Real Estate vs. Stock Portfolio

80 Replies

Coming across this website and the Financial Independence subreddit, I've gotten an itch to increase my rental real estate portfolio to start generating residual income.  My wife and I sat down together to look at our finances, and she thinks it's a bad idea.

Where we currently stand, we own a rental home and our primary residence outright, with no loan.  Rental home is worth about 450k, generates about 2k/month in rental income.  Primary residence is probably worth about 600k+.  

Our stock/investment portfolio, including Roth IRAs and 401ks are worth about 600k.  Of that, about 250k is in taxable accounts that we could withdraw if needed.

My wife's argument is by buying another rental property, we would be dipping into the 250k and we would be overweight in real estate vs. stocks if you don't count the 401ks and IRAs.  She thinks it'd be more wise to have the 250k in our stock portfolio, so we're more diversified and also because it's more liquid.

Thoughts?  Suggestions?  Is she right?

Thanks!!!

Charles

And what if the stock market crashes? 

The only thing here is you have to agree on the decision. Maybe you can give her some what if scenarios with real estate. 

The stock market is extremely high right  now and owning stocks is a terrible idea at the moment. The $2k you're getting off that $450k property is really weak, you should sell it and buy a few multi family properties in cheaper markets that cashflow better, unless your current rental is a multi, I'm not sure. You could definitely make a big splash in real estate if you wanted to.

How did your stocks contribute to the de-worsification of your portfolio today?    I've dumped all my market-based investments for real estate and real estate lending for the following reasons:

1) Control - I'm in charge, not some crook on Wall St.

2) Stress - market volatility has no direct impact on me.

3) Leverage - can get more more on RE

4) tax advantages - where else can you depreciate an appreciating asset

5) cash flow

I'm not missing the stock market one bit!

Wow, I wasn't expecting THIS negative of a reaction towards the stock market!

Just like the real-estate market though, I don't believe in market timing, so although the market may be "extremely high" right now (if you disregard the last few weeks), historically the stock market has annualized double digit returns.  

Those who dumped the stock market in 08 due to the crash missed 30%+ returns in 09.  Those who thought the market was at an all time high in 12-13 again missed 20%+ returns in 13-14.

The stock market affords me liquidity and less on-hand management and less "expertise" so you will.  The real estate market scares me because I'm a 100% novice at it, use a property manager, and am unsure how to fully navigate the tax benefits.

I'm definitely very interested in getting a rental property, mainly for the points brought up: leverage and cash flow.  The difficult part is knowing if I'm getting a good property.  As some of you have said, my current rental property doesn't seem to be performing well... but when I look at comps as far as home prices and rental/sq ft, it seems on par... Is northern california just tough?

Approximately 75% of millionaires made their fortunes via real estate.   I'm not sure what the % for stock investors, but it's gotta be a small fraction of that.

Hi Charles,

No right or wrong answer. It comes down to the comfort level of the investor and what you understand.

There are some financial planners who say diversify into a bunch of things you are not an expert in. This way if something goes up and something goes down hopefully you are still ahead some.

On the flip side there are those who say invest in what you know and are an expert in. That camp thinks diversification is dumb.

I have friends that have a lot in either one and I mean tens of millions.

Real estate has many classes and also various real estate cycles that do not happen all at once. So an RE expert can exploit upsides and deals in any market.

For the person saying get better rents Cali is mainly an appreciation market. You might find you do not have time for the higher yield rentals due to area and type of tenants.

Real estate can be passive but usually with larger properties in the millions to tens of millions in price. 

I'm with @Vincent Crane ; dump the $450k rental property and buy properties in market with much greater cash flow. Once better cash flow is in place, review the situation, see how you and your wife feel, then make a decision about whether or not you want to sell stock to invest in additional real estate.

@Charles Ho , you are on BP, and you expect an un bias opinion? lol

I'm going to sing a different song here. One of the big reason for real estate is leveraging. Without it, it's not that much better than stocks IMHO. ( of course there are other benefits too, but thinking about them hurts my head, so I'm going to ignore them for now). 

S&P index averages about 10% a year historically. Homes in most of the bay area average appreciate about 5-7% a year for the past 20 year. Sacramento and Folsom are less. Without any leverage, you better off putting the money in the stock market.

So the question is are you comfortable with reasonable amount of leveraging? Judging from you own two homes outright, I'm assuming you are fairly conservative in risks. 

Charles,

All bad advice above especially the cashflow guys. Don't listen to any of them. Listen to your wife. Happy wife = happy life. Your life will be a living hell if you do it against her desire. After all, none of these guys are paying the price for their advice. You are.

With that said, I'm heavily invested in real estate in the Bay Area. Thank god my wife's responses are typically "It's your call, or it's up to you." Sigh relief........ :0)

Hey @Charles Ho welcome to BP, we're neighbors! I live in EDH.  

I think @Eric Z. hit the nail on the head.  Leverage is the key to winning in Real Estate.

If your goal is really financial independence, what does that mean to you?

Diversification in the stock market is not a road map to financial independence.  It's good if you want to stay passive and let other people help you double your money every 7-10 years.

Ask yourself the questions, can we be financially independent if we double our stock over the next 7 years?  For some maybe... 'But it will be a safe way to keep money' (says the wife).

Why does it need to be immediately liquid? Real estate is liquid, you can always sell.

I also don't think you'll become financially independent in 7 years buying single family rentals. There needs to be a massive action plan!

You can take a more passive approach to REI and it could take 10-20 years to build a great real estate portfolio to retire on.

Read: The Millionaire Real Estate Investor - and make your wife read it too!

Or become aggressive, build a Real Estate Business that produces massive income and runs on it's own.  <- My plan, but far from it :(

@Minh Le Great advice :)-  

I need to get my wife to hang out with yours!

To add what @Chris Soignier said.

Double dip appreciation - Rent appreciates as well as home values.  

Also, you can buy RE at a discount and improve the value of RE... can't do that with general stock.

Charles Ho Opinions are a dime a dozen.., I'll give mine. I like real estate as a diversification component to an overall portfolio. Sounds like you're of a similar mindset. IMO the main benefit of owning individual properties is controlling your own outcomes - if you enjoy that and want to build the skill and get good at it, buy more properties. But, plan on buying lots (more than 10 units?) in order to benefit from systems and scale. If you want to be passive and use property managers, save yourself the headache and look at the RE crowd funding platforms. You'll make just as much money (probably more) investing in 5 year hold equity deals with far less work and risk.

@Charles Ho - Consider moving some $ to a self direct IRA and from there you can invest in RE while keeping the deferred tax advantages. Talk to an accountant before moving that $ though, there is some red tape to consider.

I plan on retiring before 62.5 years old, (planning for 45) that had a huge impact on what I did with my existing 401k and IRA's.

The stock market dipped 300+ points today, why?  Fear over Greece, the FMOC maybe raising the fed funds rate 15-25 basis points (trivial) sometime in the next year, low oil prices, who knows why...  Blue Chips and the S&P500 companies have more cash on hand than ever, M&A activity is trough the roof, banks are well capitalized, P/E ratios are historically strong so again, why the 300 point swing today?  Who knows, its irrational.  My best guess is high frequency traders (a.k.a. computers) making algorithmic trades based on current positions, not the fundamentals of the companies or the economy. 

If rental income drops you know why, its rational.  You can specifically point to a reason such as a major employer moving its corporate office, a military base closed, the news may be bad but at least it's rational and generally local.  Greece and Crimea probably wont effect your ability to retire if you invest in a rental in Austin TX.  Compared to the stock markets, rental income (separate from housing/appreciation values) was a better investment than stocks in 2008.  

Bill Schrimpf, Real Estate Agent in NV (#11844)
(775) 313-0778

@Charles Ho The 25.94% gain in 2009 was preceded by a 36.55% loss in 2008.

$100K on 1/1/08

$63.45K on 1/1/09

$79.91K on 1/1/10

$91.75K on 1/1/11

$93.68K on 1/1/12

$108.56K on 1/1/13

Five years recovery time to make 8.56% on your money. I'm not arguing that stocks don't have a valuable place in a portfolio, but they have just as much risk as any other investment.

Income producing properties often have multiple ways of returning money. Cash flow is one. Potential Appreciation is another. Tenants pay down debt (increased capital) is a third. Depreciation is another. 

If you can leverage the $450K into a 32-unit, $1M apt building in a secondary market, you might see:

$40K in cash flow

$36K in depreciation

$10K in appreciation

Return is 19.11%. Not to mention debt reduction.

(Obviously this is an example only)

Stock market returns based on http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/histretSP.html

I can promise you one thing, it's not going to be a good time for stocks this year or next year. We've seen a 7 year bull run without a correction of 10% or more which is the 3rd longest in U.S. history. Stocks are going to see a 20-30% haircut sometime in the next year, we're due.

Originally posted by @Charles Ho :

The stock market affords me liquidity and less on-hand management and less "expertise" so you will.  The real estate market scares me because I'm a 100% novice at it, use a property manager, and am unsure how to fully navigate the tax benefits.

 I recently pulled my entire 401k out of the stock market to invest in real estate... So that should tell you about my feelings on using the stock to diversify.... But I agree with other comments that you should invest in what you know and what you are comfortable with. Your comments quoted above as well as your modest cash flow on your current property indicate that you aren't as comfortable investing in real estate as other areas. Therefore, no matter how much many of us here on this real estate investing website would love to advise you on how to capitalize on your situation through real estate investing, you ultimately need to make the choices that make the most sense to you.

I've been focused on the stock market the last few years and it's been good to me.  However, I don't feel I can get to early retirement with the market, but it's 100% doable in real estate. 

I do plan to keep the retirement acts and a smaller cash act for speculative stuff in the market but moving forward I'll be focusing on RE. I'm not willing to take the 40-45% hit by withdrawing money from IRA and I don't want to deal with all the headaches of investing in RE via an IRA, easy decision to leave it in the market.

The market is an emotional roller coaster, it's gets much easier with experience but it definitely has a small affect on my daily mood.  I don't see real estates doing that consistently, there are always bad days regardless.

I don't invest in stocks.

My friends that have tens of millions in them take this approach.

They do not invest in risky stocks. They take a long term approach versus selling. When the market crashes and things go low they simply buy a lot more of the stuff they already own at a discount.

Over time by not short selling with the fear of the herds of a market crash they do better than others.

I can tell many investors can't stomach the ups and down of the stock market. Stock can be worth 100 a share today and tomorrow can be worth toilet paper. At least with RE I have a physical asset with a track record of cash flow. Might dip a little in value with cycles here or there but as long as I didn't pay a crazy price to acquire it I will be fine over the long term.

With businesses you just do not know what the company is hiding or underreporting with a stock.

Some people love it but it's just not my thing. RE does really well for me and I don't need something else.     

Hi @Charles Ho ,

The real estate vs stock market debate is always an interesting one.  And as mentioned already, you will get a real estate bias here given the nature of the site.

I'm as biased as anybody here.  I hate the stock market.  I don't like the lack of control and the entire thing strikes me as a legalized gambling operation where the house has their thumb on the wheel.  My wife and I have no stock investments other than her 403b, to which she contributes only what is required to get the employee match.  Our IRAs are self-directed and we use them to invest in real estate (Notes, joint ventures, etc).  

We own 17 doors (a mix of SFR, duplexes, and triplex) in GA and TX, though I live in the SF Bay Area. I am always looking to buy more for long term holds (want to move into multifamily commercial) along with my flipping and wholesaling, which I'm using to fuel the buy and hold for wealth generation.

As others have mentioned, your $2k/month rent on the $450k property is not very good cash flow, but depending on where that property is in CA it may be more of an appreciation play anyway. Others will differ, but I am of the opinion that for buy and hold SFR, cash flow is the icing on the cake. If you get any, great. If you're getting a lot you're probably in an area that will not appreciate much. The real money is in appreciation of a leveraged asset and principle pay down.

Look at it this way. The S&P500 historically returns like 8% annually. So if you were to invest $250k into the S&P500 in 10 years you'd have $540000 and would net $290k before taxes. Now let's say you used that same $250k to put down 20% on $1.25m worth of SFR. Historically SFR nationwide appreciates at about 3.5% annually. So in 10 years your $1.25m with or real estate is worth $1.76m. Let's assume you had no cash flow for the 10 years. Let's also not factor in depreciation. Let's also assume you had 30 year notes at 4.5%. At the 10 year mark you'd have paid down about $200k of the $1m worth on loans. Now you sell everything and pay 8% in closing costs and commissions leaving you with $820,000 after paying off the loans. So your $250k investment has netted you $570k before taxes. Almost double the S&P 500 and I am not accounting for depreciation and am assuming you get no cash flow for 10 years. I'm also not factoring in any of the tax advantages real estate affords you that the stock market does not. For example, you could do a 1031 exchange with these properties and pay no taxes upon sale. You can also refinance and pull cash out of the properties tax free. If you want to pull cash out of your stocks you need to pay taxes and sell the underlying asset, thus reducing your future returns.

Speaking of refinancing, did you say you own your rental property and your primary residence free and clear?  Get financing and you can pull hundreds of thousands of dollars out of them.  Then you have the money to buy more real estate without having to sell your stock and take a tax hit.

Just my 2 cents.  I happen to be procrastinating (I'm working on taxes) so I went on for a while.  @Minh Le advice is sage.  You need your wife on board with whatever you do or you're in for a world of hurt.  Luckily my wife gives me free reign to do whatever I want (from an investment standpoint).  

Good Luck!     

   

I think diversification is great. I also think you have a lot of capital wrapped up in a rental home based on the rate of return. I would guess if you include taxes, insurance, maintenance and capital expenses your return on that rental is in the 2-3% range, and worse if there's any vacancy, which is a lower return than just buying a long-term treasury and not having to deal with tenants. 

If raising rent is not possible, and buying better deals is not possible in your market, I would probably be looking to go in the other direction - divest myself of the rental, hold the primary note-free home, and reinvest some of the rental house proceeds into a reasonable growth mutual fund or similar, and some of the proceeds into something more solid. In my opinion, REI is not worth it at that rate of return unless you just like owning houses.

@Charles Ho diversification is a term that people use loosely.  If you and your wife are actively managing your investments in the stock market that might be a wise choice to spread between the market and real estate.  In my case, I am from the tech industry, so I only invest in that sector.  Even within that sector, I only invest in a very narrow field; I know the companies and the technology behind their products.  I have very little knowledge about pharmaceuticals, apparel, software, mobile devices, music, precious metals, etc... so there is no way that I can make an educated investment in those other industries.  My belief is that portfolio/fund managers push diversification because they know the average investor cannot have the depth needed to invest wisely in multiple fields.  Therefore, the average person will pay fees to investment firms for their expertise because they have been lead to believe they "need diversification".  

"Wide diversification is only required when investors do not understand what they are doing" - Warren Buffett

As many have pointed out, REI is very focused investing with a great amount of control, especially if you invest locally.

On the liquidity side of things, there is some merit to her concern. If you need cash tomorrow for some emergency, stocks can be liquidated with a push of a button. But remember, depending on your basis, your tax ramifications could be painful. In your case you own your primary home free and clear... Go get a HELOC and sit on it. Sure there is interest that you have to pay on that money, if you use it, but you need to compare that against the potential taxes you would pay in selling shares. There is a pay back time component in this equation, but I think the general idea of what I am saying is clear. With the HELOC, if you need cash for an emergency you have immediate access. If you get more comfortable you can also use that HELOC money to invest in future properties. Personally, I would leverage the equity in my properties by getting some conforming loans. But I think your wife might be financially conservative, so I would not push her at this point in using the HELOC to buy other properties.

But at the end of the day @Minh Le is right... "happy wife = happy life".

Originally posted by @Jeff Pollack :

Hi @Charles Ho ,

As others have mentioned, your $2k/month rent on the $450k property is not very good cash flow, but depending on where that property is in CA it may be more of an appreciation play anyway. Others will differ, but I am of the opinion that for buy and hold SFR, cash flow is the icing on the cake. If you get any, great. If you're getting a lot you're probably in an area that will not appreciate much. The real money is in appreciation of a leveraged asset and principle pay down.

Look at it this way. The S&P500 historically returns like 8% annually. So if you were to invest $250k into the S&P500 in 10 years you'd have $540000 and would net $290k before taxes. Now let's say you used that same $250k to put down 20% on $1.25m worth of SFR. Historically SFR nationwide appreciates at about 3.5% annually. So in 10 years your $1.25m with or real estate is worth $1.76m. Let's assume you had no cash flow for the 10 years. Let's also not factor in depreciation. Let's also assume you had 30 year notes at 4.5%. At the 10 year mark you'd have paid down about $200k of the $1m worth on loans. Now you sell everything and pay 8% in closing costs and commissions leaving you with $820,000 after paying off the loans. So your $250k investment has netted you $570k before taxes. Almost double the S&P 500 and I am not accounting for depreciation and am assuming you get no cash flow for 10 years. I'm also not factoring in any of the tax advantages real estate affords you that the stock market does not. For example, you could do a 1031 exchange with these properties and pay no taxes upon sale. You can also refinance and pull cash out of the properties tax free. If you want to pull cash out of your stocks you need to pay taxes and sell the underlying asset, thus reducing your future returns.

Speaking of refinancing, did you say you own your rental property and your primary residence free and clear?  Get financing and you can pull hundreds of thousands of dollars out of them.  Then you have the money to buy more real estate without having to sell your stock and take a tax hit.

Just my 2 cents.  I happen to be procrastinating (I'm working on taxes) so I went on for a while.  @Minh Le advice is sage.  You need your wife on board with whatever you do or you're in for a world of hurt.  Luckily my wife gives me free reign to do whatever I want (from an investment standpoint).  

Good Luck!     

this is all solid advice. as in everything in life it comes down to what your family's goals are. Get on the same page as your wife and go from there. If your family's goal is truly financial independence, and getting their in the most attainable and efficient way possible, then I would shift money from your stocks into RE, and better allocate current RE holdings. Again, to do it the quickest way possible will take a lot more leg work then you are currently putting in. If you are happy with being completely passive as your investments (rental & stocks) indicate, I think you can still allocate your funds better as mentioned by a previous poster here, "

If you want to be passive and use property managers, save yourself the headache and look at the RE crowd funding platforms. You'll make just as much money (probably more) investing in 5 year hold equity deals with far less work and risk.

"

notes and crowd funding are viable options for you. In your position you can cashout refi just your primary, and start playing banker on deals with private money. You can earn a nice interest only profit, or seek equity deals. The possibilities are truly endless. I like to tell people to start at the end of what you want to achieve, and when you want to achieve it.. Then, work backwards from there. People who tend to completely write off the stock market or RE altogether for an exclusive investment strategy tend to make blanket statements, and I would take what they say in stride. There are benefits to both, and it is very situational based on your preferences. IMHO keep your long term securities, and get as much cash as possible to play monopoly with. From there determine how passive/hands on you want to be, and what your end goal is. Even if you want to be completely passive it is my belief that you can get some better gains just through a shift in your allocations. Good luck, and happy investing.

@Lee S. did you know that you can convert your retirement account into a self directed IRA 401k retirement account. Then you can invest that money into real estate, being the lender, buying notes and stocks and a few more investments. It is a nice way to own real estate and defer taxes and or avoid taxes altogether.

did you buy that house you were talking about back in july?

Gordon Cuffe, Lender in CA (#1037464)
916-261-2381

Join the Largest Real Estate Investing Community

Basic membership is free, forever.