Indexing versus real estate for low income investors

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
Topic Author
TM90
Posts: 131
Joined: Mon Mar 06, 2017 2:13 am

Indexing versus real estate for low income investors

Post by TM90 » Wed Feb 12, 2020 11:24 am

Basically I was wondering if it isn't better for people with lower incomes to take advantage of the leverage in real estate to invest and to grow more quickly as opposed to just saving a small amount each month and investing it in index funds?

Am I missing something?

MotoTrojan
Posts: 8224
Joined: Wed Feb 01, 2017 8:39 pm

Re: Indexing versus real estate for low income investors

Post by MotoTrojan » Wed Feb 12, 2020 11:29 am

One is a job and one isn’t. Also low income implies low number of rental properties so uncompensated risk is higher.

medic
Posts: 86
Joined: Thu Jul 18, 2019 11:30 am

Re: Indexing versus real estate for low income investors

Post by medic » Wed Feb 12, 2020 12:00 pm

MotoTrojan wrote:
Wed Feb 12, 2020 11:29 am
One is a job and one isn’t. Also low income implies low number of rental properties so uncompensated risk is higher.
There are lots of paths to real estate investing. Only a few of which actually involve purchasing and operating a property yourself. REITs are a prime example that are passive options with low investment and higher diversification, but also crowdfunded real estate. With higher incomes you have additional options off of the open market. That's not counting things like lien purchases or similar higher risk strategies.

To the OP, indexing (assuming something like TSM) and RE are two different beasts with different risk profiles and investment horizons. Lot of people make six figure net worths without ever trending in real estate. Assuming equal risk profiles, because of the leverage RE would be the better option mathematically, but leverage works both ways and with low income you have a lower tolerance for volatility and asset concentration and potentially a higher need for liquidity. Even with a higher than average income and net worth, RE is still only a small fraction of our overall asset allocation and we've chosen to do it without purchasing and managing property directly (besides our own home which we don't count in our net worth)

Before investing in your taxable accounts, are you taking advantage of your other tax free accounts - HSA, 401k, IRAs, etc? I see many lower income peers get enamored by the potential for RE and miss the fact that they're sitting on advantaged positions. Many miss the generous company match we have at work, but even without this, they're paying 15-20% in income taxes that they then invest in taxable accounts to face a continued tax drag when those same assets could be allocated elsewhere. If you're already maxing these other tax free accounts, then I'd say RE can be part of your overall portfolio (an AND, not an OR). Also, I'd reconsider calling yourself "lower income" since socking away $30K+ in savings a year is well above what most are able to do.

MotoTrojan
Posts: 8224
Joined: Wed Feb 01, 2017 8:39 pm

Re: Indexing versus real estate for low income investors

Post by MotoTrojan » Wed Feb 12, 2020 12:03 pm

medic wrote:
Wed Feb 12, 2020 12:00 pm
MotoTrojan wrote:
Wed Feb 12, 2020 11:29 am
One is a job and one isn’t. Also low income implies low number of rental properties so uncompensated risk is higher.
There are lots of paths to real estate investing. Only a few of which actually involve purchasing and operating a property yourself. REITs are a prime example that are passive options with low investment and higher diversification, but also crowdfunded real estate. With higher incomes you have additional options off of the open market. That's not counting things like lien purchases or similar higher risk strategies.

To the OP, indexing (assuming something like TSM) and RE are two different beasts with different risk profiles and investment horizons. Lot of people make six figure net worths without ever trending in real estate. Assuming equal risk profiles, because of the leverage RE would be the better option mathematically, but leverage works both ways and with low income you have a lower tolerance for volatility and asset concentration and potentially a higher need for liquidity. Even with a higher than average income and net worth, RE is still only a small fraction of our overall asset allocation and we've chosen to do it without purchasing and managing property directly (besides our own home which we don't count in our net worth)

Before investing in your taxable accounts, are you taking advantage of your other tax free accounts - HSA, 401k, IRAs, etc? I see many lower income peers get enamored by the potential for RE and miss the fact that they're sitting on advantaged positions. Many miss the generous company match we have at work, but even without this, they're paying 15-20% in income taxes that they then invest in taxable accounts to face a continued tax drag when those same assets could be allocated elsewhere. If you're already maxing these other tax free accounts, then I'd say RE can be part of your overall portfolio (an AND, not an OR). Also, I'd reconsider calling yourself "lower income" since socking away $30K+ in savings a year is well above what most are able to do.
OP framed it as all or nothing. Going 100% in REITs is a bold move. Holy volatility.

User avatar
Sandtrap
Posts: 9130
Joined: Sat Nov 26, 2016 6:32 pm
Location: Hawaii No Ka Oi , N. Arizona

Re: Indexing versus real estate for low income investors

Post by Sandtrap » Wed Feb 12, 2020 12:09 pm

TM90 wrote:
Wed Feb 12, 2020 11:24 am
Basically I was wondering if it isn't better for people with lower incomes to take advantage of the leverage in real estate to invest and to grow more quickly as opposed to just saving a small amount each month and investing it in index funds?

Am I missing something?
Considerations:
1. Low income and/or low money to invest + leveraging to buy income property + repeat and get rich with minimal effort and risk. . . = sells lot's of books and seminars (Rich Man Poor Man) = high potential for bigger debt (can't borrow out of debt) = myth that those with wealth have used this strategy to amass great wealth.

2. The first step is to maximize income, reduce debt, increase savings, invest slowly in index funds after maximizing contributions to employment retirement funds, and personal emergency funds and cash backups.

3. When you are no longer low income and have little invest, and now have higher income streams from great employment, and have a lot saved to invest, then take a portion of that and only a portion of that, and invest in your very first real estate rental unit with a down payment and a mortgage.

Are you missing something?
Perhaps a lot, but learning is a first step to wealth.

j :happy
Wiki Bogleheads Wiki: Everything You Need to Know

Topic Author
TM90
Posts: 131
Joined: Mon Mar 06, 2017 2:13 am

Re: Indexing versus real estate for low income investors

Post by TM90 » Wed Feb 12, 2020 12:17 pm

Hi all thanks for all your replies I'm not from the US so I don't have these tax advantaged accounts!

I'm now investing 6000 per year and saving a bit more. But I realize the concentration risk is higher but just mathematically speaking;

Purchase 100 000
Reno and expenses: 20 000
Mortgage: 90 000

Own input: 30 000
Montly rent: 700
Income per month after costs: 350

Income/ year; 4200

ROI: 4200/20 000*100 = 21%

This is without the equity side.. (price of property going up after reno)

Indexinvesting:long term average return 7%

I mean mathematically the numbers can't be so different can they? There's no free lunch right?

adamthesmythe
Posts: 3186
Joined: Mon Sep 22, 2014 4:47 pm

Re: Indexing versus real estate for low income investors

Post by adamthesmythe » Wed Feb 12, 2020 1:42 pm

If you have spare time and skills to do part or all of the renovations you have a real advantage. It would be, as noted, another job, maybe another job and a half. Higher-income people may not have the time, desire, or hands-on ability to do the work.

The risks of no diversification remain and it may be difficult to borrow the money.

ncbill
Posts: 663
Joined: Sun Jul 06, 2008 4:03 pm
Location: Western NC

Re: Indexing versus real estate for low income investors

Post by ncbill » Wed Feb 12, 2020 8:08 pm

adamthesmythe wrote:
Wed Feb 12, 2020 1:42 pm
If you have spare time and skills to do part or all of the renovations you have a real advantage. It would be, as noted, another job, maybe another job and a half. Higher-income people may not have the time, desire, or hands-on ability to do the work.

The risks of no diversification remain and it may be difficult to borrow the money.
Yep, one of the more successful residential RE investors I've read online had a local government job, so he was free nights/weekends to buy, demo, renovate multiplexes...after ~20 years of that he's retired in his early 50s with a modest pension & rental income...the time to start on that path is in your 20s or 30s given the amount of "sweat equity" required.

bhough
Posts: 85
Joined: Wed Feb 15, 2017 6:53 pm

Re: Indexing versus real estate for low income investors

Post by bhough » Wed Feb 12, 2020 8:19 pm

Dear OP,

Your math is wrong. Your denominator should be $30,000. Also, you didn't account for a sink fund for repairs. You didn't account for vacancies, you didn't account for property management (if you are doing it yourself, this is work and you should be paid for it--more importantly, if you find you hate property management and want someone else to do it, you should find out how much they charge--it's alot), you didn't account for utilities when the tenants move out and don't pay.

I recommend you go to a site called bigger pockets. However, they may be overly optimistic. What you should really do is pay an accountant to spend 60 minutes with you speaking about the numbers and what their other clients who own real estate typically get in return. That may cost you $100 for 60 minutes, but it will save you thousands of dollars.

After you know those numbers (no disrespect, but you don't know the numbers), then you can make an educated risk about buying a property.

Good luck,
b

User avatar
Sandtrap
Posts: 9130
Joined: Sat Nov 26, 2016 6:32 pm
Location: Hawaii No Ka Oi , N. Arizona

Re: Indexing versus real estate for low income investors

Post by Sandtrap » Wed Feb 12, 2020 10:43 pm

TM90 wrote:
Wed Feb 12, 2020 12:17 pm
Hi all thanks for all your replies I'm not from the US so I don't have these tax advantaged accounts!

I'm now investing 6000 per year and saving a bit more. But I realize the concentration risk is higher but just mathematically speaking;

Purchase 100 000
Reno and expenses: 20 000
Mortgage: 90 000

Own input: 30 000
Montly rent: 700
Income per month after costs: 350

Income/ year; 4200

ROI: 4200/20 000*100 = 21%

This is without the equity side.. (price of property going up after reno)

Indexinvesting:long term average return 7%

I mean mathematically the numbers can't be so different can they? There's no free lunch right?
Purchase 100k
Mortgage 90k
So you put 10 down payment?
So monthly mortgage payment is about $350 ??

You are going to renovate after purchase and spend $20k
There is no rental income when you are renovating. True?

The monthly expenses are mortgage at about $350, then you have property insurance, etc. You also pay a % tax, fed/state on rental income. Are there monthly HOA fees? Other fees? Business fees? So, likely your true monthly net income is what?

You expect to collect rent at $700/mo. Correct.

Less the monthly expenses, costs, taxes, = net 2-300/month ????

Are you calculating your ROI correctly?
Your CAP rate correctly?

Can you afford to continue to pay mortgage and expenses if the unit is vacant for 4 months?

How are you calculating the average annual appreciation rate in that area based on the rise in curb value of similar units, comps?

Are you self managing, renting, and repairing this rental unit yourself? Live in the area?

If the water heater breaks down, you will have to replace it at your expense as the landlord. Water heaters cost from 4-5-800 depending on type, elec, gas, etc. Do you have financial resources to do this?

j :happy
Wiki Bogleheads Wiki: Everything You Need to Know

Nappyloxs
Posts: 13
Joined: Tue Feb 28, 2017 1:06 am

Re: Indexing versus real estate for low income investors

Post by Nappyloxs » Wed Feb 12, 2020 11:14 pm

ROI seems wrong. You would be putting in $30k, so it would be 14%. Plus, there is vacancy rate, insurance, property taxes, and income taxes. So even if you made $4,200 depending on taxes and depreciation it is actually less. As others mentioned, biggerpockets is a great website for real estate investing.

If you have $30k to spend, there might be better places to put the money. Pay down debt, renovate your own home, or put in an index. Under your scenario, you don’t break even for about 8 years excluding future expenses, taxes, etc. $30k invested at 7% compound over those 8 years is about $51.5k.

msk
Posts: 1470
Joined: Mon Aug 15, 2016 10:40 am

Re: Indexing versus real estate for low income investors

Post by msk » Wed Feb 12, 2020 11:30 pm

For RE you have to be right on location, in space and time. Almost any location has had or will have its time. I am sure that investors are raking in millions right now in war torn areas, Kabul, Idlib, Tripoli, etc. You make a lot of money in the locations that people are loathe to invest in. Perhaps in your own city it's possible to make far higher returns as a slum landlord than in a posh area of town. Nobody can point out where, in time and space, you ought to invest today. Looking at "safe" locations, in space and time, leads to returns that are usually lower than diversified ETFs. Why? because everyone thinks it's easy to make money in RE and I am always amazed at how many people feel that investing in a stocks portfolio is too complex. See how many people waste 1 to 2% of their portfolios annually by paying professional advisors, yet the same people feel that any idiot can make millions in RE. So there is too much money chasing RE in "safe" areas. Choose your location, in space and time, correctly and you will flourish.

Uncorrelated
Posts: 434
Joined: Sun Oct 13, 2019 3:16 pm

Re: Indexing versus real estate for low income investors

Post by Uncorrelated » Thu Feb 13, 2020 4:11 am

TM90 wrote:
Wed Feb 12, 2020 12:17 pm
Hi all thanks for all your replies I'm not from the US so I don't have these tax advantaged accounts!

I'm now investing 6000 per year and saving a bit more. But I realize the concentration risk is higher but just mathematically speaking;

Purchase 100 000
Reno and expenses: 20 000
Mortgage: 90 000

Own input: 30 000
Montly rent: 700
Income per month after costs: 350

Income/ year; 4200

ROI: 4200/20 000*100 = 21%

This is without the equity side.. (price of property going up after reno)

Indexinvesting:long term average return 7%

I mean mathematically the numbers can't be so different can they? There's no free lunch right?
I'm not sure if you have calculated the ROI correctly. But aside from that, this investment is incomparable to the stock market for 2 reasons: 1 it's a job, 2 a single leveraged properties is far riskier than an index fund composed of 5000 different companies.

It think it's a better idea to compare a single property investment with 5x leveraged stock market futures. That might have somewhat comparable risk...

User avatar
AerialWombat
Posts: 1208
Joined: Tue May 29, 2018 1:07 pm

Re: Indexing versus real estate for low income investors

Post by AerialWombat » Thu Feb 13, 2020 5:14 am

TM90 wrote:
Wed Feb 12, 2020 11:24 am
Basically I was wondering if it isn't better for people with lower incomes to take advantage of the leverage in real estate to invest and to grow more quickly as opposed to just saving a small amount each month and investing it in index funds?

Am I missing something?
I’d say that what you’re missing is the fact that you’re asking this question on a forum that is fairly anti-real estate and pro-indexing. Ask the exact same question on BiggerPockets, and you will get very different types of responses than here. :shock:

But, from me as a real estate investor that used to be incredibly low income, the short answer is “yes”, with many caveats. Pay particular attention to the long list of questions that Sandtrap posted up above.

IowaFarmBoy
Posts: 744
Joined: Fri Jan 22, 2010 8:19 am

Re: Indexing versus real estate for low income investors

Post by IowaFarmBoy » Thu Feb 13, 2020 5:45 am

I'm kind of repeating what Sandtrap said but there is significant risk in real estate. Depending on what your definition of "low income" is, you may not have the income to cover the unexpected expenses and problems that will inevitably crop up. Also, financing generally requires some amount of down payment which may be hard to pull together.

User avatar
danielc
Posts: 1053
Joined: Sun Dec 10, 2017 4:48 am
Location: Iowa, USA
Contact:

Re: Indexing versus real estate for low income investors

Post by danielc » Thu Feb 13, 2020 11:54 am

TM90 wrote:
Wed Feb 12, 2020 11:24 am
Basically I was wondering if it isn't better for people with lower incomes to take advantage of the leverage in real estate to invest and to grow more quickly as opposed to just saving a small amount each month and investing it in index funds?

Am I missing something?
If leverage magically made real estate a superior investment, then everyone would do that. Real estate investment, with its leverage, does not have a higher expected return than an index fund. In fact, I would argue that real estate is much riskier because it is a non-diversified investment. I think that a low income investor would be better off with a low cost index fund.

User avatar
AerialWombat
Posts: 1208
Joined: Tue May 29, 2018 1:07 pm

Re: Indexing versus real estate for low income investors

Post by AerialWombat » Thu Feb 13, 2020 12:24 pm

danielc wrote:
Thu Feb 13, 2020 11:54 am
If leverage magically made real estate a superior investment, then everyone would do that. Real estate investment, with its leverage, does not have a higher expected return than an index fund. In fact, I would argue that real estate is much riskier because it is a non-diversified investment. I think that a low income investor would be better off with a low cost index fund.
Sorry, but you are incorrect: Leveraged real estate has significantly higher expected return than index funds. I wouldn’t buy the property otherwise, I would just stick the cash in index funds!

I expect (and get) a 30%+ return on equity on my properties. Expected return in index funds is less than 1/3 that.

The problem with this entire conversation is that we are not comparing two investments that are even remotely similar. Instead of deciding between a cat and a dog, we’re deciding between a cat and a dump truck. Real estate is a business, a job, there is nothing passive about it (I’ve already put 8 hours into managing my property manager this week).

It also has the risk profile of a small business, because it is one. But because of that risk, it delivers a much higher return.

User avatar
abuss368
Posts: 18125
Joined: Mon Aug 03, 2009 2:33 pm
Location: Where the water is warm, the drinks are cold, and I don't know the names of the players!
Contact:

Re: Indexing versus real estate for low income investors

Post by abuss368 » Thu Feb 13, 2020 12:29 pm

TM90 wrote:
Wed Feb 12, 2020 11:24 am
Basically I was wondering if it isn't better for people with lower incomes to take advantage of the leverage in real estate to invest and to grow more quickly as opposed to just saving a small amount each month and investing it in index funds?

Am I missing something?
No chance. Why would someone with low income take on the high cost and undiversified risk of owning a second home? They will not have the means or cash flow to address issues that will arise.

I would recommend low cost index funds and if they would like additional real estate exposure than consider Vanguard US REIT index and Vanguard International REIT index.
John C. Bogle - Two Fund Portfolio: Total Stock & Total Bond. "Simplicity is the master key to financial success." || Buy Total Stock until it hurts. Then find a way to buy even more!

User avatar
abuss368
Posts: 18125
Joined: Mon Aug 03, 2009 2:33 pm
Location: Where the water is warm, the drinks are cold, and I don't know the names of the players!
Contact:

Re: Indexing versus real estate for low income investors

Post by abuss368 » Thu Feb 13, 2020 12:34 pm

Sandtrap wrote:
Wed Feb 12, 2020 12:09 pm

1. Low income and/or low money to invest + leveraging to buy income property + repeat and get rich with minimal effort and risk. . . = sells lot's of books and seminars (Rich Man Poor Man) = high potential for bigger debt (can't borrow out of debt) = myth that those with wealth have used this strategy to amass great wealth.
When typing my response I actually had a couple of info commercials come to mind regarding this.

Carlton Sheets, Dean Graziosi, Robert Allen, Rich Dad Poor Dad, etc.
John C. Bogle - Two Fund Portfolio: Total Stock & Total Bond. "Simplicity is the master key to financial success." || Buy Total Stock until it hurts. Then find a way to buy even more!

User avatar
danielc
Posts: 1053
Joined: Sun Dec 10, 2017 4:48 am
Location: Iowa, USA
Contact:

Re: Indexing versus real estate for low income investors

Post by danielc » Thu Feb 13, 2020 12:39 pm

AerialWombat wrote:
Thu Feb 13, 2020 12:24 pm
danielc wrote:
Thu Feb 13, 2020 11:54 am
If leverage magically made real estate a superior investment, then everyone would do that. Real estate investment, with its leverage, does not have a higher expected return than an index fund. In fact, I would argue that real estate is much riskier because it is a non-diversified investment. I think that a low income investor would be better off with a low cost index fund.
Sorry, but you are incorrect: Leveraged real estate has significantly higher expected return than index funds. I wouldn’t buy the property otherwise, I would just stick the cash in index funds!

I expect (and get) a 30%+ return on equity on my properties. Expected return in index funds is less than 1/3 that.
With a 30% return, you would turn an initial $200K investment into $141M in 25 years. Is that what you expect?

Real estate cannot possibly have that kind of return. I don't want to speculate on what part of your math is wrong, but if real estate had 30% return, you would be able to buy shares in a company that invested in real estate (maybe an REIT, maybe not) and get an absurd return.

rascott
Posts: 1433
Joined: Wed Apr 15, 2015 10:53 am

Re: Indexing versus real estate for low income investors

Post by rascott » Thu Feb 13, 2020 12:57 pm

danielc wrote:
Thu Feb 13, 2020 12:39 pm
AerialWombat wrote:
Thu Feb 13, 2020 12:24 pm
danielc wrote:
Thu Feb 13, 2020 11:54 am
If leverage magically made real estate a superior investment, then everyone would do that. Real estate investment, with its leverage, does not have a higher expected return than an index fund. In fact, I would argue that real estate is much riskier because it is a non-diversified investment. I think that a low income investor would be better off with a low cost index fund.
Sorry, but you are incorrect: Leveraged real estate has significantly higher expected return than index funds. I wouldn’t buy the property otherwise, I would just stick the cash in index funds!

I expect (and get) a 30%+ return on equity on my properties. Expected return in index funds is less than 1/3 that.
With a 30% return, you would turn an initial $200K investment into $141M in 25 years. Is that what you expect?

Real estate cannot possibly have that kind of return. I don't want to speculate on what part of your math is wrong, but if real estate had 30% return, you would be able to buy shares in a company that invested in real estate (maybe an REIT, maybe not) and get an absurd return.

The return on one deal may well be that... or more.... but doing it on a compounding basis is impossible. These kinds of deals usually involve buying some sort of distressed property and then improving.... both time consuming and difficult to find.

cheezit
Posts: 275
Joined: Sat Jul 14, 2018 7:28 pm

Re: Indexing versus real estate for low income investors

Post by cheezit » Thu Feb 13, 2020 1:52 pm

Who is going to be on the other side of this transaction and why? I can understand renting in a market where it's cheaper than buying or at least close, or in a market where property values are so sky high that it takes years for someone at the local median income to save up for a down payment, but I cannot understand paying a 100% premium (before taxes and the insurance differential are accounted for) for the 'privilege' of having to deal with a landlord in an area where the price of purchasing a home is so reasonable.

Post Reply