It shouldn’t surprise anyone that I read a lot of financial websites and blogs. For some reason it seems that I’ve recently read multiple times about the comparison between stock market and real estate investments. More specifically, what I’ve read is usually something similar to the following statement:

Over long periods of time stock market returns outperform real estate returns.

The supporting data used to support such a claim is usually something like saying that the stock market averages around 8% while real estate only averages 3 or 4 percent (or pick your own numbers based on some past time period). On the surface, this seems like a pretty cut and dry conclusion, one that one person will say “it’s proven that a diversified portfolio generally beats real estate investments”. I can’t say that I agree with this statement, and wouldn’t say that it’s been “proven”, especially if it’s only “generally”.

This aside though, I don’t understand how one can think stock market investments will outperform real estate, especially diversified stock market investments, which usually means index funds or mutual funds. When these people think of real estate investments, they must only be concerned with the actual appreciation of the full value of the property. In this case, stock market returns may be higher. But I believe that most people would be and should be concerned with their actual returns.

When looking at real estate investments, the more important measure of your returns is better viewed as a percentage of the actual amount invested. For instance, if you put 20% down on a $100k property, then your actual cash outlay is $20k. If the property increases in value only 4%, it’s now worth $104k. This four thousand dollar increase is then a 20% return on your initial investment which is much better than what most people will attribute to real estate. You just can’t forget the effect of leverage on your investments.

And I haven’t even mentioned the benefits of the cash flow properties can produce and what’s known as Cash on Cash return. I’ll leave this for another post though. I just wanted to put my thoughts out there on this subject since I keep hearing that broad index funds and the like are supposedly so much better than real estate. Such a blanket statement just can’t be true.

So I’ve finally talked with a property management company and gotten an idea about their fees and how they work. Since this will be my first experience using a property management company, I’m excited to see how everything plays out. It sounds like I’ll be able to be pretty hands-off, and they’ll handle most everything. This obviously comes at a price, that’s to be expected. So here’s the basic rundown of what it’ll cost:

• $195 to market the property which includes putting it on the MLS, taking and processing applications, and screening the tenants before presenting them to me for approval.
• Once a tenant is accepted, the company takes the first months rent as it’s commission for finding and placing a tenant.
• Going forward, the property management company will take 11 or 12 percent of the rent depending on what the eventual rent price is. (I was hoping this would be cheaper, but I guess I’ll have to deal with it.)

So as you can see, it’s not exactly going to be cheap to have the property managed. On the other hand, I’m not going to have to manage it myself. While in the future I’d like to own more and more rental real estate, I don’t want to end up buying myself another job in the landlording field. So we’ll see how this first one goes, and I’ll keep you updated through the process

About two years ago I decided that I wanted to buy a house, and specifically a rental property. I was still in college at the time, but I didn’t want that to stop me from reaching a goal that I had set for myself. To make a long story short, my now wife and I ended up purchasing a small house relatively close to where we both went to school. I knew that we would be moving in the coming months for me to take a job in the Midwest after graduation, so I began actively marketing the house for rent so that the payments would be covered when we moved. It took some doing, but we eventually got a rental contract in place. And there we had it, our first rental property.

So now it’s about two years later and we’ve decided to sell this little house. We put it on the market for a couple of reasons, one being because I’m going back to school in the fall and won’t be working. The other reason is because of the increase in value and what we could make off the sale. So yesterday we finally received an offer on the house that we’re going to take, and the net of the sale should be a little over 20 percent of what we paid for it. It’s interesting to note that even in these troubled financial times, it’s possible to make money.

What I’ve Learned From All This

1. The first thing isn’t so much something I’ve learned, but rather something that’ been reaffirmed to me. We’re constantly hearing of declining real estate prices and how bad the market is, but these are all national numbers and averages. Real estate however, is very local, and you can’t draw conclusions about your local market from the overall national averages and trends. This is very evident in our most recent experience.

2. It’s also important not to let yourself get overextended. When analyzing a deal or purchase, I always consider what could be the worst-case scenario so that I’m prepared for it if it were to happen. In this case, the house we purchased was well within our means to afford while we were living in it. I also structured our current finances so that if we were to lose our renter and have a vacancy we would be able to carry the mortgage ourselves. The amount we save each month is at least equal to the amount we would owe in the worst case scenario. I have never worried that we wouldn’t be able to make the payments on the house.

3. The third lesson follows closely from the second. When maintaining an active investment such as a rental property it pays to have substantial liquid funds on hand in case of an emergency. Emergency funds are frequently advocated by many, but how much is widely debated. If you base the amount on a set time period of expenses to maintain, such as enough for 6 months or a year, then this will need to increase when you have an investment you need to look out for each month as well.

4. The last point I want to make is to think and plan ahead. When we bought this house, I knew that I wanted to turn it into a rental property. Going in with this perspective helps to keep the emotions from inflating the price you’re willing to pay, and it makes sure that you’re more aware of all the associated details and expenses. It’s much easier to figure out how you’d handle certain situations before getting yourself into them, rather than scrambling to find a way to handle things.

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This fall I’m going to be going back to school to get my MBA. After being accepted to all three schools that I applied to, I’ve decided to go to Arizona State for a variety of reasons that you can read about my MBA category. It’s always seemed to be off in the semi-distant future, but in actuality it’s a little less than five months away. So I guess I’d better start getting everything in order before then.

Probably my biggest concern that I need to address is how to handle the fact that we own our home here in St. Louis and will now be moving to the Phoenix area. Originally I had thought that I would just try to put it on the market and try to sell it for at least what we paid for it and break even. It’s not like we live in one of the real estate markets that saw wild appreciation and is now suffering, but it’s not exactly an active seller’s market either.

So instead, I’ve finally made the decision to rent the house out when we leave. I’ve already done this sort of thing once when we moved out here to St. Louis, but I had the benefit of being able to let my parents manage the property that we left behind. This time I’m going to have to enlist the services of a property management company. To date I’ve only called one company, but I plan on making some more calls to ultimately find one that I’m comfortable with. Hopefully this will all work out, but I’ll keep you posted.

This time around I’m a little more concerned about things since I’ll be in school and won’t really have an income to fall back on if I need to carry things myself for awhile. I really think that this is going to be the best option though, and it’s something that I’ve always wanted to try out. Having a company handle/manage everything for me would be the best “hands off” approach to making it a passive investment. But if things get a little rough, I suppose I could always put up a donation button on this site and appeal to everyone’s good nature…

This is the fourth part in the Why I Like Real Estate Series. If you haven’t already, take a look at Part I, Part II, and Part III.

For my fourth reason, I’m just going to come out and bluntly state it. I’ve never seen real estate go to zero. This may not seem like that big of a deal to some of you, but it’s a huge benefit. I’m not saying that I’ve never seen real estate decline in value, I have (and am currently). What I am saying is that I’ve never seen real estate go completely sour and lose 100% of it’s value. It just doesn’t happen.

I have, on the other hand, seen plenty of other investments do just that and ultimately be worth less than the paper they’re written on. This isn’t to say that other investments are bad and no good, it’s just a fundamental difference that should be taken into account. You can look back and find many different companies that have gone bankrupt or what have you, and have left their investors completely empty handed.

Real estate is different and will maintain at least some value. It’s a tangible investment and something that they aren’t making any more of. I don’t want to mislead anyone though, and have you think that you can’t lose money with real estate because you can. The point that I’m making here is that the value of the underlying asset will not go to zero. It may go up, it may go down, but not to zero. It’s that simple.

This is the third in my series that details why I like real estate. If you haven’t yet, take a look at Part I and Part II where I talk about control and leverage.

It’s no secret that real estate has great tax benefits, but they seem to be largely ignored sometimes and often downplayed. When you look at real estate as an investment and compare it to other investment options such as the stock market, you can’t ignore the tax incentives you get with real estate. They can significantly add to the bottom line of your investment.

First off, let me say that I’m not a tax expert, but I do have a rental property and have firsthand experience with the benefits that I’m talking about. They’re real and can be used by anyone who is willing to learn and seek professional advice. So now let’s talk about some of the specifics.

When you operate a rental property, it is a business and is able to be treated as such. Expenses that are associated with the property are deductible from any income that the property generates. It shouldn’t come as a surprise that the mortgage interest of any loans on the property are deductible. You can also deduct any expenses associated with maintenance of the property. Another great deduction is any travel associated with the property. For example, if the property is out of state from where you live, you can deduct the cost of the plane ticket or the mileage needed to visit it. This is something that not everyone is aware of, but can be a great perk.

You are also able to depreciate the property over a set number of years which is different depending on whether the property is commercial or residential. For residential properties it is depreciated over 27.5 years. Basically this means that you take the purchase price of the property and divide it by 27.5; this is the amount that you can deduct in any given year. This is what is called a paper loss. You’re deducting an amount of money that you never really spent, it just occurs on paper. Using this deduction you can actually offset some of your positive cash flow and essentially give yourself some tax free earnings.

These are just some of the tax benefits associated with real estate, and every property will have a little bit different scenario. If you happen to also take a real estate course or seminar, you can deduct the cost of it as well. All of these tax benefits add another element that should be considered in your comparison of investments, and they’re another reason that I like real estate.

This is the second post in the Why I Like Real Estate series. If you haven’t already, check out Part I.

The concept and power of leverage is a simple one, yet it’s often misunderstood or not thought of when people think about real estate. I find this interesting since leverage is one of the most powerful reasons to invest in real estate.

All too often I’ve heard people say how real estate consistently under-performs the stock market, and we should therefore just invest in the stock market for long term gains. This may be true if you look at total gains, but leverage changes things.

Leverage basically means that you’re able to combine someone else’s money with your own money to buy an asset or invest in something. While it’s true that you can do this in the stock market with a margin account, most people who think real estate is too risky definitely would think a margin account is too risky.

By leveraging your money you’re able to multiply your gains, and this is why real estate can be (notice I said can be) much more profitable than other investments like the stock market. I suppose it would be best explained with an example:

Say that you put $10K into the stock market and you average an annual gain of 20%. Most people would say that this is quite an extraordinary rate of return. So, after 3 years your $10K would have grown to $17,280 which is outstanding.

Now let’s say that you put that same $10K as a 10% down payment on a rental property and finance the other 90% (this is the leverage part). We’ll also assume a rather conservative gain of 3% annually, well below what the stock market earned in our example. After three years, the property would then be worth $109,272 meaning that your $10K is now worth $19,272.

So as you can see, you’re money will still grow faster with an investment property appreciating at 3% than in the stock market at 20%. I understand that there are many other considerations, but you can’t dispute the power of leverage. This is why leverage is another one of the reasons that I like real estate.