I’ve been investing in the stock market for over 17 years now and it has served me well, very well I might say. from time to time however I’ve been tempted to maybe take on a rental property or two but after 17 years I still haven’t. I’m not giving up on the possibility completely. So the question remains; invest in stocks or rental property?
Here’s why I personally hesitate: If you get into rental properties you can build yourself a pretty handsome passive income. In return you have to deal with people. Not that
there is anything wrong with dealing with people but, you generally have to deal with people (your tenants) when it isn’t fun.
You have to deal with them when the rent is late, you have to deal with them when the basement floods and their pissed at you for not having maintained the sump pump and you have to deal with them when eviction comes in play.
Things can get very personal and very emotional for both you the landlord and your tenants. It is not easy to evict someone. Not easy from a personal perspective and not easy from a logistical and legal perspective.
Investing in stock is different. It is not personal. Sure I got pissed at Wall Street when the market fell apart in 2009 but Wall Street is an anonymous entity. I have less control over what happens to my investments but then again as a Landlord you only have so much control as well. Local laws can make life for landlords very difficult.
Without cause it is not easy to do anything no matter how much you don’t like the renters in your property.
Return on investment
Return on investment on a rental property is all up to you and to some extend your tenants, however if all goes well, mostly up to you. You are very much in control of what your return looks like. You can control it by determining how much you are willing to pay for the properties and how much rent you collect. Real estate professionals use what is called a cap rate to determine the returns.
Cap rates can be calculated using the:
Annual rent you’ll receive: The rent you receive may be something that is probably determined by existing renters (easy) or will have to be determined based on similar properties in the same neighborhood (not easy as it can be hard to find apples to compare to apples).
Annual expenses for the property which can consist of:
• Property taxes
• Various forms of insurance expenses
• Last but not least vacancy costs
Don’t overlook the last item. Chances are you won’t have a tenant immediately and tenant(s) may default. Assume a vacancy cost between 5% and 10% of the annual rent.
The Cap rate can be calculated as follows: (Annual rent minus expenses) divided by cost of the property.
As an example let’s rent out a nice little waterfront property you can purchase for $200,000. You’ve figured out you can charge $2000 a month.
property tax: $4,000
association fees: $400
utilities and repair: $3,500
vacancy cost: 5% or $1,200
total expenses: $9,100
Net income: $24,000-$9,100 = $14,900
Cap rate = $14,900/$200,000 = 7.45%
7.45% is a decent cap rate. Here’s the catch, cap rates can be deceptive, the calculation assumes the property is paid in full. Most of you will get loans on your properties in which case cap rate can be a good indicator whether it may be a good investment but it won’t actually get you the true return on your investment. I could go on but things get more complicated from here.
Things get more complicated… in itself is another reason you may choose investing in the stock market over rental income: things can get complicated real fast. estimating/calculating potential profits isn’t easy, taxes are more complicated and lets not forget the countless laws depending on where you live that can make your life easier but in general more complicated.
Of course return on investment on stock purchases can be a crap-shoot as well (maybe even more than rental income). I personally follow the philosophy of KISS (keep it simple stupid) and invest almost exclusively in ETFs (Exchange Traded Funds). You can go by Dave Ramsey’s estimate of 12% return on your investments but based on my own numbers I like to stick closer to 8%-9%. More conservative financial advisers will put it even closer to 6%.
The thing about returns on stock investments is that as a private investor you have very little control over the returns. As an investor in 2009, I saw my investments dwindle by over 50%. I lost close to $300,000 (on paper) during the great recession. These investments have since back come back with a vengeance but don’t kid yourself, your just along for the ride.
The housing market crashed as well and although many people went back to renting, which was good for the rental market, many landlords saw their equity dwindle which probably hurt as much as my losses. Property prices have come up somewhat but not at the pace at which the stock market did.
So where do we land with this? Is getting rental properties better than investing? I think if you ask a landlord they’ll tell you its rental properties. If you ask an investor you’ll be told the stock market is where you want to be.
Both investment vehicles are suitable means to generate an income. I think it boils more down to what is best for your personality.
Do you like to deal with people? Do you like managing conflict? Do you like to get your hands dirty and clean out the gutters of your property? Do you like to be in full control of your investment? Getting one or more rental properties may be the way for you to go.
Do you like to stay hands off and not get personal with your investments; the stock market is probably the better place to be for you. Sure it hurts when the market goes down. I got a pit in my stomach come 2009 but I stayed put, bought some more at some of the market bottoms and came out just fine.
I’d love to hear from you whether you believe rentals are better than the stock market and vice versa.
In the meantime good luck turning your financial goals into reality