Risk Reward Question

[Eric Sulek]

Hello everone,

More I read and get into how to buy rental properties the more this one question nags at me.  It seems like so many properties i'm reading about only have a couple hundered dollar a unit profit.  Higher the amount of units the the higher the initial investment.  

It seems like the ROI is in par with the S&P 500 average rate of return. So where I get lost is if you can have the same if not very close to the same ROI as the S&P but its a much higher risk, how are so many people making money on this or why starting. I feel like i'm missing something.

[Joseph Cacciapaglia]

Quote from @Eric Sulek:

Quote from @Joseph Cacciapaglia:

It sounds like you're comparing the cash flow from real estate to the total returns for the S&P 500. If you're looking at cash flow only, then it makes sense to compare that to the dividends you receive in the S&P. Cash flow is only one of several ways you make money through real estate. I've been investing since 2005, and my personal investments in real estate have far outpaced stock market returns over the same period.

Heres the math for why i am confused. If i buy a 100k house and have to put 30k down (fix it up and down payment). I bring it about 300 a month in net profit thats 3,600 a month. That coupled with lets say 2% appreciation in the property means in 10 years your total profit is about 50K (assuming you et 70% of the profit from selling the property after taxes) or 166% ROI.

Same 30K goes into S&P index at a historical avg 10% return compounded over 10 years is about 71K total or 41K in profit.  I understand you make an extra 9k with real-estate but the risk of losing everything is much higher.

Question I have is am i missing something or maybe the average profit from rentals is closer to 1K instead of a few hundred which would change the math a lot. 

2% appreciation for the property is pretty terrible, and well below the long term average in the US. That's one place where you're not comparing apples to apples. If you're going to assume the long term average for stocks, you should do the same for real estate. In general, I've made about $4 in profit from appreciation for every $1 I've made in cash flow over the last 21 years (that's including the properties I bought prior to the GFC). 

You're also ignoring the ability to buy real estate at a discount and/or force appreciation through renovations. If you're buying $100K houses for $100K, you're doing it wrong, unless the particular market you're investing in is very attractive (in that case, again the appreciation rate you're using is too low). I've bought lots of properties over the years that I could have immediately sold for a profit, but instead held and let the free equity compound. I think free equity is the #1 advantage real estate has over stocks.

Also, if you're buying today, there is a good chance that over the next 10 years there will be either cash our or rate and term refinance options that will juice your returns. I wouldn't buy assuming this is the case, but it's potential upside that I think is highly probably.

Finally, depending on the strategy you're using, there could be significant tax benefits.