Ultimate Guide To Calculate Stock Market vs. Real Estate Returns
Understand what to consider and calculate when comparing the stock market and real estate investments. Follow along with the Real Estate vs. Stock Market ROI calculator.
Introduction: Understanding how to compare Stock Market vs Real Estate Returns
Investing in the stock market or real estate is a complex decision. As much as tons of articles talk about it, only some calculators can guide your 10-year return on investment (ROI) by diving deep into the different financial factors.
While comparing historical returns is expected, that single % figure does not give a realistic picture of your actual ROI for real estate. For stocks, it’s straightforward because you can buy, hold, and not have any recurring expenses. However, with property investments, you must consider your down payment, upfront fees, leverage (or the loan), mortgage, and monthly cash flow.
In this ultimate guide, you can understand what to consider when analyzing the two options, compare the pros and cons, and see the results of a scenario I ran in the live calculator.
And to make it even better — you can use the openly available calculator to create personalized plans and then send copies of the business case results to yourself. That way, you’ll have a copy to review with your financial advisor or accountant, whom you should consult before making any significant decisions.
Theory is good, but numbers matter. Let’s dive in.
Table of Contents
- How to Compare Stock vs Real Estate Returns
- Using the Stock Market vs Real Estate Investment Investment Calculator
- Understanding the Results of the Stock vs Real Estate Calculator
- 16 Exhaustive Pros and Cons of Investing in Stocks vs Real Estate
- Stocks vs Real Estate — Making a Decision
1. How to Compare Stock vs Real Estate Returns
Do not use historical returns in isolation
Here is an example to illustrate. The S&P 500 group of stocks returned about 10% over the last 50 years, and the Real Estate housing market returned 3% — 5%, depending on which Canadian or US city you are targeting. At a glance, you might say you should invest in stocks instead of real estate; however, those returns would not indicate your actual return on investment (ROI) over the next ten years. Follow along to find out why.
Let’s assume you have $100k to invest in either option.
For the stock market — the 10% return is not far off because you can buy an exchange-traded fund (ETF) that mimics the S&P 500 for a meagre cost and with meager management fees through your brokerage. So your $100k returns about 10% per year, or slightly under $10k, net of fees. In short, you invested $100k, and made $10k, therefore your ROI is 10% ($10k/100k).
For real estate — the 5% return is inaccurate. This is because of leverage.
- You use $100k as a down payment as leverage to secure a loan of $400k, which means you can buy a $500k investment property ($100k + 400k).
- When the $500k property grows 5% annually, that gain is $25k.
- To measure your ROI, you must compare it to the amount you invested out of pocket, which was $100k.
- In short, you invested $100k and made $25k; therefore, your ROI is 25% ($25k / $100k)
- The real estate scenario is simplified to get the point across. Historical returns on the total property value serve as only one data point when calculating investment returns.
Factors you need to consider
Stock market investments are straightforward when following the buy-and-hold mantra for an S&P 500 broad stock market index. You usually have minimal fees from your brokerage when purchasing the stock ETF. Afterwards, the only other factors are the annual return and the annual management fees, also known as the MER or Management Expense Ratio.
Real estate investments are much more complicated and have many factors at play. You must consider the following criteria to help you make the best possible financial decision.
- Down payment amount
- Mortgage interest rates
- Mortgage insurance
- Legal and regulatory fees
- Realtor fees
- Land transfer taxes (local, state, provincial, etc.)
- Property taxes
- Rental rates
- Maintenance fees
- Repairs
- Occupancy rate (will your unit be rented 100% of the time?)
- Utilities (does the landlord pay or the tenant?)
- Insurance
Lucky for you, the Real Estate vs Stocks financial calculator includes all of these factors to help you get a complete picture of your impacts and minimize future surprises.
Death and Taxes
As the saying goes, these are the two things in life you can’t avoid. For this guide, I’m only addressing the dreaded taxes.
Selling the investments and taxes are not factored in. There are a variety of treatments to minimize taxes on an annual basis or at the point of sale. Those situations are personal and need professional accounting help.
It is worth noting that many value-driven investment gurus and pundits recommend buying any asset intending to hold it indefinitely. And find ways to leverage that asset to pull out additional investment funds without selling the underlying asset.
2. Using the Stock Market vs Real Estate Investment Calculator
First: Pick a budget and search for property listings
For this example, let’s assume you have $100k ready to invest. Your options are
- Invest $100k in an S&P 500 stock ETF, or
- Use the $100k for a down payment in an investment property, allowing you to secure a $400k loan and buy a $500k property.
You need to be aware that there are other upfront real estate expenses beyond the down payment, which are also covered below.
So, with a $500k budget, you search for properties around $500k in Toronto, Ontario, Canada, which happens to be one of the hottest markets in North America at the time of writing. I found a 1 Bed, 1 Bath, 1 Garage unit for $500k at Yonge and Finch. It is north of the downtown core but directly on the subway line with healthy rental demand. You will need to gather the financial details for this 500–600 square foot unit.
- List price: $500k
- Down Payment: $100k
- Land Transfer taxes: $12,950 (Toronto has both a City and Provincial land transfer tax (yikes!), I used this calculator to create an estimate.)
- Legal and Regulatory fees: $3000
- Home Inspection: $0 (I’ll skip this since it’s a condo, but I would verify all of the building certificates and their financial standing)
- Rental Rate estimate: $2,450
- Property taxes: $1561
- Condo Maintenance fees: $458
- Utilities: $0 (In this case, the tenant will register all their utilities in their name)
- Property Management fees: $0 (If you can manage the condo on our own.)
- Fee to Find a Tenant: $0 (If you can post through social media such as Facebook marketplace, and show the listing yourself.)
- Insurance: $0 (I will be covered for major structural issues under the building insurance. However, I will ensure my tenant has content insurance.)
- Mortgage Rate: 4.5% (assuming this is the average rate over the next ten years, it’s always good to err on the higher end of the range. Check out RateHub for some estimates).
- Real Estate Appreciation Estimate: 4% annually
Regarding the Stock ETF inputs — the S&P 500 ETF information is already entered in the calculator. You can adjust the return and expenses for any other ETF you prefer.
Second: Plug in the information into the Stocks vs Real Estate Calculator
Head to the Business Case Guy calculator to start plugging in all the information you’ve captured. Some assumptions for Real Estate and Stocks are inputted. You can change anything in the Yellow Cells and see your live updates. Below is an example of the ‘ Enter Info Here ‘ section.
For the stock ETF investment amount, you’ll see below that the total amount is $116k instead of matching the $100k for the property down payment. Comparing equally requires that all upfront real-estate spending is included in the stock investment.
Third: Review Your Stocks vs Real Estate Calculator Results
Please continue to the next section so we can jump into the numbers.
3. Understanding the Results of the Stock vs Real Estate Calculator
The Business Case Summary
This information is available on the Business Case Summary tab. It will show you how your equity will change from year 1 to year 10. Here are the four cost and benefit areas outlined.
- Down Payment
- Transaction Fees and Expenses
- Operations Cash Flow: If positive, then
- Appreciation & Principal
In this specific case, based on all the inputs entered, you will be ~$100k ahead with real estate at Year 10.
The Cash Flow Summary
You will have negative cash flow for the first few years, meaning you will have to pay out of pocket to cover some expenses. However, your cash flow position will improve over time as rental rates increase and you contain your expenses. By Year 10, your cumulative cash flow can turn positive, $8k in this scenario.
The Return on Investment or ROI
When it comes down to the annualized %, you can see Real Estate is ~5 percentage points higher than Stocks, based on this scenario.
- Real Estate Investment Annualized ROI: 15.3%
- S&P 500 Stock ETF Annualized ROI: 10.4%
The Break Even Analysis (Monthly cash flow = $0)
If negative cash flow is a big concern, these numbers will help you understand how much has to change to break even on your first year's monthly and annual cash flow. Based on all the data entered you can see below that there are two ways to break even if all other expenses remain the same.
- Reduce your offer by $117k (from 500k down to $382k) or
- Increase your rent by $589 each month (from $2400 to $2989).
These are only guidelines; the market may not allow these price adjustments. However, you now have an understanding of which factors need to change. Compare a different area or city to see if the results are more favourable.
4. 16 Exhaustive Pros and Cons of Investing in Stocks vs Real Estate
In this scenario, you can see more upside to Real Estate. However, that doesn’t mean that is the right decision. You have to ask yourself, are the added investment gains worth the extra effort and risk involved with managing a property? Here are the pros and cons you must consider carefully before investing in real estate.
5. Stocks vs Real Estate — Making a Decision
Now that you’ve read this guide, you should be more knowledgeable and can decide whether to invest in the Stock Market vs Real Estate. This customizable business case guy calculator will increase your understanding when comparing real estate vs stocks.
If you pick stocks, the following steps are straightforward: open a stock account and buy an S&P 500 ETF. If you want to go down the path of real estate, then keep reading.
Six (6) Real Estate Investment Questions to Review with Your Advisor or Agent
- What are the total costs to purchase and close the real estate transaction?
- Will my rent revenue cover my expenses, or will I be out of pocket each month?
- To break even each month, what’s the maximum price I should pay, or how much rent will I need?
- What % can I estimate the property to appreciate over the next ten years?
- What will my equity position be by Year 10?
- Can I accept or mitigate the risk of these significant items not going as planned, such as a lower occupancy rate, bad tenants, lower rental rates, higher expenses, and major repairs?
When choosing between real estate and stocks, thorough research based on all available data plus your best estimates is vital. Evaluating and estimating upfront costs, recurring expenses, appreciation, and other important factors is essential to make an informed decision.
When reviewing with your financial advisor or agent, you can present this information and determine how well they understand the scenario. If they are a qualified professional, they will not shy away from diving into these details with you.
Seven (7) Steps to Make an Informed Real Estate Investment
- Learn the benefits, costs, pros and cons of real estate investing (Step 1 is complete if you have read this far already 👍).
- Know what you can afford upfront and monthly, including emergency funds.
- Identify properties of interest by searching through online listings. Using websites that let you see the sold price for sales and leases will improve the accuracy of your estimates.
- Use the business case guy calculator to compare each property. This article is based on a comparative calculator for stocks vs real estate. For a real estate investment-only calculator, click here)
- Present the results to your advisor or agent (and ask them to use the calculator).
- Once you identify a target property, work with your agent or lawyer to make an offer and close the sale. Good luck!
- Monitor your results by tracking your actual numbers against your plan. Continuously review and keep learning to prepare for your next real estate investment.
Disclaimer
This guide is for informational purposes only. It is not meant to decide for you. All figures are inputted based on your best estimate and can fluctuate based on the variety of risks outlined. Business Case Guy is not responsible for the outcomes, good or bad, of any decisions made using this guide. Please review all financial choices with your financial advisor, real estate agent, accountant, or any related, qualified professional.
Originally published at https://businesscaseguy.com on June 30, 2023.
