If that's the question that keeps you up at night, welcome to the club. Many
investors are wondering where to park their cash. And with the stock market in
the dumps and real estate going gangbusters, who hasn't wondered if becoming the
next Donald Trump is where it's at?
Nationally, housing prices are up 6.4 percent as of August, but in some
places they've soared more than 20 percent in the past 12 months, the National Association of Realtors
reports. Why not bag the bears and bulls, purchase a tax-friendly rental
property and watch your investment grow? After all, you reason, it'll continue
to appreciate while producing a steady income stream.
Trouble is, it's not that simple. Housing prices do fall from time to time
and there's already word of a housing bubble
that's likely to pop.
So, let's say you've got an extra $100,000 or just came into a $50,000
inheritance. Do you plow it into real estate or put your faith in Wall Street?
The quick answer: There isn't one. Yes, real estate can pay off big time - as
can stocks. But both can plummet in value. And while real estate may provide
steady rental income, it's a non-liquid asset so you can't sell it in a pinch.
Variables aside, however, there is some math to crunch. So pull out that
calculator and let's take a look.
First, consider the two ways you can potentially make money on rental
property. That'd be rental income and/or a fat payout if you sell the place at a
If you've got a monster mortgage and high expenses, rent may not cover your
overall costs, even though they're deductible. By the way, don't forget some of
those costs could include a professional caretaker to deal with tenants if
you're not the kind of person who wants to put a lot of effort into property
Once you figure the costs, you've got to determine if your rent will leave
you in the red or the black. In general, if you want to break even your rental
income should equal 10 percent of the property's value.
So, let's say you take that $50,000 and use it as a 20 percent down
payment on a $250,000 rental home – can you make at least $25,000 in rent a
year? Check out ads for rental units in your area to see if your projection
These days, while the housing market remains hot, you may have trouble
renting at all. If someone can buy as cheaply as renting, they'll often buy.
That means landlords have to lower prices to attract tenants. In fact, they're
already doing so. While rents have risen about 3.5 percent nationally in the
past decade, this year they're down an average of 2 percent. And in some
markets, like San Jose, San Francisco and Austin, rents have dropped 12 percent
to 25 percent in the past year, according to NAR.
"We're looking at a very strong housing market so more renters are becoming
homeowners," said NAR economist Sigrid Fennemore. In fact, rents should drop
nationally by another 1 percent next year, she predicts, as massive layoffs take
As it turns out, it doesn't take much to beat the Street. Consider your
$250,000 rental property.
- If it climbs 6 percent in value the first year - the historic average annual
gain on housing nationwide - you'd be sitting on an asset worth $265,000. You
would have made 30 percent on your $50,000 downpayment.
"That's the effect of leveraging," said Gerald Weiss, a certified financial
planner in Dublin, CA, who notes the value of your entire investment goes up,
rather than just the value of the downpayment you contributed.
Now let's try a similar equation using stock investments.
- Assume you plunk that $50,000 into an S&P 500 index fund that returns a
conservative (though difficult to achieve lately) 8 percent. That's a $4,000
- Not bad. But in order to make the same amount on your rental property, it
would have had to appreciate far less – by just 1.6 percent. (To do the math,
divide $4,000 by $250,000 and you'll get 1.6 percent.)
So, is real estate a slam dunk? NO.
Experts like Schatsky and Weiss say they advise clients to have 5 percent to 10
percent of their portfolios in real estate – including Real Estate Investment
REITS have earned more than 30 percent since 2000 - plus they've delivered 7
percent dividends. Best, to make this money you never have to deal with a