Which is a better investment – the Stock Market or Real Estate?

Over the winter months, I found the 3 bedroom single-family home pictured in this article for sale in Willoughby. It was a foreclosure that was in good shape. I mentioned it to one of my clients, but he said he preferred the Wickliffe area and passed on it.

So I decided to make an offer on the property for my self-directed retirement account.

The offer I was contemplating was slightly above $50,000. Before I made the offer, I wanted to compare the long-term return on investment from this home vs. leaving the funds invested in the stock market. At the time, these retirement funds were invested into the “blue chip” stocks of Johnson & Johnson, Coke-Cola, Walmart, and McDonalds.

I figured this portfolio of stocks would probably average around 9% annually through dividends and stock appreciation. What would the $50,000 turn into if I simply kept the stocks and passed on this rental property? Here’s what $50,000 turns into overtime with an average annual return of  9%:

$78,284 in 5 years
$122,567 in 10 years
$191,902 in 15 years
$300,457 in 20 years
$736,528 in 30 years

Now lets compare these returns to the $50,000 rental property.

The idea would be to use the funds to acquire the home for cash and then reinvest the monthly income back into the same “blue chip” stocks each month through dollar cost averaging.

I did a market analysis and determined this particular home would rent for $975 per month. The monthly property taxes were $150 and the homeowners insurance was estimated at $50 a month. If we subtract another $100 a month for maintenance and repair costs, the monthly net income would be about $675 after paying the expenses of the property.

Each month, the rent would get forwarded to the self-directed IRA. I would budget for taxes, insurance and repairs and then invest $675 into one of the blue chip stocks listed in this article. If this $675 monthly investment into blue chip stocks averaged the same 9% annually as we used in the above estimate, the $50,000 rental property investment would grow to…

$51,293 of blue chip stocks in 5 years + the $50,000 home  = $101,293
$131,601 of blue chip stocks in 10 years + the $50,000 home = $181,601
$257,339 of blue chip stocks in 15 years + the $50,000 home = $307,339
$454,204 of blue chip stocks in 20 years + the $50,000 home = $504,204
$1,245,019 of blue chip stocks in 30 years + the $50,000 home = $1,295,019

The growth of the monthly $675 investment provides significantly more future wealth once you get past the 7 or 8 year mark. This is because the rental property will ultimately put more funds to work in the blue chip stocks as the various tenants make their monthly rent payments over time. By year 10, the blue chip stock portfolio would grow to $131,601 all accumulated from the rental income from the single-family home. PLUS, the self-directed IRA would still own the the $50,000 mortgage-free rental property.

Based on these rough calculations, buying the rental property for cash and reinvesting the monthly income provides an extra $550,000 in thirty years.

The reason why the investment property provides so much additional future wealth is because of double-compounding. The home provides a 16% annual return on investment. ($8,100 annual income/$50,000 purchase price). This 16% annual income is then reinvested into blue chip stocks providing another 9% return. If the funds were simply left in the blue chip stocks, the double-compounding would be lost.

This comparison doesn’t factor in any appreciation on the home which doesn’t tell the whole story, because the home was available below market value.  Other comparable homes in the area have sold in the $80,000 price range. Any appreciation of the home’s value over time would simply be a bonus.

I ended up buying the home for my retirement account for $51,000! The home transferred at the end of February and is now rented to a great family on a three year lease at $975 per month! I don’t ever plan on selling the home. I’ll simply continue to reinvest the monthly income following this plan for years.

Even though I think about this stuff on a daily basis, it still amazes me how one $50,000 single-family home can turn into a million dollars over time. Compound interest is truly magical.

(Note these numbers are not factoring in inflation or taxes. We are simply calculating what the $50,000 would grow into if it averaged 9% annually and we are using this same 9% estimate for both comparisons. Inflation and taxes would definitely impact the returns in both investment opportunities.)

Leave a Reply

Your email address will not be published. Required fields are marked *