Reasons Why Real Estate (Rental Properties) Will Always Beat Stock Market Returns Part 2

Reasons Why Real Estate (Rental Properties) Will Always Beat Stock Market Returns Part 2

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Part 2 (Part 1 can be found here): In this post, we will take a look into the typical returns between traditional stocks and rental properties. The numbers used for this analysis will be industry acceptable values. Your returns, and expenses will vary.   We will also assume the rental property is leveraged as most real estate investor utilize leverage for their investments. The example below is based on a $20,000 investment utilizing historic returns of the S&P 500 compared to a $100,000 dollar rental property purchased with $20,000 dollars down payment and an $80,000 loan.  We will compare taxes of both investments based on a single filer making less than $90,750. State taxes are excluded as they vary with some states having no income taxes.

The median return of the S&P 500 since 1970 is 12.6%. 3.4% of the total returns comes in the form of dividends. Currently, the tax rate for both long term gains (the investment is considered long term gains if held for longer than 12 months) and dividends is 15% for single filers making less than $90,750.

Stock Investment Calculation

$20,000 investment x 12.6% (median S&P returns) = $2520 gains

Taxes – $2520 x 15% = $378

After tax gains = $2142 or 10.7 percent.

Rental calculation parameters:

Yearly Rent = 12% of property value ($100,000) = $12,000

Property Appreciation = 3% of property value ($100,000) = $3,000

Maintenance – 1% of property value ($100,000) = $1,000

Property taxes – 1% of property value ($100,000) = $1,000

Insurance – .5% of property value ($100,000) = $500

Interest – 4% of loan note ($80,000) = $3200

Loan principle – 1.25% of note ($80,000) = $1000

Property depreciation – The IRS allow the building value (not including property value) to be depreciated over 27 1/3 years and this amount is deducted from our taxable income. It is important to note, when selling a property you will be subject to a 25% recapture tax (in another post we will discuss ways to avoid this recapture tax). In our example we will assume the building value is $80,000. $80,000 divided by 27.333 = $2,926 yearly depreciation.

Rental Property Calculation

Total rents $12,000 minus costs (property taxes, maintenance, interest and insurance) $5,700 = $6,300 returns – $2,926 depreciation = $3374 total taxable income.

These returns are subject to ordinary income taxes rates. FICA taxes are not included in this calculation as most investors aren’t considered a real estate professional per IRS guidelines. Individuals who work more than 15 hours per week can qualify as a real estate profession, which changes taxes and tax deductions. We will discuss the advantages and disadvantages of a real estate professional in another post. The tax rate for single fliers making less than 490,750 is 25%.

Taxable income $3374 x 25% = $843 total taxes paid

Total Investment Gains

After tax gains = $5,457

Property appreciation gains – $3,000 -$450 (capital gain taxes) = $2550.

Principle reduction = $1,000

Total gains = $9,007 or a 45 percent gain on our original $20,000.

While this calculation was only hypothetical, it is intended to indicate how the use of smart leverage and tax advantages of rental properties can provide a substantial, low risk return.
Standard Lease Agreement


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