Sandy, an Income Investors Academy member, asked a great question on our group coaching call today.
“What is the main advantage of investing in single family rentals vs the stock market?”
This is a GREAT question that really is about a deeper issue – active vs passive investing.
I have a lot of experience in both, but I believe that one is much better and I can prove it to you.
But first, back to Sandy’s question.
Most people will answer: leverage.
Meaning that you can acquire a cash-flowing (maybe) asset for only about 20–30% of the actual purchase price and finance the rest.
This leverage can increase your returns exponentially.
Here's how that leverage works in your favor.
(This is a simple example not taking into account expenses or taxes, etc but you'll get the idea.)
If I buy a $100,000 house with cash and collect $1,000 a month in rent, at the end of the year my return is 12%.
($1,000 X 12)/$100,000
But if I only put down 20% ($20,000) and borrow 80% at 7% interest from the bank ($5,600 in annual interest only payments), at the end of the year my return is 46.9%.
($1,000 X 12)/$25,600
Looks great, right?
Like right about now a bunch of peeps are thinking, “Hot damn! I'm gonna go buy a rental with a mortgage and get rich!”
The problem with that is then you have to deal with what we in real estate joke about as the dreaded three T’s:
Toilets, tenants, and trash.
Being an Active Real Estate Investor
Being an “active” real estate investor by fixing and flipping or being a landlord is not easy.
And honestly one big expense (like a new roof or HVAC) can wipe out your cash flow for months if not years.
I was an active real estate investor for 23 years.
I've been there, done that, and got the t-shirt.
Now I am only investing in truly “passive” real estate investments.
These are available in the public market like the stocks Sandy mentions or in the private market via private placements and crowdfunded syndicates.
Leverage Isn't Exclusive to Active Investing
The thing that most people miss is that you can use leverage when investing in the public markets as well.
Just buy on margin.
Margin is a loan that you get from your brokerage platform.
It’s a heck of a lot easier to qualify for than a mortgage.
The amount you can borrow is based on the type and value of the securities you have in your brokerage account – not on your income or debt to income ratio or cash reserves or any of the other guidelines they use in mortgage lending.
The maximum you can borrow is 50%.
If you are buying $20,000 worth of Apple stock, you’ll just need $10,000 in cash and you can borrow $10,000 from Schwab at 7.5% – 9.3% interest.
The interest rate is based on the size of your brokerage account.
In this sense, leverage isn’t really exclusive to active investing.
But let’s forget about leverage for a minute and do an apples to apples comparison to really get into the nitty gritty.
Being a Passive Real Estate Investor
Let’s say you have $200,000 cash to invest in real estate.
You can buy two single family rentals for $100k each OR you can buy two publicly-traded real estate investment trusts (REITs) investing $100k in each.
I ran some numbers to see what that would look like after 30 years in terms of capital growth (equity) and income.
These numbers are based on (conservative) industry averages.
Take a look and see what wins:
129% More Equity. 30% More Income. 100% Passive.
By investing in the “stock” (in this case REITs), you’ll have 129.3% more equity and 30.8% more income over the course of 30 years.
Not to mention you never have to spend any time at all to “manage” your REIT portfolio.
You never have to deal with a tenant or a toilet.
You’re a true investor as opposed to a landlord with another job.
Oh, and if you want to sell it all you can instantly for just $4.95 and the push of a button.
If I Had it to Do All Over Again
Looking back on this, part of me wishes I would have chosen the easy path and invested in publicly-traded real estate securities from the start.
But I know that without the experience of being an active real estate investor, I might not have the insight to be an effective financial educator and coach.
And for me, that makes the journey worth it.
For others, I think the dream of “getting rich quick” is what leads people to active investing.
They see the flashy guys rolling around in videos in Lamborghinis and on HGTV making big bucks flipping and that's what they want.
The truth is there is no such thing as getting rich quick outside of winning the lottery or inheriting a bunch of money.
But the promise of “getting rich slow” just doesn't have the same mass market appeal.
What about you?
Do you want to be an active real estate investor or a passive real estate investor?
It's a decision only you can make for yourself – just make sure you're making it for the right reasons.
And whatever you decide, I wish you much success!