Real Estate Return on Investment Vs. Stock Market Investing

Analysis of Stocks Market Investing Versus Real Estate ROI

Most Americans participate either directly or indirectly in the stock market. It is generally assumed that the best investment strategy for the average Joe is to sock away a percentage of their paycheck into a diversified stock portfolio and hope for the best. In this article, we wanted to take a look at the potential difference in real estate ROI (return on investment) versus stock market investing.

First, a short disclaimer: We at Browder Property Investments are not licensed financial advisors. Anything in this or any other article that may be construed as “advice” should be taken to your financial advisor before acting on it. We are also experienced real estate investors and though our examples and results are realistic from an experienced investor’s background, one should always exercise caution when investing in real estate and be aware of the potential for loss – especially if new to real estate investing.

A Look at Stock Market ROI

We’ll begin by noting that, like any investment, the range of returns on stocks vary wildly. There are many reasons for this difference. Some people are professional investors that day trade or take short positions and have the time and money to constantly study the market and select individual securities to buy and sell. While we suspect the majority of people who attempt this do not make money in the long term, there are probably many who make consistent excellent returns. It would be difficult, though, to provide anything resembling an average analysis of day traders, market timers, etc. because their results are largely private and would be enormously varied.

For the sake of comparison, we will look at the average annual returns for Vanguard funds. Vanguard is one of the most trusted names in stock and fund investing. They were one of the originators of ETF’s (exchange traded funds) and are major player in that world.

Since most people participate in the stock market by investing in funds via their 401(k) or 403(b) plans, we will use the best returns we can find on Vanguard’s site. We will be generous in our analysis and take only the average annual return for the best performing index fund people would be likely to be familiar with (and therefore invest in). As of the date of this article (9/5/17), the best performing fund’s annual return with name recognition was the S&P 500 benchmark fund. As of today, the average annual return was 16.23%.

Now, most people realize that 16% return on a fund is not realistic long-term, but for sake of comparison, we’ll use it.

Some Stock Market Math

Let’s look at the ROI for a $100,000 investment in the fund mentioned, held for one year, and then sold. First let’s calculate what the account increase would be:

Investment $100,000.00
Annual increase at 16.23% $16,230.00
Total account value $116,230.00

Now, we need to account for those pesky fees. As of the date of this article, the average ETF fee is around 0.44%. That is very low in the fund world, but we’ll assume our hypothetical stock market investor was savvy enough to avoid those high actively-managed fund fees:

Total account value $116,230.00
Average ETF expense ratio (0.44%) $511.41
Account value less average expense ratio $115,718.59

Lastly, let’s also consider taxes. This also gets into tricky territory that is complicated to have an example that would apply to everyone and you should always consult your tax professional before embarking on any strategy to determine the tax effects. For our analysis, though, we’ll assume the fund was held for all 12 months and it was sold at once. This means that the entire gain (less expense) would be subject to the long-term capital gains tax rate (currently 15%):

Account value less average expense ratio $115,718.59
Long term capital gains tax (15%) $2,357.79
Net income after expenses and tax $113,360.80

Finally, we’ll calculate the return on investment percentage for our stock fund example.

After tax gain $13,360.80
Original investment $100,000.00
Return on investment % 13.36%

So, we see that it is possible to achieve a 13.36% ROI in stock investing (via ETF funds). This is a respectable return, but we can be sure it’s not possible to achieve these results consistently. A more realistic figure would be to use Vanguard’s 10-year average return of 7.61%, resulting in a 6.07% ROI.

Real Estate ROI Example

For the real estate ROI example, let’s take a look at some of the properties currently listed on BPI’s Available Listings page as of the date of this article. We’ll use a house listed in Waco for sale for $40,000 with an estimated ARV (After Repair Value) of $69,900 and an estimate repair cost of $10-15k. First, we’ll assume a cash purchase as lender expenses will add complexity to the equation. Let’s figure out our initial investment to buy and repair the property:

Investment $40,000
Repair costs (10-15k) $12,500.00
Total property investment $52,500

Next, we’ll assume a cash buyer comes along with no agent and purchases for $69,900. This is not atypical in these types of deals. Let’s calculate what our gross profit on the transaction is:

Sales price $69,900
total investment $52,500
Gross income $17,400

To be fair in our real estate ROI analysis, we’ll account for costs the same way we did for stocks. Closing costs will vary depending on contract negotiations. In this case, since we’re assuming a cash buyer and no agents, let’s estimate we’ll pay $1,000 in closing costs:

Gross income $17,400
Assume closing costs $1,000
Profit after closing costs $16,400

Finally, we’ll also need to consider Uncle Sam. The tax rules for real estate can be extremely complex. We have to consider what is an allowable adjustment to cost basis, what is not, did we live in the property, are we actually classified as an investor (therefore benefit from a 1031 exchange), etc. For ease of our calculation, we will assume that we did not live in the house, we held it for a year, all repairs count as adjustments to cost basis, and we are not pursuing a 1031 exchange (which would allow deferment of capital gains tax).

These assumptions allow us to use the preferential 15% long term capital gains rate used for our stock example. Let’s see how this works:

Profit after closing costs $16,400
Tax at 15% $2,460.00
Profit after closing costs and taxes $13,940.00

A novice might think the profits are roughly equal to the stock transaction and stocks held less risk and effort. When we consider the ROI percentage, though, we see there is really no comparison:

Bottom line profit $13,940.00
Initial investment $52,500.00
Return on investment 26.55%

In terms of real estate ROI, a realistic real-world scenario beats even an overly-optimistic stock ROI hands down.

Other Considerations in Real Estate Versus Stocks Investing

When comparing standard ETF or mutual fund investing, a successful real estate transaction will likely be more lucrative. There are other variables to consider when determining if real estate is the place you should be investing. We’ll discuss the non-ROI factors in an upcoming post, but they center on your drive, risk tolerance and financial situation.

For now, we’ll content ourselves with the knowledge that real estate investing produces greater ROI than typical stock market investing.

Have a property to sell, or are you looking to acquire investment properties? Call us at (214) 643-8755 for a cash offer or help finding that perfect investment

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