Rental Real Estate vs Bonds — Which should you invest in and why.
By Odulaja Olaitan.
Investors nowadays have a wide range of investments they can choose from including stocks, bonds, and real estate, but each investment must be tailored to suit the portfolio of the investor. When comparing investment opportunities as an investor, you need to look at the Time Frame for holding the investment, the Rate on Return and the Risk.
To begin this comparison, lets define what a bond is and what we call rental real estate (or single family rentals). Bonds are fixed interest rate investment that consists of loaning money to an entity that borrows the funds for an agreed period of time. Rental real estate (Single-family Rentals) are income generating real estate properties. Single-family rentals give steady cash flow which are not fixed but are subjected to increase year-on-year.
To compare this two investment classes, we will use this simple framework:
- Risk vs Return
- Income Taxes
- Inflation
- Leverage
- Equity Build-up
Risk vs Return
Bonds are considered to be the safest investment, but it is worthy to know that the safer the bond investment, the lower the interest rate of return. Government bonds are considered the safest but are usually below the rate of inflation (e.g. 8.89% yield on a 10 year bond vs 12.56% inflation rate as of June 2020). Also, Government bonds are easier to buy and sell than real estate, but if you’re earning a 8.89% interest and inflation rate is 12.56%, your real return on investment(ROI) is -3.67% (12.56% - 8.89%).
Single-family Rentals consistently yields single digits returns from cash flows (rent) and double-digits returns upon sale. You get an equity appreciation over time in addition with cash flow.
Income Taxes
Many Government bonds (e.g Municipal bonds) are not taxed at the Federal level, but if you decide to go for higher-yield corporate bonds, you’ll get higher interest rate of returns and you will be paying capital gains tax on that interest depending on how long you hold the investment. However, investing in corporate bonds exposes you to the risk of the company defaulting.
Unlike Bonds, SFRs get some great tax breaks with depreciation reduction being one of the best. Depreciation reduction lets you deduct some portion of the property value every year, which in turn provides great tax reductions upon sale in the future. You get taxed only on depreciated amount!
Inflation
Inflation can reduce your returns on the safest bonds investments, if you have a bond that has a 9% interest rate, and the rate of inflation after purchasing this bond grows to 12%, you are essentially looking at a true rate of return of -4%. Also, the value of bonds are static and they a pay a fixed rate over the lifetime of the investment, so purchasing power with that interest drops with inflation over time.
For SFRs, you can generate higher rents in periods of inflation and in generally inflation drives up property prices. Single-family Rentals offer a way for you to reap cash flows as well as gain appreciation over time, hence you gain value over time unlike bonds.
Equity Build Up
As mentioned earlier, bonds are static and do not offer appreciation over time. SFRs on the other hand offer what we call equity build up through debt decreasing (mortgage) or property value increasing. The bond issuers simply pay back the principal at the end of hold period.
Leverage
Leverage is using borrowed money to increase your investment buying power. Bonds can be leveraged but the interest that you have to pay on the borrowed money you are using to leverage your bond investment is generally going to be higher than what you are earning from the interest the bond is paying you. So for this bond leverage is too costly.
For SFRs, you can walk into a bank with any property you have gotten through roofonecapital.com and get cash or loan in less than 24 hours!
In Summary
If we look at many other aspects, one will think that SFRs investing is superior to bonds investing. So while bonds offer the safest investment and are straightforward they come at low returns and compared to real estate, bond returns receive devastating blows with inflation.
If you are seeking investment opportunities and are serious about making your money grow the farthest, consider real estate over bonds, you’ll more than cover the costs of tying up your money in property through rental.
Roofone does not provide investment or financial advice. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal
Credits:
The balance — Bonds vs Rental Real Estate for investors
Cityvest — Real Estate vs Bonds
