Real Estate vs Stocks
The primary goals of a passive investor are to build wealth while also drawing a regular income from investments. Ideally, the investor will not have to deal with the routine stressors associated with hands-on investing activities and can simply enjoy a steady stream of returns. Two of the more popular options available for passive investing are income-producing properties and dividend-paying stocks.
The path that you choose to take to achieve your passive income and wealth-building goals should be selected after a careful review of the facts. While some investors may lean heavily toward one of these opportunities, others may find a happy medium between both of them. What should you know as you make upcoming investment decisions strategically?
The Historical Return on Investment
When you analyze the historical return of these two investment types, you will immediately notice that the annualized return on stocks is between 9 to 10 percent. On the other hand, the appreciation on a traditional single-family home across the decades is close to 5 percent. However, this does not tell the whole story.
Keep in mind that asset value appreciation is only one aspect of the return. Everything from cash flow from investments to tax advantages and risks must be taken into consideration as well. The return that you will realize from your investing activities will depend on the specific investments that you select as well as how you manage those investments, your tax situation, and other factors.
The Ability to Produce Steady Income
Because passive investing is your focus, the ability for an investment to produce a steady income is crucial. For stock investments, income is derived from dividends. The average stock dividend is approximately 3 percent today, but there is tremendous variation in this. Generally, stocks that pay a higher dividend are riskier.
Furthermore, those high-yield stocks may not have a history of maintaining that high dividend amount. The stocks that have maintained their dividend rate for many years often have a yield at or below the average. Given a yield of 3 percent, you would need to invest $100,000 in stocks just to draw $3,000 per year in dividends. Keep in mind that most dividends are paid out either quarterly or annually.
Rental properties, on the other hand, produce regular income through the rents paid by tenants. Tenants are contractually obligated by a lease to make regular payments, and this provides a level of certainty in the monthly income that you would receive from your investment. While some tenants will breach that contract, there are legal options to collect the money if that happens.
In addition, if you or your property manager maintain high standards during the screening process, the risk of a tenant not paying rent is minimized. Because businesses always have the right to adjust their dividend, income security is generally higher with rental properties.
Which investment type has the higher yield? You have significant control over your return with rental properties. Your net income from this type of investment will be based on the rental rate that you charge, the property’s operating expenses, and the mortgage payment. Careful research prior to your property selection as well as adjustments to loan terms can establish a relatively steady return that you have strategically set up.
The Opportunity to Invest with Debt
The ability to leverage the purchase of a rental property is truly advantageous. You can certainly take out a loan against another asset to purchase more stocks, but you are placing that asset at risk and increasing your expenses with a new loan payment in the process. This is not the case when you buy a rental property with a loan.
Your new mortgage is secured by the rental property rather than by one of your other assets, and the mortgage payments are covered by the rental income. The tenants are essentially paying off the mortgage debt through their monthly rent. In the process, they are building up the value of your investment portfolio.
In line with the $100,000 investment example described previously, you could use that as a down payment on a $600,000 to $750,000 property depending on the loan terms that you qualify for. Property value appreciation will be based on the full value of the asset rather than on the amount invested out of your pocket. In addition, your rental income on a property this size could be substantially higher than the $3,000 annual return from a comparable stock investment.
The Tax Advantages
A notable benefit of stocks is that they can be purchased in a tax-advantaged retirement account. While this is important for wealth building, however, retirement accounts are not suitable for building a passive stream of regular income. This is because penalty-free distributions are dependent on age and other factors.
On the other hand, the tax advantages for real estate investments are considerable. Consider that the mortgage interest and all property-related expenses can be written off. These expenses offset the taxable income that the property produces. In some cases, investors can turn a sizable profit with regular monthly income, and the deductions result in only a modest amount of this income being taxed. Property depreciation is another major deduction that further offsets taxable income from your investment.
Tax benefits related to your properties continue when you sell the investments. Through a 1031 exchange, you can avoid capital gains tax altogether if you reinvest in a similar type of property. Overall, you can save a substantial amount of money through all of the allowed deductions on your investment property’s income.
The Need for Regular Management or Oversight
One of the more notable reasons why the typical passive investor may forego the incredible benefits associated with rental properties is related to management. The amount of time and stress that may be allocated to dealing with tenant issues, property upkeep, vacancies and more can be considerable. None of these time drains are present with stock investments.
However, stocks do require regular oversight. The market moves throughout the day during trading hours. You may intend to hold your stocks as a long-term investment, but you still must observe market movement so that you can act quickly to preserve your assets if your stock price takes a nosedive. You also must be aware of announced changes in dividends and other news related to the companies that you have invested in.
You can see that both types of investments require regular oversight. You can hand over your stock portfolio to a broker. In the same way, you can hire a property manager to tend to your property’s daily operations.
The Importance of Diversification
Drawing all of your passive income from a single source can be unnecessarily risky. Whether you are focused on building wealth or building passive streams of income, diversifying your portfolio is crucial. Some investors will add both stocks and rental properties to their portfolio so that they can take advantage of the benefits that both offer.
Through passive investing activities, you must never lose sight of your ultimate goals. You have a limited amount of funds available to purchase investments. At the same time, your need for reliable income from your investments is predetermined. To optimize income potential, leveraging property purchases with mortgages may be essential.
A Word About Liquidity
Another reason why many people prefer to invest heavily in stocks is that they are highly liquid. With a few clicks of your mouse, your sell order can be placed. Within a few days, after the transaction is settled, you can transfer the money to your checking account. On the other hand, it could take many months to sell real estate.
While liquidity is an important benefit, it has its downsides. Consider that you may be more likely to draw funds out on a whim or to sell stocks based on emotion. Selling real estate is a major undertaking that requires significant planning and effort. This ultimately can help you to protect the wealth that you built in your investment.
Structuring Your Portfolio Strategically
Research is essential as you set up your portfolio. This begins by identifying how much income you need to draw from your portfolio regularly in order to live comfortably. Defining the amount of your investment capital is the next step.
Because of the many benefits, it makes sense to draw a significant portion of your passive income from property investments. Researching investment opportunities and loan terms is the next step. At the same time, you can identify high-yield stocks that have not adjusted their dividend in many years.
Thanks to the ability to leverage rental property purchases, you may develop your passive streams of income more quickly than you realized was possible. The time to begin preparing for your future and to focus on wealth building is now.
Disclaimer: The views and opinions expressed in this blog post are provided for informational purposes only, and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action.