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December 06, 2013


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Why do you consider real estate investing superior in building income vs. stocks? Also, I would not consider myself retired if I had to manage and repair a bunch of properties. If you hire someone to manage your properties and their repair then I would definitely challenge your returns vs. stocks/bonds over the long run.

Also, when I retire I want to be free to travel and visit friends, not be stuck in one area of the country maintaining and managing my real estate properties.

If I need more income than my portfolio of stocks and bonds generates, I will grab a part time job (on my terms, not when my tenants call) in whatever part of the country I am in to help offset the bills.

Sure, when I get really old working may not be practical, but neither will be plumbing, roofing, etc.

Ron --

I consider RE superior because you can earn 10% income from it (or at least I do and, yes, even with a manager) while INCOME (not total return) from stocks is 4% at the very best.

Also, I live in OK and my properties are in MI, so I am in no way stuck in one area of the country.

I think you're dealing with some old misconceptions about real estate.

I inherited my landlord status and I hate it. The rent net of real estate and income taxes, insurance and repairs isn't worth the hassle of getting late night phone calls, calling tenants to secure the rent and renovating a property practically destroyed by the tenants. The nicer you are to them, they seem to take advantage of you more and more. Needless to say, I am disposing of these properties as quickly as I can.

I do agree with you, however about the back to income phase. That's where we are now. We do a lot of investing in dividend and interest generating products so even if their value falls in the market, the payments just keep coming. Much easier than real estate!

We're in the wealth generation phase, with a little bit of the back to income phase as well with our two rental units. In the next few years I imagine that we'll spend more time figuring out the details of how to slowly spend down the wealth accumulated. But for now, our energies are going into our jobs to make more of it!

Kathy --

I'm not saying that all real estate is like the set up I have. You have to pick the right properties, get the right team, etc. It does take time and effort to do it right. Since you inherited it, you didn't have the chance/choice to do it as you might if you were planning on living with it.

As for the late night calls and dealing with tenants, that's where a professional real estate management person or company can make a world of difference. I lucked into finding a perfect one because they were already managing a property I bought. If you can find a similar company, they will take most of your headaches away. Yes, they do cost money, but if you buy right and set the financials up correctly, you will be able to afford them AND make your return.

I've had one evening phone call on a Thanksgiving Thursday over a water heater leak. Personally, that is the extent of my late night calls in more than six years as landlord. We have 24 hours to respond to all other non-emergency calls.

Real Estate investments vs Stock and Mutual fund investments.

I know many people that have done very well with both types of investments.

Real Estate requires management of the properties and unless you have a property manager it means dealing with tenants, handling repairs, maintenance & renovations, and sometimes even attorneys. One or two bad tenants can cause a load of headaches. Generally speaking real estate investments can be safely held for the long term and over the long term they increase in value and generate a lot of income.

Stock & mutual fund investments require a lot of expertise if you are to do really well. You don't have to deal with people (which is what I like about them). However you can lose a lot of money in individual stocks. Many years ago I had one stock investment of $6,000 in which I lost it all because of fraud by the owner of the company - that's why I gave up buying individual stocks. Too often you can find that your stock becomes the "Disaster de Jour" and has a huge 1-day drop because of a very poor earnings report or some other very negative piece of news.

You also have to do a lot of research and analysis if you are to beat the market in owning mutual funds by practicing very good fund selection along with some market timing. This however requires a lot of time and great investment skills. Using Buy & Hold is hardly any work and you will basically be following the market UP and you will be following it DOWN.

My own investment success would have been nothing like it was if I had rode the dot.com bubble back down as did many people. Instead I had experience with analysis tools and indicators that enabled me to sell everything within the 4 days following the market top. That bubble was in my opinion a once in a lifetime event for the Nasdaq.

Old Limey --

I think there are pros and cons to both RE and stocks and returns can be similar when you talk TOTAL return.

But for income only, I think most people would agree that RE is a better performer in most cases.

Out of interest I just checked the chart of the Nasdaq 100 index. It's still well below its peak after 13 years.

This describes the DOT.COM bubble.
09/17/1998 .... 1,291
03/27/2000 .... 4,704
09/23/2002 ....... 843

12/05/2013 ..... 3,477

I totally agree that on the basis of income that real estate easily beats bonds. The main reason I don't like rentals is because, unless you have a property manager, you have to deal with tenants. I have had two vacation rentals during my lifetime.

The first was a ski cabin at Lake Tahoe (250 miles away) - that worked out very well because I only rented it to neighbors and people I worked with. When the kids were much older I sold the cabin to buy a beach condo (25 miles away).

The only problem with vacation rentals was clearing up after tenants. Fortunately our son now lives in the condo and spent a lot of money on improvements. It's still in our name but he will inherit it.

RE vs stocks

The real boost that RE provides over stocks is the ability to use leverage in a safe and measured way.

I know many people went broke using leverage in RE in the last 5 years but it was neither safe nor measured what they did. The past decade brought an era of RE investing where most properties were cash flow negative and the primary driver of investment was rapid (and unsustainable) appreciation. Buying into that environment is not investing, it is gambling and most gamblers lose it all eventually.

Leverage can be used with stocks via margin or options but it is inherently more risky. When a stock purchased on margin declines the broker requires extra cash to be added to replace the decreased margin buffer. If you do not have the cash they will sell you out at a loss. That is not safe or measured and it is not investing, it's speculating. There are professionals who do it, but they are called speculators, not investors, and some of them go broke.

Real estate is different. There are no margin calls. If the value of the property you have leveraged has dropped 20% you may very well be insolvent on that property (known as underwater). As long as you can maintain enough rental income to pay the mortgage there is no risk of default and the bank will never come knocking asking for you to give them more money like the brokers will do on a margin account when a stock you bought on margin drops in value.

So if you buy properties with sufficient cash flow which is easy to do in the current environment and you use 75% leverage, you can easily achieve returns that exceed 20% and with the right properties can push up towards 30% (I don't have any of the 30% properties but they do exist). And this is repeatable, annually. And this does not include any appreciation or tax benefits of which there are both, and both of those will raise your actual full after tax returns. All the numbers I used above are based on my own portfolio of properties which is a 7+ figure portfolio purchased with a little less than 75% leverage.

(I have looked at FMF's numbers on his properties. He has great investment properties that are more pure investment based than mine. My numbers are ones I consider quite good. If he applied 75% leverage to his properties, his numbers would exceed mine. In this environment, those returns are not abnormal, they are very normal.)

There is no comparison between stocks and real estate when you use leverage in a measured way.

Now to be fair, this was nearly impossible to do 8 years ago. That's why so many of those people went broke. They purchased properties using leverage that had negative cash flow and never made sense unless the value of the property continued it's rapid pace of appreciation. That is gambling. And that kind of real estate market will likely return again some day. And if it does I will liquidate my holdings into it and wait for a more sane market to return.

I am the first to admit that real estate investing isn't for everyone. In fact I would argue it's not for most. I certainly don't advocate everyone run out and jump into real estate. Many just aren't prepared for that kind of investment.

But I do always find it interesting the number of people who try to downplay the benefits of it or even go so far as to argue it's inferior. It's more work (you can hire a property manager to make that go away), and requires more analysis and a bit of business acumen and that's why it's not appropriate for many but it's certainly not inferior or even on par with other investments.

Safe, repeatable, 20%+ cash returns, every year for the foreseeable future + appreciation and tax benefits. I haven't seen an alternative investment that is legal about which you can say that.

Before I became very active in the stockmarket after I retired in 1992 there was a very rewarding period between 1979 and 1989 when the rates for 30 year mortgages ranged between 10.20% in 1986 and 16.63% in 1981.

There was a company in San Jose, CA that was in the business of putting together short term 2nd. Trust Deeds for real estate investors that were trying to put deals together in order to buy homes and apartments. The company would handle all the paperwork and the final Trust Deed would be owned by a small group of investors like myself. The company also collected all the interest payments and then mailed out monthly checks to each investor. There were also late fees that we would often collect as well as a fairly large fee if the trust deed was terminated early.

I was in quite a few of these trust deeds, never lost a penny and received interest ranging from 10% to as high as 16%. We also only made loans up to 40% of the value of the property and I always inspected the property before investing to ensure that it was in excellent condition.

There was one property that I was in that was a gorgeous home in a great location and owned by a builder. The builder went into foreclosure and we thought that maybe we would end up owning it for a pretty low price. However the builder went into bankruptcy owing the IRS a lot of money, they stepped in ahead of us (as was their right) took ownership of the property and just paid us what we were entitled to.

Now that we have been in an easy money period for many years the company is probably no longer in business but it was a nice ride while it lasted.

@Old Limey,

That sounds like a pretty good and safe investment. However how would you say those returns compared to prevailing returns and rates? 1979-1984 was an extremely high interest rate period. The Fed funds went to 20% in 1980 and again in 1982. Even up through 1989 it was still a moderately high interest rate environment. The returns you list are above the average interest rates of the time but probably not like they would be compared to interest and bond rates today wouldn't you say?

In that period my primary investment was my 401K and I knew nothing about bonds. However in 1977 we bought our present home. The old one we bought new for $27K in 1963. It sold quickly for $90K and we wanted to move into a nearby custom development where the only home we had looked was priced at $150K was on a corner lot and had a pool, two features we didn't like. We then contacted a Century 21 realtor that "farmed' the area and after a while she called me at work to say that she had just got a listing. Evidently the couple that owned it had just had a big row, decided to get divorced, and put the house on the market. We met her at the home 1/2 hour later and it was just what I wanted. It was at the bottom of a court, had a small front yard and a huge back yard, and no pool. It also had a side yard that was perfect for my future vegetable garden. The realtor had convinced the owners that $107K was a good price and we signed the agreement to buy right then and there, as did the owners, and it was a done deal. However it was soon apparent that the owners didn't know the value of their home because prices had been going up fast. The owners wanted out of the deal and other realtors were pressuring my realtor with much higher offers. However we held fast to our legal agreement and closed escrow within a week or two. Today the home would sell very fast, with multiple offers for over $1.5M. These days there's usually a bidding war between would be buyers. We put down 25% and obtained a conventional 25 year loan at 5%.

I think the income first phase is much longer than five years. The average person won't reach their peak earning potential for many years to come which is when they really start to accumulate wealth.

I make 90k. I am 32 and 2nd year into my job. Got married, no kids. Sole earner. Never invested.

In the next 5 years:
- start family.
- generate income.
- buy home.
- invest in index funds.

From your article, not sure for how many years I will be in the Income First phase. Probably, since I started late, it may take a while to catch up with others of same age. Wonder how else I can prioritize.

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