I had an interesting discussion with a good friend who also happens to be a fund manager. He is also an investor in stocks and bonds. He studies the financial markets religiously and has a comprehensive stock portfolio. Our discussion went something like this. The ROI on my index funds have out performed inflation and….my guess is that it has also out performed the real estate market. "Ummm," I said. Not expecting a response, I took the opportunity to educate my friend about leverage and why real estate investing is more likely to make you financially free quicker than investing in stock. This is what I said:
If you invest $1000 in a stock and it goes up 5% then the ROI is 5%. However when purchase real estate, you do not have to put invest the full $1000. You only have to invest 20% or $200 to purchase the property. The balance is through a mortgage. If real estate goes up 5% it has gained $50.00 in value, just like the stock. BUT, the ROI is actually 25%. ( 50/200=25%). Not so fast, said my fried, but you have to pay the mortgage. Yes, I said confidently. You do have to make a mortgage payment, but you also receive rental income so in fact the tenant is really paying off your mortgage. Huh! Take that!
Assuming the rental income pays all your expenses, you really make more than a 25% return on your investment of $200. Your mortgage balance has gone down $10.00 so if you add the increased equity to the appreciation you are really making a 30% return (50.00+10.00 / 200 = 30%) When is the last time you made 30% return on any of your other investments?
Where else can you buy something and only put 20% down, someone else puts up the other 80 % and someone else pays off the mortgage for you and at the end of 25 years you own a significantly appreciated, income producing asset. Now do you understand why real estate is such a great investment?