Ready for a financial face-off? When it comes to investing, few groups are as divided as real estate enthusiasts and stock market investors. It’s like comparing the North and South of financial planning. So, which investment gives you better returns in the long run? Let’s figure it out by crunching the numbers MyMoneyDesign-style.
In a previous post, I explored the idea of buying a vacant house in my neighborhood to rent out for extra income. While this seems like a solid plan, many argue it’s too risky. Instead, why not invest the money meant for a down payment and closing costs into a stock market Index Fund? This way, you only have to worry about market performance.
To determine which is better, we need to set some assumptions, build models for each scenario, and project the financial outcomes over 30 years.
First, here’s a quick recap from my post on buying a rental house:
– Sale Price: $79,900
– Down Payment (20%): $15,980
– Closing Costs: $2,000
– Loan Amount: $63,920
– Interest Rate: 4.00%
– Monthly Mortgage Payments (including taxes): $519
Initially, you’d be in debt. To climb out, rental income is crucial. Suppose you rent the house for $800 monthly and use this to cover the $519 mortgage, you’d make a monthly profit of $281, totaling an annual profit of $3,372.
On the other side, if you took the $15,980 down payment and $2,000 closing costs to buy an S&P 500 Index Fund, your balance sheet would look like this:
– ASSETS: $17,980
– LIABILITIES: None
– EQUITY: $17,980
Fast forward 30 years with the following assumptions:
– The house was rented out every month for 30 years.
– Both the house value and rental income increased by 3% annually due to inflation.
– No other costs incurred.
Based on these assumptions, the balance sheet for the rental property would be:
– ASSETS: House value: $193,938, Rental Income: $163,749
– LIABILITIES: None (mortgage paid off)
– EQUITY: $357,687
How about the Index Fund? Assuming an 8% annual return:
– ASSETS: $180,927
– LIABILITIES: None
– EQUITY: $180,927
Comparing $357,687 versus $180,927, rental income seems to win!
Of course, assumptions can be questioned – like home repairs or vacancy periods. To be fair, we can look at two key points:
1) If home values only increase by 3% per year, the house’s value would still be more than the Index Fund: $193,938 vs. $180,927.
2) If rental income is lost, calculating the break-even point shows that you could afford to spend your entire rental profit on repairs and still come out ahead.
However, it’s important to consider all assumptions carefully before deciding.
Why not combine the best of both worlds? Use rental income to invest in an Index Fund or another property. This way, you benefit from both real estate and stock investments.
If you want to check my numbers or explore different scenarios, feel free to use my spreadsheet.
