Wanted to see what everyone's take is on borrowing for real estate investing versus stock investing.
I get that when you buy real estate the payment is essentially not affected by the price movement of the property, while the stock appreciate can be more volatile. Is that essentially the crux of the argument. I know we've been on a successful market run so looking back it seems like an easy answer, but I wanted to see if anyone has used leverage in this way, did it work out or not?
Note: I know leverage gets a lot of big investors/funds, mainly that was the whole thing with Long Term Capital management.
Note 2: Numbers wise, if you borrow $500k, buy a place that rents for $4k a month, or $48k a year, that's a 9.6% return. Stocks you could argue average 10%, so you'd get $50k plus dividend of ~$6, but its much more risky.
Based on the most helpful WSO content, the key distinction between borrowing for real estate versus stocks lies in the nature of leverage and risk management:
Leverage in Real Estate: Real estate inherently allows for higher leverage with relatively lower risk due to the tangible nature of the asset. For example, you can put down 20-30% equity and finance the rest through a mortgage. This means your returns on equity can be amplified significantly (e.g., 5x leverage with 20% down). Additionally, real estate loans are considered more secure by lenders because they are backed by physical assets, which serve as collateral. This makes borrowing for real estate more accessible and less volatile compared to margin accounts in stock investing.
Leverage in Stocks: While you can use margin accounts to leverage stock investments, the risk is substantially higher. Stock prices are more volatile, and margin calls can force you to sell at a loss if the market moves against you. Unlike real estate, where payments are fixed and not directly tied to property value fluctuations, stock leverage is directly impacted by price movements, making it riskier.
Cash Flow and Returns: Real estate investments often provide steady cash flow through rental income, which can help cover loan payments and generate returns even if property values remain stagnant. In your example, a $500k property generating $48k in annual rent offers a 9.6% gross return, which is comparable to stock market returns but with the added benefit of tangible asset security and potential tax advantages (e.g., mortgage interest deductions). Stocks, while potentially offering higher returns (e.g., 10% plus dividends), come with greater volatility and no guaranteed cash flow.
Risk and Diversification: Real estate is less liquid and has higher transaction costs, but it provides diversification and stability in a portfolio. Stocks, on the other hand, are more liquid but subject to market swings, making them riskier when leveraged.
In summary, borrowing for real estate is generally seen as a safer and more structured way to use leverage due to the stability of the asset and the ability to generate cash flow. However, both strategies have their pros and cons, and the choice depends on your risk tolerance, investment goals, and market conditions.
Sources: Why invest in real estate rather than the stock market?, https://www.wallstreetoasis.com/forum/real-estate/investment-in-rental-property-should-you-leverage-if-you-have-ability-to-100?customgpt=1, Why do you love Real Estate?, Let's Talk About the Pros and Cons of our Gigs in RE Finance, Leveraged Buy Outs in RE?
You should be thinking about return on equity invested in real estate. So if you buy a $500k property, you’re likely investing $100k. Then if you rent it out for $4k/mo, you have to assume a margin (say 60%) then also account for mortgage payments. The other considerations for rental real estate is property appreciation over time, and the numerous tax benefits
And also that you’re building equity with your mortgage payments. It’s essentially an LBO that you’re able to do for your personal investments. A big consideration is that real estate investing takes much much more effort than dumping into S&P, so make sure you factor that in
True. I'm not recommending or even considering borrowing to invest in the S&P. My thinking is just, if you borrowed to invest in the S&P, wouldn't you technically also be building equity and could you also create a system to sell off shares as they appreciate to make the loan payments?
Yes, low leverage will generally outperform no leverage on public equities. Rates are higher though, at least for retail, and it may not be tax efficient.
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