Whats A Better Investment: Rental Property or Traditional Investments?
Clients ask all the time is my rental property a better or worse investment than my traditional investments (stocks, bonds, ETF’s, mutual funds). ? While this is not necessarily an apples to apples comparison we can break down the two investments to get a pretty good analysis.
Let’s start with the easy one, traditional investments. Lets say you put $100,000 into securities, you can easily calculate your growth on an annual and since inception basis. If it grows to $110,000 after year one you’ve earned 10%, if its at $200,000 5 years later you’ve earned an annual return of 20%. If you want to get more detailed you can reduce that return by the amount you’ve paid in taxes on the investment income and recognized gains.
The rental property is a little more difficult. First is it truly a rental or is it mixed use? Lets assume for now its purely a rental property. To calculate the return you have to look at cash flow. There is generally an initial investment (down payment, renovation, etc.) and then annual cash outflows (expenses) and annual inflows (rent). Annually or cumulatively you take the initial investment add or subtract the net annual cash flow including unrealized increase or decrease in value of the property and you can calculate your return. So if your original investment was $100,000 and year 1 your net cash flow was a $5,000 loss and your unrealized equity in the home increased $10,000 then you would divide $10,000/$105,000 which gives you a return of 9.52%. For mixed use you would need to value your personal use. Generally you would take what you would receive for a period of time in rental income and assume you would pay that amount to rent something similar. You would then add that value to your cash inflows for the year. You could also calculate the return without assigning any value to your personal use.
These are general statements and may not apply to your individual situation. You should always consult your CPA, Investment Advisor or other professional to see how this relates to you.