Investing in Real Estate

Hello everyone, I previously wrote about renting versus owning property. Now, I want to talk about different options for investing in real estate. What I’m comparing below is investing in a REIT (Real Estate Investment Trust) to an investment property in Fremont, CA. So let’s dive right into a hypothetical example, I have 70K to invest.

Option 1: Put 70K in a REIT.

Option 2: Put 70K down payment towards a 690K house in Fremont, CA.

Let’s compare both options with a conservative 3% annual growth in real estate over a 10 year period. Historically over the past 30 years it has been >5% on average.

Income generated with Option 1:

VGSLX, a Vanguard REIT, pays approximately 4.5% annual dividends. Let’s see the 10 year income generated with an increasing dividend of 3% annually because of the fund’s value increasing.

Year 1 dividends paid: $3150

Year 2 dividends paid: $3245

Year 3 dividends paid: $3342

Year 4 dividends paid: $3442

Year 5 dividends paid: $3545

Year 6 dividends paid: $3652

Year 7 dividends paid: $3761

Year 8 dividends paid: $3874

Year 9 dividends paid: $3990

Year 10 dividends paid: $4110

Appreciation of asset after 10 years with the 3% growth we assumed: 70,000 * 1.03 ^ 10 = $94,000 — $70,000 = $24,000.

Cost for Vanguard to manage the REIT:

0.12% annually, will be leaving this out as I’m not including home closing costs for option 2, you will notice how negligible these costs are once you see the final numbers.

Total profit for 10 years with Option 1: Dividends paid + appreciation = $60,000 or a handsome 6.5% on a 70K investment over 10 years.

Income generated with Option 2:

For a 3 bed, 2.5 bath property in Fremont, CA, one can expect ~$3,200/mo in rental income, at let’s say 91.7% occupancy rate (11 out of 12 months rented out), putting it at ~$2,950/mo income.

Costs for Option 2:

Using this mortgage calculator with 3% interest over 30 years, total monthly payment will be ~$3,700/mo which includes principle, interest, taxes, PMI (PMI is needed only until loan amount > 80% of home cost, then this cost of ~$300/mo can be deducted. In this example, it can be removed after ~5 years or 68K more of principle paid off, so prorating the monthly cost to $150/mo over 10 years). This brings the cost down to $3,550. The principle can also be removed from this as it is being put into the asset, but is indeed a monthly burden, but that is not what I care about for now, only true incurred costs. The cost is down to ~ $2,250/mo. This property and similar properties have HOA of ~$200/mo, and let’s throw in an extra $100/mo for other maintenance that is not included. The total cost is up to $2,550/mo. Let’s throw in the cost of a property management company to not have to deal with tenants, standard costs in the bay area are ~8% of the rental income, or ~$250/mo, getting the cost up to ~$2,800/mo. Let’s include a one-time closing cost payment of 7.5K that I’ll subtract at the end.

Putting the numbers together with 3% appreciation and annual rent increase:

Year 1 profit: (2950–2800) * 12 = $1800

Year 2 profit: (3038–2800) * 12 = $2856

Year 3 profit: (3129–2800) * 12 = $3948

Year 4 profit: (3223–2800) * 12 = $5076

Year 5 profit: (3320 -2800) * 12 = $6240

Year 6 profit: (3420–2800) * 12 = $7440

Year 7 profit: (3522–2800) * 12 = $8664

Year 8 profit: (3628–2800) * 12 = $9936

Year 9 profit: (3737–2800) * 12 = $11,244

Year 10 profit: (3850–2800) * 12 = $12,600

Because property management fees will also go up 3% with the rent increase, let’s total how much extra cost that’ll be: 250 * 1.03 ^10 is $335/mo increase of $250/mo by the 10th year. Total will be <=$600/yr on average for the entire 10 years, or $7,200 which I will subtract in my total calculation.

Property appreciation: 690,000 * 1.03 ^ 10 = 927,300–690,000 = $237,300

Total profit over 10 years for Option 2: rental profit+ appreciation — costs of increasing property management fee — costs of one time closing cost= $292,500 profit or or an average of a whopping 11.5% annual return on a 70K initial investment and $1300/mo towards the principle every month over 10 years.

Conclusion:

It seems like purely based on the numbers, an investment property is better (6.5% versus 11.5%), but it’s not for everyone, in fact, it’s for very few people. The risk is far greater on an investment property: What happens if the economy goes down? What happens if renters don’t want to rent it? What happens if bay area specifically doesn’t do well? What happens if I can’t afford the payments? In fact, most people can not afford the monthly burden ON TOP of their existing expenses. Selling a property also introduces some fees and headaches.

However, if monthly burden is not an issue, and you want to hold on to this investment for the long run, an investment property is the better investment. The better real estate does, the better the investment property does compared to the REIT. Even if real estate grows as much as inflation (1–2% on average), it is still a better investment than an REIT. The only situation in which the REIT does better is if real estate doesn’t grow as much as inflation (less than 1–2% annually), which is historically unlikely. The key is that you get the benefit of a 690K asset while only putting 70K as down payment, while the rent income takes care of the interest and other expenses.

All that being said, I want to hear what other people have to say, please comment below or message me privately!