You may be wondering whether it’s better to invest in real estate or the stock market.
It’s a valid question. We all have limited dollars (some more than others) and need to decide what to do with those dollars.
The debate between investing in real estate or stocks is a good one. There’s no doubt that both asset classes can provide significant long-term growth.
There are also advantages and disadvantages to both types of investments. Advocates on either side of the debate can be very passionate about their preferred asset class.
I personally invest in both asset classes. I have 10 rental apartments in Chicago and a rental ski condo in Colorado. In addition, I invest in the stock market primarily through index funds.
Both asset classes play a key role in my journey to financial freedom. From my perspective, you don’t have to choose one asset class over the other. You can invest in real estate and own stocks.
We’ve spent a lot of time in the blog already talking about the significant long-term upside of investing in the stock market. If you need a refresher, check out my post on investing early and often to benefit from the magic of compound interest.
Today, I want to discuss one of the main reasons to invest in real estate. The reason comes down to a simple term:
Cash flow.
When investing in real estate, cash flow is the money left over each month after paying all your bills.
There’s an old saying, “Cash is king.”
For me, “Cash flow is king.”
My goal is to use real estate to accelerate my journey to financial freedom. To that end, I invest in real estate primarily for the cash flow.
Let’s dive in.
Stocks and real estate will each provide incredible long-term benefit.
Both stocks and real estate can provide significant long-term upside. Besides that upside, I invest in real estate for the immediate benefits of cash flow.
In terms of your Budget After Thinking, your Later Money is for future expenses. Your Now Money and Life Money are considered immediate life expenses.
Let’s talk about the Later Money category for just a moment. We can hopefully agree that both the stock market and real estate investments can generate incredible long-term wealth.
The S&P 500 has historically provided an average annual return of 10%. While not guaranteed to continue in the future, 10% average annual returns represents a powerful wealth generator.
With real estate, the long-term prospects can be harder to sum up with one simple number. There are a lot of variables at play, not least of which are the type of real estate and the geographic market.
For example, I primarily invest in small multi-family properties in Chicago. According to Redfin, residential home prices in Chicago were up 9.1% compared to last year.
Certain neighborhoods in Chicago have fared even better. In the neighborhood I invest in, prices are up 11.1% since last year.
Those are nice short-term trends.
On the other hand, in the past 25 years, home prices in Chicago have only doubled, which actually lags the national average. That’s not so nice.
By the way, you can find data like this for most markets across the country so you can do your own homework on your market.
So, what’s the takeaway?
For me, it’s quite simple:
If you hold real estate for long enough (think decades, not years), it will go up in value.
Given enough time, like the stock market, real estate always goes up.
How much your real estate will increase in value is hard to predict.
My expected long-term returns in Chicago are different from somebody who invests in condos in San Francisco. Likewise, my Chicago rentals are different from my Colorado rental ski condo.
I don’t expect my Chicago properties to increase in value at a rate of 10% over the long-term. I certainly hope the value of my properties beat the historical average in Chicago, but I’m not expecting that either.
The point is, whatever happens long-term, I’m OK with it. The reason I invest in Chicago rental properties is not really about the long-term upside.
It’s about the cash flow.
For me, cash flow is king.
Cash flow is king because it can cover present day expenses.
To be truly financially free, you need to cover immediate life expenses at the same time you are saving for future life expenses.
My definition of being financially free means not being dependent on the income from a primary job to cover your life expenses.
My goal is to be truly financially free. That means I need money to pay for my life now, not just decades from now.
We just talked about how the stock market and real estate can both help with the future life expenses.
For me, the primary benefit of investing in real estate is to help with those present day, immediate expenses.
In terms of your Budget After Thinking, that means helping with your Now Money and Life Money.
This is where cash flow comes in.
I can use the cash flow from my rental properties to help cover my present day expenses. By having cash flow available in this way, I have accelerated my journey to financial freedom.
In fact, I’ve been hard-pressed to find any other asset class that provides as many benefits in the here-and-now, while also providing benefits in the future.
Let’s explore that point next.
I prefer cash flow from real estate over stock dividends for my current expenses.
Don’t get me wrong, you can certainly reach financial freedom by investing in the stock market. As we just talked about, the stock market provides significant long-term upside.
Plus, you can certainly cover your current expenses with dividends from your stock investments.
However, I think cash flow from real estate is a better option.
Here’s why.
In order to fund your current life with your stock investments, you either need to withdraw some of your earnings or even sell some of your stocks.
When your stock portfolio is growing, you can leave your principle untouched and live off of the earnings. That’s pretty nice.
But, what happens when the market drops? You still have bills to pay and a life to fund. To cover those expenses, you may need to sell some of your stock assets.
Selling assets is not a great way to sustain long-term wealth.
With real estate, you can live off of the cash flow without having to sell the asset.
While your property may go through periods where it decreases in value, if you keep it long-term, the asset will increase in value. During that time frame, you can use the cash flow to fund your life.
Let’s explore this concept a bit further with an example using the popular 4% Rule.
What’s better for monthly expenses: cash flow from real estate or dividends from stocks?
Let’s say you just received a windfall of $250,000. Pretend it’s a bonus from work or an inheritance from a distant relative.
Your goal is to achieve financial freedom as soon as possible so you are not dependent on your W-2 job.
You are considering two investment options.
Option 1: You invest the $250,000 into a total stock market index fund, such as Vanguard’s popular offering (VTSAX).
You’ve done your homework and know that based on the 4% Rule, you can safely withdraw 4% of your money in the first year and then 4% plus an adjustment for inflation in subsequent years. If you do so, your money should last 30 years.
That means you can safely withdraw $10,000 in the first year year, and a bit more each year after that. For simplicity, let’s just look at the first year when you can safely withdraw $833.33 per month ($10,000 / 12 months = $833.33).
Remember, your goal is to leave your primary job. With this investment, you can assume you’ll have $833.33 per month available to cover your monthly expenses. Not too bad.
One important note: the 4% rule contemplates that your original investment should fund your lifestyle for 30 years. Importantly, there’s a chance your portfolio may be completely depleted after 30 years.
There’s also a chance your portfolio may be worth more in 30 years than when you started withdrawing.
Your results in large part depend on the percentage of stocks you own in your portfolio. If you are interested, you can read more about the 4% Rule and successful withdrawal rates here.
One of keys to remember is that while the market does not always go up every year, you will still be making withdrawals every year.
There may be a year where the market drops by 5% on top of the withdrawals you made that year. When that happens, your account balance drops. If you are not flexible in your withdrawal rate, this could lead to problems.
True, when the market goes up, your account balance goes up. The 4% Rule attempts to factors in these up-and-down cycles over a 30 year period.
However, when you are making constant withdrawals over a long enough period, there’s a chance that your account balance will eventually drop to zero.
Keep this in mind as we consider our next option.
Option 2: You use the $250,000 for a down payment on a rental property valued at $1 million.
We will soon learn how to evaluate rental properties. Countless books have been written on the broad topic, and it’s beyond the scope of this post.
Humor me for now since this is only a hypothetical scenario.
Without getting into specifics, I am willing to bet that any decent real estate investor could generate more than $833.33 per month from a $1 million property.
Personally, if I had $250,000 to invest in Chicago, I would not settle for anything less than $2,000 per month in cash flow. And, that would be the bare minimum for me to even tour a property.
With an initial investment of $250,000, my focus would be on finding a rental property with at least $3,000 in monthly cash flow.
For now, you’ll just have to trust that cash flow like that is possible with rental properties. I’ll soon show you how to do the analysis and manage your properties to target returns like this.
To recap, with the same $250,000 investment, you should be able to earn more monthly cash flow in real estate than dividends from stocks.
It gets even better.
If you hold your property long-term, your monthly cash flow should increase over time. Over those 30 years, inflation will naturally cause your rental income to increase.
At the same time, if you have a fixed rate mortgage for 30 years, that major expense stays constant. The difference between your increased rental income and constant mortgage payment results in more cash flow.
So, if you are hoping to sustain financial freedom without a primary job, which investment gets you closer to covering your monthly expenses?
Investing in real estate offers so much more than just cash flow.
Don’t stop reading yet.
On top of the monthly cash flow, real estate provides so much more.
Here’s a sneak peak continuing our prior example:
After 30 years, you will own an asset without any debt. In our example, even without any appreciation, you would own a $1 million property debt-free. And, that debt was paid off entirely by your tenants.
Add in appreciation, another major reason to invest in real estate, and your property will likely be worth $2-$3 million debt-free after 30 years.
Compare that to the example with stocks using the 4% Rule. After 30 years of depleting your investment account, your investments may be gone.
To put a bow on this point:
With stocks, you can earn $833 in monthly dividends and possibly have no money left after 30 years.
With real estate, you should reasonably earn $2,000-$3,000 per month (improving over time), and after 30 years will own an asset worth $2 million-$3 million, debt free.
When you look at it this way, the choice is really not that hard, is it?
On your journey to financial freedom, are you convinced that cash flow is king?
I’m not saying it’s bad to invest in stocks or you should only invest in real estate. I personally invest in stocks and real estate.
I see a place for both asset classes in my future.
If you haven’t previously considered investing in real estate, maybe you’ll now think about how that monthly cash flow can fit into your overall investment portfolio.
If you’re striving for financial freedom, are you convinced that rental property cash flow can accelerate your journey?
Let us know in the comments below.
