Editor’s Note: Dennis Fassett is a former corporate finance executive turned real estate investing “Cash Flow Mercenary.” Dennis specializes in single-family and multi-family cash flow properties and thoroughly enjoys assisting his fellow investors with their own strategies, including how to buy your first apartment building.
As an ongoing contributor to Mogul’s “Market News Updates,” Mr. Fassett provides us with his own unique, lively, and thought-provoking commentary on the timely industry news and events of today that are impacting our industry. And be sure to check out his other super-helpful Market News Updates. For now, enjoy...
From Dennis Fassett, Cash Flow Mercenary...
As I’ve written in this space multiple times, I’m primarily a buy and hold investor. I started buying rentals back in 2004 when the automotive company I worked for starting tanking due to the crash of the industry.
Over time, with the volatility in the stock market, I eventually stopped contributing to a 401k completely and started plowing my cash into rentals. Was that a good decision? Time will tell.
I was completely out of the market when it crashed in 2007 and hit bottom in 2008, which I really liked when all of my friends and neighbors were borderline suicidal, but then I also missed the run-up that we’ve seen over the past few years that erased the massive market losses and tacked on some significant gains.
So at present, my “retirement planning” consists of managing my rental portfolio and selectively buying more properties.
Do I have any regrets? Zero actually.
I sleep really well at night no matter what the stock market does. Am I recommending that you do the same? Not necessarily. Rentals aren’t for everyone, and there are several factors to consider before deciding to forego your mutual funds.
I saw a piece in Money Magazine the other day that presented a pretty good analysis as to why owning rentals could be better than being in the stock market in the long run… and because we’ve seen some weakness in the stock market of late, I thought it made sense to write about it.
Before I get to what the article stated, I want to talk about the two biggest reasons that I like real estate over stocks.
Volatility
In my mind, the #1 reason for choosing rentals over stocks is volatility. Over the past eight years, we’ve seen unprecedented up-and-down swings in the stock market. This can be a killer as you get closer to retirement, because as we’ve seen, it can take years to recover.
During the dot com crash, the NASDAQ collapsed more than 50%, and the DOW collapsed a bit less. It took roughly seven full years to recover. And from the depths of the 50% stock market crash in 2008, it took about five years to get back.
With rentals, it’s different. Sure, the properties I owned sustained temporary brutal declines in value. But so what? I don’t plan on selling any of them, I had fixed rate mortgages on all of them, rents pretty much remained stable, and they continued to throw off cash flow.
So for me, the recession was a non-event with respect to my retirement planning. And in fact, it was actually an extremely favorable development, because it allowed me to add to my portfolio and buy some spectacular rentals in previously unaffordable areas at obscenely low prices.
Control
The second reason that I made this choice is control. With rentals, I control my own destiny. The properties perform in proportion to the work that I put in or that my property manager puts in.
With the stock market, it’s obviously different. Sure you have a choice in what you invest in, but owning stocks gives you absolutely zero control over their value. You’re at the mercy of management, and there’s no way to influence them.
Plus, it’s highly unlikely that the value of a rental property will go to zero. Ask the folks that had the bulk of their retirement in Lehman Brothers stock if they feel the same about stocks.
But before you make the jump, there are several factors to analyze so you have a comfort level with that decision. Here are the factors the article stated…
Risk versus expected returns
Whether putting cash into the market or purchasing real estate, you need to assess the risk versus the expected returns.
Traditional equity investments are much easier to analyze in this way. You have historical data… and although past performance is not indicative of future results, you have a bit more control over how much risk you're exposed to when deciding what amount to invest, the asset allocation and so on.
The risks when buying real estate can be much harder to quantify.
While there is data available, such as comparable home prices in the area and average rents, unpredictable changes in the market can be costly. When investing in the equity market, your risk of loss is limited to your initial investment. This isn't the case with real estate – you could wind up owing the bank more than the value of your property if the market experiences a downturn, or even due to changes that negatively impact a neighborhood.
Required capital
Virtually anyone can invest in traditional equity assets. Some shares can be very inexpensive and you can often determine the volume, as well. The same cannot be said for real estate…
To purchase a property, you need to either come up with a down payment yourself, or enlist partners to invest with you. Typically, you need to put down 20% for a traditional mortgage, and although various programs can help you to put down a smaller percentage, there are fewer options for investment properties.
Furthermore, real estate requires additional capital to maintain the property, often not at the owner's behest. With stocks, you can make a one-time investment or purchase additional shares later, at your discretion.
Taxes
Another aspect to consider when deciding to invest in real estate or the stock market is taxes.
If you own property, you will be required to pay property taxes every quarter, based on the assessed value as determined by the city or country. This is included in your mortgage payment.
There are certain tax benefits unique to owning real estate as a landlord, however. The interest expense on your mortgage is tax deductible, along with operating expenses, property taxes, insurance and depreciation. Exactly how much you can deduct will likely depend on the rental income. In most situations, under the passive activity loss rules, you cannot write off deductions that are more than the rental income, which would generate a loss.
Working with a CPA can be very helpful, particularly when investment properties or multiple residences are involved.
Stocks have tax consequences as well; first, you are required to pay a capital gains tax on any profits you made from selling stock. Furthermore, even without a sale, you are also required to pay a tax on any dividends you receive.
Inflation
Real estate can be a potential hedge against inflation as historically, rental rates and home prices rise with inflation. This provides a potential inflation hedge for both your rental income and sale of the property. Since your mortgage payments will not increase with inflation, it offers a benefit over time.
Traditional equity investments are not as directly linked to inflationary measures. Although prices do tend to rise over time, the market cannot offer the same potential inflation protection as real estate.
So there are some very attractive benefits for choosing rental real estate over stocks. Are rentals right for you? Only you can decide. But in my view, it’s time to stop thinking about rentals as strictly a real estate investing strategy and start thinking about them as a retirement strategy.
Care to share?
How do you feel about rentals over the stock market and as a retirement strategy? Share with is in the comments section below.