This blog was originally published by Marshall Reddick Real Estate Network.
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Why the Average Joe Makes Money in the Stock Market but gets Rich in Real Estate
Many of us started out our investment career with a simple savings account, perhaps to save for a car, college or the down payment on a house. Congratulations to those of you who achieved that first goal through savings.
The problem I had with my savings account was that the only time it seemed to grow was when I put money into it. The 1% interest I was receiving hardly made a difference at the end of the year. Although my savings was losing value due to inflation, it did teach me 2 important lessons: Savings accounts are a vehicle to accumulate money to achieve a goal and they pay you almost no return for the use of your money.
Many years ago I had heard that stocks offered a better return on investment than savings accounts or CD’s, so I began to do my research. I will have to admit that my early attempts at stock investing were not all that successful, but I did end up making a little more than my savings account paid. So I learned 2 important lessons from my stock market experience: Stocks can go up and down in value and there is a brokerage fee when you buy and a tax when you sell.
The Importance of Association
I had a friend who moved to a larger house and rented out the house he had been living in. When I asked him about how he did it, he explained that he took out a second loan on his first house that was large enough for the down payment and closing costs on his new house. The rent he received covered the loans on the first house and there was a little positive cash flow as well. I didn’t act on this lesson at the time, but it planted a seed for later.
In my pursuit of a better return on investment, I learned that real estate investing offered benefits that other investments did not. The primary advantage being, I could buy more with less. By using leverage, my money could go farther and earn a better return. I also learned the IRS allowed what they call a “depreciation write off” which helped act as a tax shelter for my regular income. It was like getting a raise at work when I could recuperate more of my taxes paid at the end of the year.
In calculating my return on investment (ROI) I was able to add positive cash flow+ depreciation + appreciation + principal pay down. A big improvement over stocks.
When calculating my Cash on Cash return (money in, money out) I could see a big improvement. With 20% down + closing costs, here’s what my calculation looked like: Down payment + closing costs = $25,000. Net rental income after expenses = $250.00 per month or $3,000.00 per year. Divide the $3,000 by $25,000 = 12%.
The 12% return looked pretty good compared to my stock market return which had been averaging about 7%. In comparing stocks to real estate, this is what I found: With a 7% return on $100,000 invested in stocks, the yield is $7,000/ year. The same $100,000 invested in leveraged real estate, controlled $400,000. With the same 7% return in real estate, the yield is $28,000/ year (4 times as much). This is the power of leveraged investing.
Lessons learned: While you can accumulate money in stocks and get a better return than a savings account, you won’t be able to build true wealth until you make use of the leverage that real estate investing allows. There’s a reason why 97% of all millionaires have built their wealth through real estate.
More from the Author: https://www.mrren.com/education/articles/page:1