Why People are Investing in Real Estate vs Stocks – Video
Kathy: Let’s talk about numbers and basics, and why I do love leverage. A lot of people are afraid of loans because its debt, you taking on a lot of debt. In our case, it was over $5 million worth of debt, which can sound really frightening, unless you know how to do it. I’m going to give you and example of three different people, and how they use leverage.
Each person, in this example, who has $100,000, and wants to know what to do with it. A lot of people are really, really scared today, nervous about our country, nervous about the future economy of the world, the debt crisis we have, the fiscal cliff, all that stuff.
All right, Joe uses $100,000 to buy gold [see video 00:51 to see slide]. $100,000 that’s something that’s usually taken some blood, sweat, and tears to earn. Joe says, “I want to buy gold, I feel comfortable in this economy buying gold. He buys $100,000 worth of gold, very difficult to leverage gold.
Then we have Mary who takes her $100,000 and buys stock on margin. She’s able to buy $200,000 worth of stock with her $100,000.
Now, Pat, and I’m leaving Pat ambiguous here. We don’t know if Pat is a male or female. Pat got $100,000 and decides to use it as a 20% down payment and buy property, and this is leverage that is able to afford $500,000 worth of property. $100,000 leveraged as 20% down payment, equals $500,000 in property.
Let’s go 15 years down the road and see how these three are doing. Assuming a 5% annual growth. Okay, this is a huge assumption and nothing ever really turns out exactly 5% per year. It could be 10% one year and 0% or negative or whatever, but I’m just going to say 5% annual growth, just for the sake of comparison.
Joe’s gold would be worth about $207,000 in that 15 year period at a 5% growth rate. Well, Joe probably only bought that gold as a hedge against major inflation. Again, we’re not talking about that, we’re talking about a world where there’s 5% growth with these investments.
Mary’s stock is worth $415,000, she’s pretty excited. She’s like, “Hey Joe, I out did you here.” I’m going to pay off my $100,000 margin and $100,000 capital that I put in it, and my profit is 215,000, so I doubled Joe’s profit. Mary’s feeling good.
Now Pat, bought that property of 5% annual growth rate is worth a million dollars in 15 years. The $400,000 loan by then has been paid down to $200,000 because Pat was smart and got a loan that is fully amortized and is being paid down every month. The remaining profit is $700,000.
I think we have a clear winner here, but there is more. Pat gets even more bonuses. The properties were rented producing income every month, earning from a cash flow. 10% of $100,000 is an additional $150,000 in cash flow in those 15 years from renting out those properties. You can’t rent out gold and you can’t rent out stock, but you can rent out a property.
Now, if Pat put all that cash flow toward paying off the loan, instead of pocketing that $150,000, then the property would have been paid off in those 15 years. The result is a million dollars in equity, plus the ongoing rental income from owning those properties for life. That’s $120,000 income for life and a million dollar equity. And remember, Pat started with $100,000, 15 years earlier, not to mention the tax deductions that Pat may have received during that time.