Many people that I interact with know that I am a proponent of rental properties, and lately I have had many people asking me about just that. Why and how seem to be the two main questions, and so today I thought I would tackle why. Fair warning, this will be long. So if you are not interested in learning about why I chose rental properties as my way to financial freedom, now would be the time to check out.
Still with me? Ok.
First off, I believe that a rental property is safer, smarter, far less risky, and far more profitable than investing in Stocks, Bonds & Mutual Funds. (I am not a licensed or registered financial adviser, and this should not be taken as such. You should always ask your professional investment adviser before making any decisions.) Here is why:
With Stocks you have no insurance. If the business goes bankrupt, or takes a massive hit, or loses its patents, or any number of things: you lose part or all of your investment with no way to make it back other than to pray that the business picks back up. With Real Estate you can have property insurance and liability insurance. If the house burns down, many times you can get more money back than you originally paid for the house. You can have property managers who take care of all of it for you and have to listen to what you say.
With Stocks you are taking all of the risk. You need to put down 100% of the money to buy them, so you are 100% screwed if the price of the stock goes down. You have no insurance. You have no control. With Real Estate you only need to put down 20% of the purchase price, and the bank takes on 80% of the risk. You have insurance. You have complete control of the asset.
With Stocks, if a stock costs $100, you have to pay $100. So if you have $20,000 you only get $20,000 in assets. With Real Estate, if a house costs $100,000, you only have to pay $20,000 (or less in some cases.) So if you have $20,000 you can get $100,000 in assets (or more if you buy under market value or find more favorable lending terms.)
Let’s say you buy $20,000 worth of stocks and the value of the stocks goes up 10%. You just made $2,000. Let’s say you buy $100,000 worth of house for $20,000 and the value of the house goes up 10%. You just make $10,000.
Ways to Profit off of Stocks:
1. The price of your stock goes up. – You have to sell it to profit off of it. You get taxed at capital gains rates on the sale of that stock. (Which is your normal tax rate, which for most people is around 30%.) And you no longer have an asset to profit from.
Ways to Profit off of Real Estate:
1. Rents – Let’s say you buy a 3 bedroom house for $100,000, with 20% down, so you don’t have mortgage insurance, at a 5% rate. Your monthly payment is going to be $533.62 (www.mortgagecalculator.org/). In Des Moines, IA, renting that property for $1000 a month would be undervaluing it. You could get a property manager for 10% of that ($100). That means that you would be making $366.38/month. (1000-100-533.62=$366.38) And you would still own the asset. And you would only be taxed at the current passive income tax rate: assumed 15%. So $366.38 x 12 months = $4,396.56 x 0.85 = $3,737.07 extra dollars at the end of the year that you get in addition to keeping the house.
2. Taxes – You get tax deductions for paying real estate interest. All rental income is taxed at the passive income rate (15%) instead of the earned income or portfolio income rate (30% minimum). You also can take depreciation, which basically means more money off of your tax bill. http://en.wikipedia.org/wiki/Depreciation
3. Appreciation – In general the value of real estate goes up. So let’s say you buy a house for $100,000 ($20,000 of your own money, $80,000 of the banks). Then you rent it out for a profit of $3,737.07 per year for 30 years, making $112,112.10. You then have a house that if we take 3% appreciation is worth $242,726.00. $354,838.10 of profit off of a $20,000 investment. And you can just keep buying more houses with the profit you earn.
So to wrap this all up. (I told you this was going to be long.)
You could buy $20,000 in stock and hope that it will eventually make you money.
Or you could use that $20,000 to buy $100,000 worth of real estate which can start depositing money into your bank account in a couple of months with a tenant. AND give you tax breaks. AND not have to sell it to make that money. AND get taxed at a lower rate for those profits. AND be insured against catastrophic loss. The choice is yours.
I welcome your thoughts in the comments below. Of course, if you know anyone interested in buying a home, selling a home, or investing in real estate, you can reach me at 515.724.3163 or RyanLynch@KW.com.