Real Estate vs. The Stock Market — A One-Two Punch
What’s a better investment — real estate or the stock market? I bet your financial advisor has an opinion … especially if (s)he gets a commission or fee for selling you stocks and managing market funds.
Still, the numbers are stark, and Wall Street isn’t afraid to throw them in your face. The S&P 500 — 10.5% average annual gain in value since 1957. Real estate? Closer to 3.5%.
Match over? Does the stock market win in a walk? Not hardly. This simplistic comparison (designed to sell you stock) neglects two key advantages of real estate that pump that average return way up. Let’s present them in a “one-two” punch.
Left Jab — Tax Advantages
Even if real estate produced slim returns compared to the stock market (and as I’ll explain below, that’s actually a false perception), it’s backwards to completely neglect the tax advantages of real estate investing.
Real estate investors get to deduct mortgage interest like homeowners, but unlike homeowners they also get to deduct expenses and depreciation. (Learn more about depreciation here.)
No such advantage exists for stock investing. You can’t deduct expenses like the computer you used to buy AAPL on RobinHood. If you sell the stock at a profit, you will owe capital gains taxes.
You will also owe capital gains taxes on appreciation if you sell your real estate investment … but you can defer those taxes with a little maneuver called a 1031 Exchange. More on that in another blog, but it essentially lets you flip your profits into another real estate investment and defer those taxes indefinitely.
For most employed or self-employed households, taxes are the single biggest expense. Savvy real estate investors can drastically reduce their tax bill … even erase it entirely. Imagine if you got every dime of withholdings refunded in April. How big a party could you have with that money?
Right Hook — Leverage
We’ve got stocks on the ropes … Now let’s knock it out with our secret weapon — a little thing we call leverage.
Leverage, in investing, is basically using “other peoples’ money” to amplify or magnify the effects of a gain or loss. Entrepreneurs access leverage by taking out business loans. Stock investors leverage their trades by “trading on margin.”
But for real estate investors, leverage comes in the form of a mortgage loan. Here’s where real estate outperforms stocks — most everyday stock investors don’t use leverage. It’s a higher level of risk than most of them are willing to assume.
Leveraging real estate with a mortgage loan, on the other hand, is considered far less risky — by lenders and investors alike. Nearly every real estate investor leverages their assets with a mortgage loan.
What impact does this have? Suppose you buy a $200,000 rental house, and it appreciates at about the national average of 3.5%. Next year, that house will be worth $207,000. A $7,000 gain in value. Let’s say it produces $500 of cashflow a month, or $6,000 a year, for a total gain of $13,000.
That’s a 6.5% gain. Not bad, but not as good as the 10.5% produced on average by the S&P.
Now let’s mortgage the house 80%. Let’s say (for the sake of this example) that the mortgage erases the cash flow and you’re operating at breakeven.
Instead of $200,000, you only have $40,000 invested in the deal (the down payment) … but it still appreciates that same $7,000.
$7,000 is not 6.5% or even 10.5% of $40,000. It’s 17.5%. Just by adding a mortgage, you have left the S&P flat on the mat, not knowing what hit it. That’s the power of leverage.
Add in the tax advantages, and you have a clear knockout for real estate!
If you want to use real estate to reduce your tax bill, leverage your investments, and beat the stock market, Martel Turnkey can help you do it the easy way. We offer “done-for-you,” ready-to-rent investment opportunities in some of the country’s hottest rental markets. Contact us today and let’s see which properties in our portfolio are a fit!