[briandear]

Real estate underperforms index funds? Perhaps in capital appreciation, but in terms of cash on cash returns, nothing beats real estate. If you can turn a $50k downpayment into a $250k property netting $300 per month after mortgage/expenses, plus get capital appreciation on top of that — you’ll make far more money on that $50k than the same money invested in an index fund. Statements such as “indexes out-perform real estate” might be true for an owner-occupied residence, but it certainly isn’t true when the real estate is an actual cash-flowing investment and not your own residence. What people fail to grasp is that a $250k house doesn’t cost $250k in cash. It costs $50k in cash. While the bank owns the other $200k in value, that $50k gives you control of that asset and the cash flow that comes from it. If that $250k house goes up to $300k in value, then you just earned a 100% return on your cash plus the cash-flow revenue. Even if the house goes down in value, if you are still cash flow positive, you are still making money. A $300 net per month is $3600 per year which is a 7% return on your $50k cash, however on top of that 7%, you also get a “free” house since your tenant is paying the note and expenses. On top of that, you get depreciation, which in many cases can make that $3600 per year tax free when the depreciation exceeds the income from the rent.

Indexes outperforming real estate is a highly simplistic view and doesn’t accurately reflect cash on cash returns, tax advantages and cash flow. $50k in an index vs $50k as a down payment on a cash flow property— the property is going to make as much in cash as your entire capital appreciation for the index. For an index to be better, it’s going to have to both appreciate at a higher rate than the house as well as pay dividends equal to the annual net from the house.

Comparing indexes and real estate shouldn’t discount the value of leverage, nor should it discount the cash flow from the asset. (In the situation you are commenting on though, the author buying a residence, I don’t disagree; I am commenting on real estate as an asset class in general.)

[lotsofpulp]

$50k downpayment on real estate has a lot more risk and a lot more work than $50k in an index fund, hence the possible higher return. It's up to the investor to determine their risk profile and whether or not they want to invest time in buying and selling real estate, finding and dealing with good tenants, maintenance issues, liability issues, spending time figuring out tax incentives and/or spending money on accountants.

There is no guarantee that property values will go up, or even stay stable. Ask the people in NJ/CT/IL/KY and other non-booming places facing skyrocketing property taxes and stagnant home sale prices. Who knows, maybe an earthquake erases all those plump west coast gains tomorrow. The index fund investment is placing bets on economic activity as a whole, not picking winners and losers of real estate markets.

[jonbarker]

Also, I was speaking from a leverage standpoint. If someone is worth less than the value of a house, and finances most of it, then they have effectively put their personal balance sheet book value into negative territory, effectively making an ROE calculation very ugly in the near term. The scenario described above is just the effect of leverage, not the fact that said leverage is applied to real estate.

[jonbarker]

The annual net from the house you live in I guess is arguably the benefit of living in it. Hard to compare that with the dividends produced by an index. The dividends produced by the index can be used to pay rent, for example.