Rentals vs Stock Market

[Alex Zaboli]

I know that this platform has experimental bias, but I've gotten solid advice pointing to maxing out tax advantage contributions (e.g. 401k which allows 19k in annual contributions) and then simply index fund investing. 

Having a long time horizon (40 years) until retirement age, what are the key factors to differentiate wealth building via real estate rentals vs stock market investing? 

To more personalize this topic, I like the concept of cash flow provided by rental property units, but I want to better understand why I would opt for that when I could take a perhaps more simple approach and dollar cost average in the stock market where I could reasonably expect around 10% over the long haul. I've heard that I should target 10% cash on cash return for real estate rental investing. It's worth noting that I have a stable and growing job that allows me to live comfortably off earned income, so I don't need the cash flow to live off of. I want to understand what real benefit(s) that extra cash affords me - is it mainly that I could build out a rental portfolio quicker? 

Thanks for your feedback!

[Chris Mason]

Max out the retirement accounts either way, especially if there's an employer match. Hard to beat free money.

The advantage of real estate over wall street is leverage. You buy a $500k asset with $125k down, borrowing $375k. It pays for itself in the short term with rental income offsetting the PITI, with change to spare ("cashflow"). Then in X years it is worth $600k, but you only owe $350k. So your $125k investment yields $250k in net sale proceeds. The asset only went up 20%, but you doubled your money. Hard to beat free money.

Plop that same $125k into $125k in stocks that go up 20% over that same time period, so you sell for $150k, you made $25k.

$125k is a bigger number than $25k. And the net positive cashflow will typically be bigger than any dividend income from that hypothetical $125k in stocks to boot. Hard to beat free money.

"Free" of course should be taken with a grain of salt. There's nothing "passive" about being a landlord, as ten thousand threads from frustrated landlords on this very forum can attest to - and time equals money. There's also per transaction type costs ("closing costs" in real estate, "brokerage fees" or w/e in stocks), which will be higher in real estate than stocks. So if you go the real estate route, you will want to somewhat minimize the number of transactions and focus on long-term asset holding, rather than short term "day trading" type ownership horizons. 

Overall, I don't think it's one or the other. Especially since lenders require "reserves" anyways (given SF Bay Area price points local to me, this can be absurd amounts of money), which can be stocks or index funds -- mortgage #7 may very well require $150k in "reserves," which is your choice of money in a checking account earning you nothing, or index funds that you find appealing anyways. So Fannie Mae is basically going to force you to diversify anyways. Max out those retirement accounts, satisfy your "reserve" requirements by investing in index funds, and the rest can be down payments.