[ad_1] Whether you choose real estate or index funds as your primary investment, each has an outstanding track record of building wealth. But is one better than the other, if maybe only by a little bit? This topic was inspired by this question from a reader: “My question: Real estate or long-term index fund investing? I know the answer is probably both, but I’ve been a person who invests in stocks (mainly ETFs and index funds). However, on my social feed, I’m getting more and more people pushing rental real estate investing as a better way to wealth than stocks. I do have a rental because it was my previous primary home before becoming a rental. So, while I know rentals, I worry that I’d make a mistake buying a property for more than it’s worth, having a prolonged period of no renters, or a large capital expenditure that might occur later down the road. But so many people are into it that I feel like I’m left out. I’m grinding right now and think I’ll have $45k to put towards a rental at the end of the year so that’s why I am thinking about a rental. But if my numbers are right and I can get the market to return 9%, then yes, in 30 years when I plan to retire, that $45k becomes $597,000. I guess you can argue that if you buy a home, it could appreciate to $400k and cash flow a significant amount of money. Any insight?” – Patrick This is an age-old question, and maybe it has no one answer. As a spoiler alert, I think the answer will be different for each investor. Let’s try to break down the reasons why this is such a tough choice. But before we do, I want to let you know I’m not a heavily experienced real estate investor. My answers are based on my own limited experience, and I’ll be coming at the topic from a financial angle. Why Invest in Real Estate? Real estate has proven to be one of the biggest wealth generators in history. It is estimated that up to 90% of millionaires obtain their wealth primarily by investing in real estate. What makes real estate such a special investment? 1. Long-term capital appreciation The median price of a home in 1970 was around $23,000. But by the end of 2021, that figure has risen to $408,000. That’s an incredible 1,770% increase in 50 years. Few investments can match that performance. 2. Rental income Properly structured, real estate investment can generate regular income, in addition to long-term capital appreciation. While the income may only cover the monthly payment of the property after purchase, returns will become increasingly positive as rents increase. And once the mortgage on the property has been paid, most of the rental income will be profit to the owner. 3. Generous tax breaks At least with investment property, depreciation expense can be claimed to reduce any tax liability. The benefit of depreciation is that it’s a “paper expense”—you can use it to lower your income, even though there is no out-of-pocket cost involved. But there may be an even bigger tax break when you sell the property. Investments for more than one year get the benefit of lower long-term capital gains tax rates. For example, while ordinary income and short-term capital gains are taxed at rates ranging between 10% and 37%, long-term capital gains tax rates are limited to between 0% and 20%. 4. Leverage Real estate is one investment where a small investor can make a big play with a small amount of money. You can purchase an investment property with 20% down and finance the rest from the bank. With an owner-occupied property, the down payment may be no more than 3%. Because of the high level of leverage, the long-term returns on real estate will be even higher than would be the case if you paid the full price in cash for the property. 5. Real estate is a tangible asset Some investors prefer holding physical assets to paper and electronic investments, like stocks and bonds. Real estate is the ultimate tangible asset because it represents ownership of land itself. 6. It can be directly managed When you invest in an index fund, or even in stocks and bonds, you’re turning control of your money over to the fund manager or company management. But when you invest in individual property, you control the entire process. The Risks of Investing in Real Estate Money and Real estate. 3D rendered illustration. Despite the easy and painless path the get-rich-quick-in-real-estate crowd claims it to be, real estate has real risks—and they’re not minor. Here are some examples: Overpaying for a property. This is more likely during hot markets, when multiple offers boost the property values. But if you buy-in at or near the top of the market, you may not recover your investment for a long time. This is made worse by leverage. Since most of the funds used to purchase real estate are borrowed, and that creates a fixed obligation, what’s really at stake is your equity. A 10% reduction in property values could cut a 20% investment in half. Unexpected structural problems. Even if a property passes a home inspection with flying colors, it can still have structural problems. Two or three years after the purchase, the furnace could meltdown, the roof may need replacing, or you can learn the property has substantial termite damage. Rising interest rates. These affect all investments, including stocks. Rising rates have a bigger impact on real estate because of the leverage factor. If rates rise significantly, your property value may go flat or even decline. A deteriorating rental market. This can happen because the major employer in the area closes down a large facility, or because a huge new apartment complex goes up nearby. Either situation can cause tenants to become scarce, forcing you to lower your rent. Legal problems. Because
