Investing in Real Estate vs. S&P 500 Index Funds

Real estate vs. S&P 500: both can be great investments. But here are pros and cons for each.

Reasons to invest in real estate over S&P 500 Index Funds

First, let’s look at ways real estate might beat index fund investing.

Use leverage to create better returns

Think about it this way. It’s much easier to obtain a low down payment loan on real estate, including investment property, than it is to invest in stocks.

For example, you can put $100,000 down on a $400,000 investment property with a steady income and a good credit score. Subsequently, your returns are based on $400,000, not just your down payment of $100,000.

Conversely, if you invest that same $100,000 in the stock market, you only receive returns on your initial investment. You must make a 100% down payment on stock investments, but only around 20-25% down payment on real estate.

With real estate, you automatically 4-5x your leverage. Leverage is not as easy to come by with stocks.

With real estate, you also have the opportunity to take advantage of a home equity loan, home equity line of credit, or a cash-out refinance. These are additional ways to leverage your investment.

Greater potential for cash-on-cash returns

Sticking with the example above, let’s assume that the property generates $500/month in cash flow after expenses. This works out to $6,000/year on a $100,000 cash investment, or six percent per year.

You may be able to achieve even greater cash-on-cash returns using a lower down payment loan. This is a conservative example.

On the flip side, investing in an S&P 500 index fund will result in 2-3% per year.

As a creative real estate investor, you can do much better than that.

Even with the basic example above, you see the potential for real estate to generate 2x to 3x more than an index fund.

Tax advantages

While it’s best to consult with your tax professional, here are some basic tax advantages of investing in real estate.

• Lower capital gains on long-term investments
• Opportunity to claim depreciation
• Access to a 1031 exchange
• Opportunity zone investments

Compare these advantages to tax risks associated with stocks, such as capital gains tax that can reach as high as 37%.

More control

You have more control when you invest in real estate.

• Screen and manage tenants
• Closely track the local market
• Make repairs and renovations that increase its value

When you invest in the S&P 500 or other index funds, you’re heavily reliant on a select few companies to perform well.

Did you know that 20% of the S&P 500’s value comes from 5 companies?!

If even one of them goes off the deep end — perhaps due to a market collapse or poor financial decision by the CEO like buying Twitter — your portfolio can take a massive hit.

With real estate, you’re still subject to larger market changes. That will always be true. However, you maintain more control over your value and returns.

Real estate is a tangible asset

This is more important to some investors than others, but real estate is something you can see and touch.

For example, if you own a single-family investment property in your local area, you can visit it as often as you wish.

• You can see it with your own two eyes
• You can step inside, and tackle a renovation project
• Watch your hard work pay off

Stocks are not tangible assets. You know your investment exists, but you can’t see it or touch it. The best you can do is monitor its performance through your investment account.

And, if the stone ages return, you can take shelter in a home. Index funds? Not so much.

Advantages of S&P 500 SPY and other index funds

After that diatribe, you might expect us to poo-poo index funds to get you to buy into real estate. After all, we are a real estate site. But…not so fast.

Index funds are pure passive bliss

Investing in real estate is hands-on. Don’t let anyone tell you differently. Even if you have a property management company working on your behalf, you’ll still spend a lot of time managing your portfolio.

With index funds, the process is more passive. Choose a fund, choose your investment amount, and make your trade. From there, you can monitor your investment as closely as you want.

Less risk of a lawsuit

There’s always a risk of a lawsuit with real estate investing. For instance, if a tenant is injured on your property, you could be in hot water. And, even if that never happens, serious investors spend all kinds of money on legal fees forming LLCs and whatnot.

All this costs you time and money, while also taking a toll on your real estate investing business.

You don’t take on this same risk with the stock market. A company you invest in could be hit with a lawsuit, but it doesn’t have a direct impact on you.

You don’t need as much of a vision

To a certain degree, every investment calls for your ability to project into the future. But this is much more important with real estate investing. You need more creativity and a vision for your investments.

• How long will you hold your investment properties?
• What is your exit plan?
• What will happen if the market tanks?

After you invest in an index fund, you can “set it and forget it” to a certain degree. It’s up to the companies you invest in to perform on their long-term vision.

A lower initial investment

One of the primary drawbacks of real estate investing is the initial investment.

You could require up to $100,000 as a down payment for a $400,000 investment property. While the return can be substantial, the upfront outlay of cash is prohibitive to many investors.

Index fund investing doesn’t require nearly as much money. You can get started with $100.

Final thoughts

The decision to Invest in real estate vs. S&P 500 index funds is a personal one. Only you know which option is right for you, your financial circumstances, and your goals.

As a general rule of thumb, there are more benefits to real estate investing, but it’s also for the more serious and dedicated investor. Keep an open mind. Doing so allows you to make confident investing decisions.