone who can maintain their own properties or with good contacts in the construction business would make more money off of the same properties than someone who had to hire out for everything.

--The value of real estate (that's insured) is much less likely than stocks to drop all the way to zero. Something to consider. Also, a stock that's illiquid is useless whereas real estate that's illiquid might still have some value through renting or farming or as a residence.


OP--What you really seem to be asking is if a typical middle class person (with typical skills in this area) with a nest egg of a million or less is better off investing in stocks or real estate. That's a narrow question which I think is a more personal question related to the investor's talents and the real estate market in question. If an investor isn't good at or interested in learning about either, then a diversified stock portfolio comprised of balanced or target date funds will most likely produce the highest returns for that person.

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Re: Real estate vs. Stocks long term: stocks win by a landslide?

Post by black_son_of_gray » Tue Oct 20, 2015 8:00 am

SimpleLife wrote: To make it even worse, a 4% safe withdrawal rate for the actual value of what my assets would be in these two scenarios, I'm making about 900K a year in SWR eligible funds, compared to a paltry fraction of that with my real estate, which is ultimately a job. Even if we continue with the numbers for the above two scenarios, you are making $20,391 a year in profits after expenses (all rents and expenses adjusted for inflation of 3%) from the house being rented out, compared to what I could be making with the stocks $69,797

Am I wrong here?
There is some nuance here you may not be considering. You are using numbers averaged over the long term, no? I'd be willing to bet that the $20,391 a year in profits after expenses from real estate has much less variability from year to year than the stock market returns of $69,797. So if the plan is to live off of this number, rather than mere accumulate it - there is a big difference. If accumulation is the goal, then go with stocks for the looong term. If living off of it is the goal, then it isn't so clear which is better, because RE has lower sequence of returns risk. The lower variability from year to year from RE means you can safely 'withdrawal' at a higher rate. Or said another way, the variability of stocks from year to year requires that you need a lot more total return just to be safe. See also: Tyler9000's commentary on his PortfolioCharts website

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Re: Real estate vs. Stocks long term: stocks win by a landslide?

Post by Sclass » Thu Oct 22, 2015 10:26 pm

What JP says. A lot of this has to do with your talents. I have pals who made their pile in RE. They tell me to stick to stocks because I can make that work. I respect their skills and I stay out of their pond. They aren't dumb enough to follow me into the stock market. These are unique skills and we both appreciate that.

SimpleLife- nice observation on leverage going away if pay off the loan. The disappearance rate is highly non linear too. Most middle class homeowners talk about leverage but they seldomly notice that it will go away...either ignorance or just not looking far enough ahead. That said my pals who made fortunes in RE knew how to sell their rentals to idiots during a bubble. They floated the loans with rent and dumped the risk as soon as they hit their targets. I'm preaching to the choir - I know you do this. It's a skill.

In my younger days I'd advise my friends not to buy a home in the Bay Area. It was bad advice for them. The ones who bet the farm and bought the most expensive places they could afford survived there and their home is their big asset. The ones who listened to me didn't buy and lost their money foolishly in a variety of ways. I feel guilty telling them do like me and you'd win. They sucked as investors in any class. Now they struggle to survive in the Bay Area and they burn effigies of me for fun.

Years of stock proselytizing made me unpopular. I'm glad I left the area.

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Re: Real estate vs. Stocks long term: stocks win by a landslide?

Post by tylerrr » Fri Oct 23, 2015 12:10 am

jennypenny wrote:Some factors that aren't being considered in the OP ...



--The value of real estate (that's insured) is much less likely than stocks to drop all the way to zero. Something to consider. Also, a stock that's illiquid is useless whereas real estate that's illiquid might still have some value through renting or farming or as a residence.
I agree that if i buy a house it will primarily be just because I want the lifestyle of living in a house. I won't be too worried about it being a great "investment". Like you said, with a house, at least I can grow a lot of food in the yard, avoid condo/apartment noise, more privacy, etc.


If I ONLY care about what gives me the greatest return with the least amount of work, I'd just stay in my Permanent Portfolio for the long term with most of my cash. Or I could just buy into an ETF like vti every month for many years.

JL13
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Re: Real estate vs. Stocks long term: stocks win by a landslide?

Post by JL13 » Sat Oct 24, 2015 9:31 am

I don't think this comparison is detailed enough to draw any conclusions. You have to look at WHY real estate and stocks have had those outcomes. Home price and stock market appreciation dont tell the full story of what happens at the investment level.

American business historically earned about 11% roe over the past century or so. About half has been reinvested and half paid out as dividends. You can verify this with a spreadsheet and a couple historical s&p quotes.

Assuming a price to rent ratio of 15, expenses being 50% of rent, and 20% down payment, that's about 11% return on equity. Those numbers are basic rules of thumb for re investors.

So the two have very similar potential returns, from a simplistic textbook finance viewpoint.

You can reinvest your rental income into more properties the same way your stock earnings are reinvested. If you did, you would achieve a lifetime investment outcome very similar to stock investing, as long as the above numbers bore out.

Your mileage may vary.

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Re: Real estate vs. Stocks long term: stocks win by a landslide?

Post by AlexK » Sat Oct 24, 2015 11:37 am

RE has helped me to grow wealth but only because I was lucky enough to live in an area which greatly appreciated after the 2012 low. If I see RE drop well below the cost to build, like it did here in 2012, I will buy again but my plan now is to sell RE and convert to stock index funds. I didn't use leverage because I saw too many friends go bankrupt doing that in 2008.

I do admit the consistent rent checks are nice though since that is what I'm living on now. It's just that the rental yields are so low now after the RE price run up. For example one house is worth $265k and rents for $1225/mo. That is less than 5% return and that is before any maintenance is done. Meanwhile the roof, paint, plumbing, etc is wearing out. My plan is to sell next year since I retired this year and made high income. One disadvantage of RE capital gains is they come in one tax year. With stocks you can spread them out over multiple years and stay under the tax threshold easily.

JL13
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Re: Real estate vs. Stocks long term: stocks win by a landslide?

Post by JL13 » Sun Oct 25, 2015 2:22 pm

Or..I guess another way to put it, as you say: real estate increases by just a bit more than inflation. This makes intuitive sense, as the value of anything should move at about the rate of inflation. It's also a bit self-referential, because housing prices ARE a part of the inflation measure.

You would expect stocks over the long run to do the same thing, as their value is a multiple of profits, and the profits are:
Revenue = costs = profit

If you increase sales by 2% due to inflation, and your costs go up 2%, then your profits end up 2% higher as well. If you keep the same PE multiple, then the value of the stock goes up 2% as well. Same as you would expect with real estate.

The major difference in your comparison, is that real estate doesn't retain earnings. A single house in 1970 is the same size in 2012, it didn't retain some of the rental income and add some more rooms or whatever (in the Shiller analysis anyway, this is held constant. In real life of course you can build on a house). Stocks RETAINED a portion of their earnings over that time frame.

If the companies had paid out 100% of their earnings, you would find that they increase by about the same 3% as house prices.

SimpleLife
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Re: Real estate vs. Stocks long term: stocks win by a landslide?

Post by SimpleLife » Sun Oct 25, 2015 3:51 pm

Gilberto de Piento wrote:I don't have an answer but I'm curious about stocks vs. real estate too. For me there's some appeal in doing both in the hopes that if one tanks the other will still be working.

My comparison above is just to show that stocks DO outperform real estate in the long run, even leveraged real estate, because the power of leverage wears off over time as the value of the house increases and the mortgage is paid down, which in turn will reduce your cash on cash returns over long periods. I've been watching this happen with one of my rentals as the price goes up in value. I found this article today ( http://www.nytimes.com/2005/08/19/reale ... .html?_r=1 )while researching it some more, and their analysts came to the same conclusion, that the advantage of real estate is largely in the beginning, but the advantage wears off as the mortgage is paid down. In the very long run, stocks would have outperformed the same investment in real estate many times over, provide a higher net worth, and a higher income using a SWR.

However; investing in real estate in the right market right now (or especially 5 years ago) can retire you with a FRACTION of the amount of money you need. So it really depends on your goals. My original plan when I first started posting here, was to retire off my rentals but also have enough in index funds to live off as well. I have enough rentals to retire now, so I think I will put money from now on into index funds (not now) and let THAT grow into a giant pile of money while I live off my rentals.

If I took all my money and bought four rentals and a paid off house to live in 4 hours from here, I could retire with 50K a year income easily. If I took the same money and put it in stocks, I would get about 16K a year. But in the long run, putting the money into stocks will turn into more money and provide far more income than the rentals would. But initially, the rentals are better, while the stocks are better in the long run. It's best to effectively hedge your bets and have both. Retire early off rentals, leave money in stocks for massive long term growth.

Again, if your goal is FI as quickly as possible, real estate will get you there faster and provide more income dollar for dollar than stocks would. But due to compounding and the higher returns on stocks in the long run, stocks will out perform real estate over long periods of time.

SimpleLife
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Re: Real estate vs. Stocks long term: stocks win by a landslide?

Post by SimpleLife » Sun Oct 25, 2015 3:59 pm

AlexK wrote:RE has helped me to grow wealth but only because I was lucky enough to live in an area which greatly appreciated after the 2012 low. If I see RE drop well below the cost to build, like it did here in 2012, I will buy again but my plan now is to sell RE and convert to stock index funds. I didn't use leverage because I saw too many friends go bankrupt doing that in 2008.

I do admit the consistent rent checks are nice though since that is what I'm living on now. It's just that the rental yields are so low now after the RE price run up. For example one house is worth $265k and rents for $1225/mo. That is less than 5% return and that is before any maintenance is done. Meanwhile the roof, paint, plumbing, etc is wearing out. My plan is to sell next year since I retired this year and made high income. One disadvantage of RE capital gains is they come in one tax year. With stocks you can spread them out over multiple years and stay under the tax threshold easily.

And this is the problem with real estate. As the price increases, the yield goes down. Your yield is probably 2-3% after maintenance, for what is a part time job. You could put that money into a REIT fund and get 4% return AND price gains, with dividends growing along the way, for doing nothing. Vanguard has a REIT index fund.

Plus the other thing is, everyone looked like a smart investor if they bought at the bottom. But now that the prices have gone up, the yields are not as high. I bought a house for 64K and was making around 20% off the rents. Now I'm making 5% for what is a part time job. And although the appreciation is nice now, it is slowing and over the long run it will be at around inflation, so basically I'm just maintaining my purchasing power rather than growing it. Same thing with the rents. They rise with inflation, so basically your income and purchasing power will merely match inflation over the long run. With stocks you actually GROW that income and networth, rather than maintaining purchasing power.

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