There’s always something to howl about

The S & P Is Up Over 16% In 2006!

Over the last half century or so the S & P has averaged, give or take, about 8% growth annually. Pretty impressive. A lot of folks are very impressed, especially those who’ve invested into vehicles tied to the S & P index. They did better than ok this year, don’t you think? Twice the average for the last half century ain’t bad by anyone’s calculations. As a matter of fact let’s say the S & P annual growth rate for the five year period) averaged 10% annually, which is still 25% better than the average since Eisenhower was president. For those already retired and receiving income from investment grade insurance vehicles, many of which are tied directly to that index, 2006 has been a banner year. If you’re wondering why the grandkids made out like bandits at Christmas this year, that could very well be the answer.

For the same period of time let’s have two investors, one in the S & P, the other in real estate. They both have a hundred grand to invest. The real estate guy is at a little disadvantage though because he’ll need to hold some of his cash back as reserves. The S & P investor can afford to put his entire hundred grand into his investment.

So the real estate guy finds three duplexes for $200k apiece. (Remember, even though it’s San Diego, it’s 2001.) He puts 10% down on each one. His total investment including closing costs was about $75k. He put the remaining $25k in the bank as a cash reserve account. The duplexes all provided about $100 monthly positive cash flow, though our investor was just hoping they’d at least break even.

Note: My office structured transactions like this a few times a month back then, month in and month out.

Even though the real estate appreciation rate was three times what we’re assigning to the S & P for these five years, we’re going to limit it for this example to 10% a year for the real estate also. This results in a value of roughly $254k half way through the five years. It’s now the summer of 2003 (June) and I’ve advised him buying in San Diego no longer makes sense. This isn’t because I don’t believe the area will continue appreciating, but that the ability to buy with 10% down is still doable, but very difficult. Therefore I advise him to exchange into Phoenix, where the median home price is now about $150k.

He nets about $146k from the sales of the three duplexes after all selling costs. (8%) He then completes his tax deferred exchange into eight Phoenix homes averaging $150k each. He used the same 10% down approach. It’s the end of July 2003 and he now owns $1.2Mil in real estate. He also has managed to use only $3k of his reserves. During the sale the buyers wanted him to buy some new appliances, and do a little painting. Not counting negligable interest, he now has about $22K left.

It’s now the last quarter of 2005 and his eight homes are worth $1,524,000 give or take a few bucks.

He’s seeing that Phoenix is on the front end of a breather, and he likes what he sees in Boise. He sells his eight homes for $1.5Mil, and after paying all selling costs (8%) he nets $280K. Over the five years he made use, of course, of the depreciation from his properties. The first three duplexes gave him about $60k total depreciation for the 2.5 years he held them. (The buildings + the personal property.) His income puts him in the combined state/fed tax bracket of 33.3%. When he traded to Phoenix his depreciation increased by about $21k due to his increased debt. The total tax savings he enjoyed over the five year period amounted to somewhat over $50k. He put these tax savings into his reserve account, preparing to add some of the cash if needed to his Boise purchases.

Arm Wrestling

It’s time for the final tally. Let’s go the the scoreboard and see what’s happend to these guys.

S & P guy put his entire $100k into the S & P. He made 10% a year growth (pretty dang good) for the five years. His original capital has grown to roughly $161k. There were no tax savings.

Real estate guy invested just 75% of his original capital because he wanted a strong cash reserve. His ending balance was about $352k. (22k remaining in reserve + 50k accumulated tax savings + $280k net proceeds from sale of Phoenix properties headed tax deferred to Boise.)

Since neither guy has chosen to sell and pay taxes, we’ll look at what each has actually earned as a simple annual return. Since both of them are sane, and pack three digit IQ’s, they’ve decided not to sell and pay taxes. Duh

S & P guy made a 10% annual return on his money.

Real estate guy made 28.62% on his money. If he’d thrown caution to the wind he’d have bought an additional duplex in the first year and come out significantly better than he did opting for the wiser approach.

Now, imagine how wide this gap becomes over 10, 20, or 30 years. Some of those years will be down years. Some will be flat or just slightly up. Some will be up 10% or more. Over any particular decade you can count on one moderate to large spike in property value. You can also count on a downturn. Pick any particular 10 year period in the last 35 years, and your numbers won’t be much different than this example, relatively speaking.

Again, take the time to apply these numbers for 10-30 years. Real estate investors not only retire better, they retire sooner much of the time.

The majority of long term real estate investors live a more financially abundant life than they did while working. Allow me to say that more clearly. They enjoy more after tax income in retirement than they ever did before retirement.

The S & P went up 16% this year!

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    26 Comments so far

    1. mike December 31st, 2006 7:02 am

      [Brian,] what do you see as ways to profit off the changing markets?

      Mike. I’m going to defer to Jeff Brown for your pointed question

      [Real Estate v. S&P for the last half century]

      I was hoping to address Brian’s “how can we profit off the changing markets,” but what you seem to explaining is “how might we have profited in past markets.”

      Or, are you saying that heavily leveraged real estate for investment is the right move to make, right now, in this changing market?

      Is it “always a great time to buy?”

    2. Kaiser Sose December 31st, 2006 9:37 am


      How do the numbers look starting at 2006 prices?

    3. Doug December 31st, 2006 11:09 am

      If real estate investing is SO profitable, then why don’t all the agents simply use their expertise to be investors instead of selling houses?

    4. Joe December 31st, 2006 12:58 pm

      still, stock market investing is so simple, just buy and hold some index funds. RE investing requires actual work, thats why there is more income potential.

    5. Jeff Brown December 31st, 2006 2:14 pm

      Mike – I’ll speak only to this changing market, though there’s always opportunities in any market change.

      There are two strategies I’m now employing in this market. As a result of my research (with massive help from my son, and others) I’ve concluded there are places that will be relatively less affected than others. One of those is Boise, Idaho. Their ‘demos’ are exceptional, there’s ample land, and they’re not afraid of the yellow-butted belly-scratching lizard. :-) Idaho itself was atop the country in year over year appreciation ending Sept. 30th this year.
      They already have elite ‘job’ numbers, and have nationally known employers coming in every year. The latest examples are PF Chang’s, and The Cheesecake Factory, along with a company bought by Microsoft, but NOT moved to Washington, a very cool sign.

      The second opportunity to gain from this market is to execute what I call the ‘long-term flip’. We go into Phoenix, Boise, or in 2007 maybe even San Diego, and by mild to moderate fixers. But instead of selling them quickly, we counsel keeping them until the spring of 2008 give or take. We feel strongly that barring an huge domestic terrorist attack, that year will mark a significant upward movement in the business.

      That approach will yield built-in profit from the rehab, plus upward pressure from increase demand. It will be crucial to select properties that will possibly be more in demand than others. Duh

      There will be gobs of money to be made in the mini-storage segment of real estate. The returns are relatively higher in terms of cash on cash, and the management is far less intensive than say residential income.

      Otherwise, I see no opportunities for the foreseeable future.

    6. Jeff Brown December 31st, 2006 2:22 pm

      And Mike, I forgot to address….”Is it always a good time to buy real estate?”

      The answer involves changing the premise which is far to general. What kind of real estate? Where? With what kind of buyer? An owner user of a home? An investor? What?

      There are only two factors limiting real estate investors in achieving their goals: their IQ/Stones, and how big their treasure chest is at any given time. Real estate is no different than the stock market in this way – knoledgeable investors make money in any market. How many times have you seen expert Wall Street guys talk about the millions they made in a bear market?

      The only factors that would cause that not to be also true in real estate is lack of capital, knowledge/experience, and/or stones.

      Great question.

    7. mike December 31st, 2006 2:24 pm

      There will be gobs of money to be made in the mini-storage segment of real estate. The returns are relatively higher in terms of cash on cash, and the management is far less intensive than say residential income.

      I find this intriguing. Can you point me to any web resources which you consider reliable so that I can read more on this?

    8. Jeff Brown December 31st, 2006 2:30 pm

      You’re far too predictable Kaiser. I speak of decades and 35 year periods, and you pick out one down year. The numbers would have gone down If I’d have made it a six year period ending now, ‘real estate guy’ still would have outgained ‘S & P guy’ significantly.

      The one thing that can’t be claimed, is that in any moderate to long term period since the end of World War II, real estate has outperformed anything to do the with ‘stock market’ hands down.

      If you don’t believe that, take all your equity out, pay any taxes you might owe, and buy the best investment grade insurance contracts you can find. They generally return 7-9% annually, are almost always tax free, and in many cases AREN’T ALLOWED to go down, even if the index does.

      Sound like a perfect solution for you.

    9. Greg Swann December 31st, 2006 2:31 pm

      > It will be crucial to select properties that will possibly be more in demand than others.

      This is eminently doable, any place, in virtually any market conditions, but you have to really know the dirt, house by house. If you invest in neighborhoods people are eager to stretch to get into, you can make money no matter what else might be going on. I suppose nothing is completely safe, but I can take you to places that will alwasy suffer last and recover first.

    10. Jeff Brown December 31st, 2006 2:37 pm

      Doug – I think we both know the answer to that one. The average real estate agent is out of the business less than two years after they’re licensed. They never figure much out, and generally make less money than in the job they previously held.

      I will admit to being mystified as to the number of long term pros I know who own their homes, and maybe another rental and that’s it. They’ve cost themselves a ‘couple commas’ in the last 20 years at least.

      In California in ’77 or ’78, I forget which, CAR published a survey that was astounding. In one of the best years for agents since VJ Day, the turnover for that calendar year was about 70%! Man, if you’re so clueless you can’t make money when times are truly magnificent, you probably won’t be a prolific investor either. :-)

    11. Jeff Brown December 31st, 2006 2:43 pm

      Joe – In general I wouldn’t disagree. However, for the average guy, (almost said Joe) there are so many more ways to get into the stock market vs the real estate market. Also, he’ll tend to believe the stock broker who is guiding him.

      You’re right about being more work, etc. But what in life has more relative rewards without requiring either more work, experience, knowledge, and/or skill?

      One of the keys I was found in my recent post on diversification. It’s always been an axiom that more risk = more profit. However, I think what may seem to be more risk is eliminated to a great degree by knowing what you’re doing.

    12. Jeff Brown December 31st, 2006 2:48 pm

      Mike – I haven’t relied on sites. However, I’ll be making use of my research next year (’07), and will at that time write much on the subject.

      Investors that are in that niche swear by them, and after spending much of 2006 investigating storage facilities, I’m in total agreement. What blew my sox off was how attractive the available financing was.

      I expect to be posting on the subject by the end of the first quarter. Honestly, I don’t have a site that I’d recommend. They must be out there though.

    13. Kaiser Sose December 31st, 2006 2:50 pm

      Jeff, thanks for the response, but it doesn’t answer my question. At today’s inflated prices and limited upside potential for appreciation for the next two or three years, how do the numbers look?

      You keep referring to 35 year historical performance and that’s great. But I would like to know if you will be able to project those returns based upon today’s market. Or, are you counting for appreciation that won’t exist for a few years at least.

      Oh, and BTW, your assumptions about how I invest and what I invest in are grossly in error.

      No need to be so defensive champ.

    14. Jeff Brown December 31st, 2006 2:53 pm

      Greg The Borg King – It’s good to see you’re getting out and around more. Hope you’re feeling a lot better.

      What Greg says is pure truth. What he’s too modest, and dare I say, humble to point out, is that in order to profit in these times you must know a guy in the area exactly like Greg. (Maybe not exactly. He could look like Barney instead.) Finding the guy who knows hands down where the bodies are buried is what lowers your risk significantly and right now.

      As I said in a post earlier this year – Spend your time finding the guy who knows where to tap.

    15. Jeff Brown December 31st, 2006 2:54 pm

      Brian – Thanks for teeing it up. :-) And remember, I’m buying.

    16. Greg Swann December 31st, 2006 3:09 pm

      > As I said in a post earlier this year – Spend your time finding the guy who knows where to tap.

      One of the Freakonomics beefs I love is the idea that Realtors do better buying and selling real estate than their clients. Duh! NASCAR drivers whip right through traffic, too. When I act in my own behalf, I know excatly what to do, when, where, why and how, and I don’t have to wheedle my principal into doing the right thing against the incontrovertible advice of his wife, his financial planner, his gut feelings and the fondly recollected gut feelings of his deceased father. I love my clients, and a bunch of them have made a ton of money on work we’ve done together. But there are days — and opportunities — that make me yearn for a power of attorney…

    17. Jeff Brown December 31st, 2006 3:14 pm

      That sound you just heard Greg was the sound of thousands of real estate experts saying Amen in unison. :-)

    18. Joe December 31st, 2006 3:59 pm

      Just to be clear, that was a different Joe than me. :-)

      I would never advocate totally ignoring real estate or just buying index funds.

    19. Jeff Brown December 31st, 2006 4:05 pm

      Joe, my comment was not intended in any way to imply you’d advocate ignoring RE or just buy index funds. I understood your point totally. Sometimes I insist proving I’m not William Safire. :-)

    20. David Saks December 31st, 2006 4:09 pm

      The real estate guy had to work a heck of a lot harder for his dough. The guy sitting on the index sits on his thumbs. Alas, Proverbs 20:4

    21. Jeff Brown December 31st, 2006 4:43 pm

      Thanks for that David. It reminds me of my grandpa, now departed, and a minister for 50 + years. He used to give his own spin to that verse: The farmer who plants wheat in the spring isn’t shocked when he’s harvesting wheat in the fall.

      My all time Proverbs favorite though, applies to everybody, and every facet of life: As a man thinks, so his is.

      We’re all products of our thinking. No passing the blame there, eh?

      You hit the nail on the head David.

    22. Russell Shaw December 31st, 2006 4:52 pm

      >I will admit to being mystified as to the number of long term pros I know who own their homes, and maybe another rental and that?s it. They?ve cost themselves a ?couple commas? in the last 20 years at least.

      I agree and also plead guilty to being one of those people. Being a successful investor is a different mindset than being a successful Realtor. It isn’t that I don’t KNOW it is possible to make a lot of money by investing in real estate – it is more an issue of knowing one can make a lot of money doing almost anything. Being a successful investor is like owning a business. The “rules of success” still apply. To be successful at anything one must keep their eyes on the prize. Being an investor isn’t “doing nothing” it is the thing that person has chosen to do.

    23. Jeff Brown December 31st, 2006 4:57 pm

      Kaiser – Oh, and BTW, your assumptions about how I invest and what I invest in are grossly in error.

      Please point out for me where I assumed you invested in anything other than your house and a condo. I have no clue what you’ve invested in, or what plans you have for your investment future.

      No need to be so defensive champ.

      Not defensive, just bored.

      Please, look at my response to Mike at 2:14 today for how I’m addressing ‘the changing market(s). My clients and I will continue making gains. The difference is we won’t be navigating roads crowded with beginners who tend to make my job tougher.

      And for the record Kaiser, you never asked me about the next 2-3 years. You asked me about the numbers for 2006, which I addressed.

      You’ve apparently found an investment strategy that works for you. Keep doing it. But try not to be irritated when folks keep making gains in markets you don’t believe in. They are making gains regardless of your beliefs. The fact is you don’t know how they do it. And frankly that’s ok, because I don’t know how you’ve been successful doing things your way. I probably wouldn’t be nearly as successful as you playing in your arena. Everyone does what they do best.

    24. Jeff Brown December 31st, 2006 5:06 pm

      Russ – The “rules of success” still apply. To be successful at anything one must keep their eyes on the prize. Being an investor isn’t “doing nothing” it is the thing that person has chosen to do.

      The exact point I was making in my post on diversification. Many agents think what you do is highly risky, so don’t enter into your arena. You however have reduced the risk tremendously by knowing exactly what you’re doing. You then decided to ‘invest’ your money, energy, skills, etc. into your business operation.

      It’s no different than my clients investing. They do what they know. In the end when there are a couple commas in your net worth, people only ask ‘how’ out of curiousity. :-)

    25. Brian Brady December 31st, 2006 9:45 pm

      Mike and Joe:

      I’m deferring to Jeff on this because he is in the investments brokerage business; I am merely a financier.

      Mike…the info on TD’s:

      It’s really basic and needs to be followed up with conversations and more examples. I’m glad to walk you through it should you be interested. I can claim a degree of expertise in TD investing.

      Joe: I think I knew the answer to the problem with the Martingdale system; both your short and long answer really made it clear. Craps is for entertainment and blog talk not for making money (but we both knew that).

      I’m being long-winded but I want to commend and thank you both for the insight and questions. I am (lifting a glass and) toasting to your success 2007!

    26. [...] has street cred.  I started watching Greg Swann expose Keith at Housing Panic and read all those glorious tales about real estate investing from Jeff Brown.  It was a rough and tumble atmosphere, filled with very smart people and I begged to play.  [...]