Who’s ready for a financial showdown? When it comes to investing, there’s a big divide between those who put their money in real estate and those who prefer stocks—like the North vs. South of financial planning.
So, which one has a better shot at making you more money over time? This might be a hot topic, but let’s settle it the MyMoneyDesign way—by crunching the numbers! Let’s see what we find out.
In a previous post, “How Much Money Would I Make If I Rented Out A House?”, I explored the idea of buying a vacant house in my neighborhood to generate rental income.
While that sounds like a solid plan, many would argue it’s too risky. Instead of gambling on real estate, why not take the down payment and closing costs and invest in a stock market Index Fund? Then, the only concern would be the market’s performance.
To figure out which option is better, we need to agree on some assumptions, build a model for each scenario, and see what the money looks like after 30 years.
For the rental house, here are the financial details:
– Sale Price: $79,900
– Down Payment (20%): $15,980
– Closing Costs: $2,000
– Loan Amount: $63,920
– Interest Rate for 30-Year Mortgage: 4.00%
– Monthly Principal and Interest Payments: $305.16
– Total Monthly Mortgage Payment (Including taxes, etc): $519
Initially, I’d be in debt. Here’s what the balance sheet might look like right off the bat:
– ASSETS: House Market Value: $79,900
– LIABILITIES: Total Mortgage Debt: -$109,859
– EQUITY: Net Equity: -$29,959
To get out of debt, rental income is necessary. If I rented the house for $800 per month and used the income to pay the $519 mortgage, the finances would look like this:
– Monthly Profit: $281
– Total Annual Profit: $3,372
If instead, I put the $15,980 down payment and $2,000 closing costs into an S&P 500 Index Fund, the balance sheet would start like this:
– ASSETS: Stock Fund Value: $17,980
– LIABILITIES: None
– EQUITY: Net Equity: $17,980
Now let’s jump 30 years into the future and assume:
– I managed to rent the house every month for the last 30 years
– House value and rental income increased with inflation at 3% per year
– No other costs were incurred (we’ll address this later)
With these assumptions, the balance sheet for the rental house would be:
– ASSETS: House Market Value: $193,938; Rental Income: $163,749
– LIABILITIES: Total Mortgage Debt: $0 (fully paid off)
– EQUITY: Net Equity: $357,687
What about the Index Fund? Assuming the stock market continues to deliver an average annualized return of 8%, the balance sheet would be:
– ASSETS: Stock Fund Value: $180,927
– LIABILITIES: None
– EQUITY: Net Equity: $180,927
Comparing $357,687 to $180,927, rental income clearly comes out ahead!
However, you might be thinking, “What about home repairs? What if I couldn’t always find renters? What if the home’s value didn’t increase?”
Fair questions! Let’s consider two fundamental points:
1. Even with a modest 3% increase in home value, the home would be worth more than the Index Fund: $193,938 > $180,927.
2. If we did lose money on rental income, we can determine a break-even point. By subtracting the future value of the Index Fund from the future home value, we get -$13,012. Over 30 years, this equates to -$22.33 per month (factoring in 3% inflation). So, even if you rented the house for $22 less than your mortgage payment, it would be the same as investing in the Index Fund.
Although these assumptions are optimistic, they highlight something valuable. Why not combine the best of both worlds? Use a rental house for income and then invest the profits in an Index Fund—or buy another rental property! This way, you benefit from both real estate and stocks.
If you want to check my numbers or try different scenarios, feel free to use my spreadsheet: Which Is Better – Rental Income or a Stock Market Index Fund.
Readers: Which one do you think is better? What have your “real” experiences been with either scenario?
1) Which is Better – Paying Off Your Mortgage or Investing the Money? – Part 1
2) Which Is Better – Paying Down Your Auto Loan or Mortgage?
3) Which is Better – Points or No Points on Your Mortgage?
