A special thanks to Ginger for her blog topic suggestion! As requested, let’s expand upon the great debate of real estate vs. stocks and kick it up a notch.
Prepare to leverage–again!
Leveraged Real Estate vs. Margined Stocks
In my previous post on real estate vs. stocks, we put 8% Cap Rate real estate head to head with 8% ROI stocks. Now, let’s really juice it up. It’s the second match and it’s time to serve up another healthy set of contenders. Let’s go with a sturdy chunk of real estate with a side of 80% leverage and give me a hot stock with a 50% helping of margin.
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We’re going to use an 8% ROI again to keep things consistent with our previous calculations. You have $100,000 to invest in each asset class and 10 years to turn some rewarding profits.
“I will buy a $500,000 property with $100,000 of cash, 20%
down”, says Real Estate.
“I will buy $200,000 of a growth stock with $100,000 of cash as well, 50% margin”, says Stocks.
Cutting to the chase, and assuming you can pull up the spreadsheet, we’ll run each scenario for 10 years with some fundamental criterion:
Real Estate: Mortgage at 5%, appreciation at 2%, as before.
Stocks: 6.575% interest on the margin loan.
Margin rates are pulled from Fidelity.
Rather than belaboring this, I think the attached spreadsheet can help give you the bigger picture: AssetRover Real Estate vs. Stocks Calculations 2
Time to round up the contenders, let’s look at the total income returned from each.
Investment: $100,000 Total Gain After Sale: $187,428
Investment: $100,000 Total Gain After Sale: $409,345
Full disclosure: For real estate, I am still utilizing one of the best tax breaks the IRS has to offer the 1031 exchange. Unfortunately, this does not apply to stocks.
It’s pretty clear who came out the best from this deal. To put it simply, the bank only requires you to put 20% down and control 100% of the asset when you purchase real estate. Appreciation and other benefits come upon you in droves once you leverage $500,000 of properties on a $100,000 down payment. Despite the hype, I won’t try to sugar coat this…you need to be extremely careful borrowing for investment properties. Consider vacancies and other issues with that property that would cause you to have negative cash flow for a month or more. AssetRover staff typically backs each investment with a year of mortgage payments to weather the storm.
Take this example, Real Estate’s first year loan payment is $25,767.44. For a property valued at $500,000, we would certainly recommend that amount in cash, in a savings account, backing the property. Wait a minute now…don’t let this post convince you to go buy stocks on margin with that money! It needs to be liquid and easily available in the event that you have vacancies or unexpected repairs.
As for stocks, they can certainly be bought on margin if you have a hot tip or think that a particular company is going to boom in the next 10 years. Be mindful, however, that if your stock drops too much, the broker will not hesitate to do a margin call and ask for some of that money. If your real estate asset loses 80% of its value, it may be unfortunate, but as long as you are paying your mortgage on time, you will never hear from the bank if your equity drops below 20% of the total purchase price of the investment property.
As Javier asked in a comment to our previous blog, “What about the tax implications or advantages?” The advantages you get with real estate is the ability to take depreciation deductions on the cash flow you receive for the property throughout your ownership period. I hope the attached spreadsheet accurately depicts the massive tax shelter that a rental property provides you over a 10 year period.
As mentioned before, check with your accountant to find out whether or not you can offset other income with the tax losses from depreciation and mortgage interest.
Before you leave:
Don't forget to check out our free rental property calculator. This will be a valuable tool in your arsenal as you analyze your existing or potential rental properties.
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The information presented does not consider your particular investment objectives or financial situation and does not make personalized recommendations. This information is not intended to be a substitute for specific individualized tax, legal, or investment planning advice. Where specific advice is necessary or appropriate, AssetRover recommends consultation with a qualified tax advisor, CPA, Financial Planner or Investment Manager.