DCA purchase of SPY vs buying RE with mortgage

Period: Jul 2007 - Jul 2017

Buy $1 mil owner-occupied property in SV with 20% downpayment, mortgage rate 3.86%, property tax = $12k p.a., insurance = $2.2k p.a. Today house worth $1.52 mil, total cash outflow (ignore time value of money) = $792k.

Buy SPY using DCA approach, initial = $200k, each month = $4938, today’s worth = $1.52 mil, total cash outflow = $792k.

No difference?

Obviously not an Apple2Apple comparison, property case has an approx debt of $520k so the equity is only $1 mil at the end of 10 years. SPY case, the investor needs to pay rent to stay somewhere. So adjusting the SPY worth to $1 mil would lower monthly investment from $4938 to $2650, a saving of $2288 for paying rent :slight_smile: From experience, the owner-occupied property would be bigger and the renter is subjected to rising rent :cry: So better to buy the owner-occupied house even at the peak of the property cycle.

However, the picture is drastically different if instead of investing in SPY, you invest in AAPL. Today, rent for a $1.52 mil property is about $3900. Assume the ridiculous case of you paying $3938 rent for 10 years, worth of AAPL at the end of 10 years would be $2.1 mil :rofl: So rent at a ridiculously high rent and start investing in AAPL at the peak of the stock market is still worth it!

Instead of owner-occupied, the property is bought for rental, how would the picture be different?

The difference in capital gain between property and SPY is the outstanding mortgage of $520k which has to come from the total rent collected less expenses.

The average rent collected less expenses = 520k/120 = $4333 per month.
This is going to be tough. So better off investing in SPY than to buy a rental. Hands down buy AAPLs :joy:

Wait a minute, comparison may not be correct :stuck_out_tongue_closed_eyes:

Update:
Some iterations required. What we want is capital gain from rental = capital gain from investing in SPY.
The amount available for investing in SPY would not be $4938 but would be $4930 less rent plus expenses.
The minimum average rent less expenses is approximately $2500 :grin:, may be possible but so much trouble, better off investing in SPY.

After all the computation, the preferred approach is to buy owner-occupied and then DCA purchase into SPY.

Total 10 year return for SPY including dividend reinvestment is 96%. Your 200k would be worth almost 400k today.

Assume that your rental has a break even, you do not need to inject capital and you do not collect any net income, your 200k downpayment is worth the sum of 500k capital gain and the principal paydown.

Seems to me that your rental performed better. When assuming a break even rental, there should be no subsequent SPY DCA

[quote=“BAGB, post:5, topic:2757”]
Seems to me that your rental performed better. When assuming a break even rental
[/quote]A breakeven rental means able to collect more than $2500. So what is your point?
IMHO, is impossible to collect an average rent less expense of $4938 for a $1 mil property in SV.

$2500 rent for 1.5M house? What expense do you account?

You also pay a $1100-1700 principal each month in the last 10 years.

If you account for principal reduction, your rental should be close to be break even

Start of year 1 house worth $1 mil, rent $2600;
End of year 10 house worth $1.52 mil, rent $3900;
Average rent approximately $3250.
Expenses are accrued cost of PM (or your labor), maintenance & repairs, accrued replacement cost of carpet/ dishwasher/ dryer/ garbage disposal/ gas range oven/ microwave oven/ refrigerator/ trash compactor/ washing machine/ water heater/ roof/ HVAC/ curtains/ lighting/ flooring/ kitchen/ bathroom, accrued cost of painting, gardening, cost of vacancy, cleaning, …

[quote=“BAGB, post:7, topic:2757”]
You also pay a $1100-1700 principal each month in the last 10 years.

If you account for principal reduction, your rental should be close to be break even
[/quote]Huh? You don’t understand the computation?
Edit: From the context of your original post, you intended “break even rental" to mean $4938 of average rent less expenses.

I never buy a rental with negative cash flow. Yeah, my original “break even” means that rent = PITI, but principal reduction was not counted to be Uber conservative.

Your principal reduction grow expentially and it’s compounded at your mortgage rate. At year 30, almost all the mortgage payment is principal reduction.

If you buy a rental with break even on day 1, I believe that your net rent over 10 years is positive due to principal reduction and rent increase, it’s probably more than spy dividend now

Monthly cash flow is not the same as accrual accounting :slight_smile: Rental is a business, so you need to “save” for asset replacement.
After 30 years, you would definitely need to change all the expenses that I mentioned at least once, some would be 2-3 times. So what is your 30-year cashflow?

Expenses can vary a lot depending on property. For BA homes, the expense ratio tends to be low so principal reduction would usually more than offset the expenses.

I find that expenses are not a huge problem except the major renovation. If you buy a new home in Dublin, your expense would be very low. For low cost area such as Texas and Arizona, expense ratio is higher but there are more new houses for you to buy, no need to buy an old house there.

I don’t think expenses would change the big picture too much. RE usually beats stocks, but there is more time involvement

you guys can survive 30 years with all that mumble jumble? No way!
That’s not life at all. :laughing:

But, that’s your money. Enjoy it. :heart_eyes:

I can tell you that is not true. Many costs are not accounted for. I have read through all the cost considerations by all bloggers here and elsewhere, always ignore many costs. Although I provide a list of expenses, you still ignore them as if the house would be as new as it was 30 years ago without doing anything and can enjoy rent increases. Expecting tenants to pay for fixer-upper like a well maintained house. There is no vacancy between change of tenant nor during renovation/ rehabbing. Or to put it another way, you’re paid a wage of managing the rental. That is, a gain, if any, is not an outcome of investment.

From your comment, you don’t even understand how the computation is done. Those points you mentioned about principal reduction is already accounted for in the computation.

After 30 years, capital gain of the house before capital gain tax & selling cost
= (market price less purchase price inclusive of all costs not just price of house)

  • total rent collected
  • total mortgage interest paid
  • total landlord’s insurance + accrued UI paid
  • total cost of maintenance & repairs
  • total cost of asset replacement
  • total cost of remodeling
  • total cost of managing it (PM or your labor)
  • total income tax paid on rent, should be zero if managing properly

Compare above capital gain with the capital gain have you invested the downpayment + PITI (invest as they occurred ) + other expenses incurred (accrued UI, maintenance & repairs, asset replacement, PM, income tax… invest as they occurred) in SPY. Throw some estimates and check for yourself whether investing in RE rental is that good.

I had thrown some estimates, it is difficult to achieve average rent less accrued expenses of more than $2500.

I know how to calculate my return, though I may not know how you calculate your return. I do not think its a sin.

What’s included in your “accrued expense”? Does it include all th expenses including mortgage interest, property tax, maintenance, property management? I do not understand why you need $2500.

I don’t care about return expressed in percentage term.
For the rental vs investing in SPY comparison, wanted to know the amount of investment put into rental if invested in SPY would it get the same capital gain (absolute, not expressed some kind of %).

[quote=“hanera, post:13, topic:2757”]
Compare above capital gain with the capital gain have you invested the downpayment + PITI (invest as they occurred ) + other expenses incurred (accrued UI, maintenance & repairs, asset replacement, PM, income tax**… invest as they occurred) in SPY. Throw some estimates and check for yourself whether investing in RE rental is that good.
[/quote]If you asking this expenses. Expenses don’t include PITI.

If not, then,

[quote=“hanera, post:4, topic:2757”]
The difference in capital gain between property and SPY is the outstanding mortgage of $520k which has to come from the total rent collected less expenses.
[/quote]Expenses in this context also doesn’t include PITI.

Cashflow is not profit. In business, negative cash flow is a killer as it can lead to you borrowing at high interest or worse declare insolvency. Having positive for the year doesn’t imply you make money, you could be selling assets.

For P&L, need to use accrual account, not cash accounting.

When I buy a rental property, the only funds I put in is the down payment. Afterwards, rent income would pay for the Piti and all the maintenance etc. Therefore the DCA for SPY is not in the picture

If I buy a new house, there would be no other capital investment. If I buy an old house, I may spend some money to renovate before renting. The renovation cost will be added up to downplayment as initial investment, but practically a later cashout refi could extract all the initial investment.

I think some calculations underestimate the return from RE, especially the flexibility of cashout refi

Stocks can also do the same thing, after some appreciation, you can sell enough to extract the initial investment, leading to an infinite return… in my AAPL case, every year, dividends are more than my initial investment… double infinity! There are many tricks to enhance return or play dirty but is not the scenario under discussion. Just a basic discussion, not an advanced sophisticated discussion that talk about all kind of tax avoidance and return enhancement.

[quote=“BAGB, post:16, topic:2757”]
When I buy a rental property, the only funds I put in is the down payment. Afterwards, rent income would pay for the Piti and all the maintenance etc.
[/quote]The first statement is already incorrect. Other than down payment, you may need to pay for escrow fee, title insurance, title company title search, appraisal, home warranty, attorney fee, courier fee, credit report, home inspection, recording fees, survey fee, and so on. Usually need to set up the house to be presentable even if new, so cost of minor repairs, may be change/ wash curtain, general cleaning, gardening, water/ electricity bills during vacancy, re-keying of locks, change all the filters and batteries of detectors, cost of leasing (PM or your labor) and so on.

Rent income pays for PITI and maintenance, that is possible in Austin too (btw, in this thread I talking about SV as stated in OP just in case you start expanding the scope), but you have not accounted for future capex, is ok not to care about them in the short-term but if you are going to hold the rental for a long time, you’re almost certainly need to replace some asset such as washer/ dryer. Such future capex are not included in the cap rate and cash flow computation but should be included in the P&L computation and when comparing with other investment instruments.

Did a quick check, so far positive cashflow, had replaced 1 oven and dishwasher for 5 Austin properties during the course of rental, purchases during setup is charged under purchase price i.e. add to the purchase price.
I have reserved $200 per month for asset replacement (in business is called depreciation, ideally when time to replace the asset, accumulated deprecation should be enough to pay for it) of each rental.

Ideally, we want capital gain of rental to be higher than investing in S&P index fund, the difference is the reward of my labor and risk taking. So far, my computation indicates that I was not paid.

You are not paid for your South Bay rental, how about Austin? If neither pays you, you can focus on stocks.

My RE performs much better in BA. Arizona did not pay me, mainly due to low appreciation. It’s still possible for Arizona to jump when Calinfornia goes to the extreme

In my calculations, closing cost is negligible compared with home price and down payment. Maintenance and asset replacement cost is nearly negligible in BA, but it’s more significant for AZ

If you picked a different time period you will see different results. How about 2000 to 2010? Why 10 years anyway. 15 years from 2004 to 2017 will also see different results.

But sticking to 2007-2017, we were still in RE bubble in 2007. You may still be able to get NINJA loans or 0% down loans. Why not get those loans instead of 20% down? I posted an article a little while back showing most people don’t put down 20%.

One major advantage of real estate is the cheap leverage. I think people should maximize their leverage. 0% down loan is better than 10% and 10% is better than 20%. Unlike stock margins, nobody will call your loan if property value goes down. That difference is key.

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