How does real estate investing compare to riskier investments in stocks, bonds and crypto: Do it right and you can earn enormous returns
Every time the stock market crashes, it reminds investors just how volatile equities are.
Jittery investors end up pulling money out of the stock market — selling low and losing money.
Real estate is inherently less liquid and therefore less volatile than stocks. Even in moments when real estate values decline, they don’t fall as fast or as deep as stock markets. That raises a question: If real estate is less volatile (and therefore less risky) than stocks, how do the returns compare?
As you explore the world of real estate investing returns, here’s what you should keep in mind.
What is a good ROI in general?
Since 1926, the S&P 500 has returned an average of around 10 percent per year. Going back even further, and adding in other industrialized countries, the average return on stocks over 145 years is around 7 percent.
Bonds do worse, with government bonds returning an average of 5-6 percent over time and AAA corporate bonds landing in a similar range.
And of course, savings accounts pay almost nothing, perhaps 1-2 percent for high-yield savings if you’re lucky.
For the sake of simplicity, let’s call a 5 percent return modest, a 7.5 percent return decent and a 10 percent return good. You can consider anything above 10 percent “very good” or even “great.”
But returns only tell half the story. You also have to worry about protecting against downside risk. Just ask anyone who earned a 50 percent return on cryptocurrencies in a month only to lose 90 percent on it over the next few months.
That was a fascinating discovery of that 145-year study mentioned above: Rental properties have historically paid higher returns than stocks but with half the price volatility. While stock markets almost always crash during recessions, real estate markets often don’t dip at all. It’s one of many reasons why rental properties can help steer your portfolio through a recession.
So what kinds of returns do different types of real estate investments pay?
ROI in real estate investing…
Like dividend-paying stocks, real estate typically generates two types of returns: Income yield and price growth. But real estate tends to generate more income and less appreciation than stocks.
For example, the average yield on REITs is more than double that of the S&P 500. I personally don’t love REITs as a way to diversify into real estate, because they share a correlation with stock markets. It’s precisely why we saw REITs get hammered in late 2022 and early 2023, even though underlying real estate assets didn’t fall nearly as far. And indeed, in many cases, real estate didn’t drop at all.
For true diversification with little correlation to stocks, you need to leave the comfort of your brokerage account and find other ways to invest in real estate. You can of course lose money on any investment, but when I invest in real estate, I expect a certain minimum return depending on the type of investment.
Long-term rental properties…
When I invest in long-term rental properties, I aim for a combined return of at least 10 percent between cash flow and appreciation — and preferably a lot more.
That often breaks down to a cash-on-cash return of around 7-8 percent yield and average annual appreciation in the 3-4 percent range. But because I only put down a 20 percent down payment and earn appreciation on the entire property value, that 3-4 percent annual appreciation can quintuple into 15-20 percent of my actual down payment.
For instance, if I put down $20,000 on a $100,000 rental property, and the property appreciates to $103,000 over the next year, that $3,000 gain in property value translates to 15 percent of my $20,000 down payment.
Of course, you also have to cough up money for closing costs and possibly for some initial repairs. The real world is always messier, but you can see how leveraging other people’s money to buy your own assets creates such an advantage in real estate investing.
In fact, it’s possible to borrow 100 percent of a property’s value, using the BRRRR strategy (buy, renovate, rent, refinance, repeat). When you have none of your own money invested in a property, every dollar you earn represents an infinite return on your $0 investment.
Beyond the potential for high returns, rental properties also help buttress your portfolio against recession risk. While stock markets and home prices often drop during recessions, rents almost never decline.
Short-term vacation rentals…
As an alternative to long-term rentals, short-term vacation rentals let you invest in the same types of properties but earn on a completely different business model. A model that comes with its own pros and cons.
On the plus side, vacation rentals sometimes generate more revenue than long-term rentals. It depends on the market, property, seasonality and more — use an analytical tool like Mashvisor to compare a property’s cash flow as a vacation rental versus a traditional rental.
Vacation rentals on Airbnb come with almost no eviction or rent default risk. Guests pay upfront, stay and then leave.
But short-term rentals require more labor to manage and come with extra expenses, such as utilities and furnishing. Some cities have effectively outlawed Airbnb as well, and nothing says more cities couldn’t do the same in the future. You could buy a vacation rental only to find the business model outlawed a year later.
I expect similar returns on vacation rentals as I expect from long-term rentals: At least 10 percent in combined returns to justify the hassle of finding, financing and maintaining them. That said, count on paying much higher property management fees, given the greater work involved. Vacation rentals must generate higher gross revenue in order to cover those extra costs.
You can earn substantially higher financial returns by flipping houses, but you can also expect more work.
For example, you might earn a 100 percent return or more on your down payment when you flip a house. And that’s not even annualized — you could earn that in six months.
But flipping houses is an active business model, not a passive investment. Finding great deals takes work, financing the property takes work, hiring and managing contractors takes work. Which says nothing of pulling permits, hassling with local housing inspectors, negotiating with buyers, and all the other headaches that come with buying a shell and transforming it into a move-in-ready gem. Even finding investor-specialist Realtors isn’t always easy.
In other words, calculate the value of your time when you calculate your returns. If a flip will take you 200 hours of labor from start to finish, account for that labor when you run the numbers. The juice may not be worth the squeeze, especially as a novice investor prone to mistakes.
Commercial real estate syndications…
On the opposite end of the spectrum lie completely passive real estate syndications. All you have to do is write a check and sit back and collect cash flow and eventually profits when the property sells.
They historically pay high returns in the 15-30 percent range. Passive investors also benefit from nearly all the tax breaks that active rental investors get. So what’s the catch?
There are a few downsides to syndications. First, they require a high minimum investment, on par with a down payment on a rental property ($50,000 – $100,000). Second, many only allow wealthy accredited investors to participate. Finally, they’re not liquid — once you buy in, you’re committed until the property sells (typically 2-7 years).
I personally love real estate syndications, and I navigate those downsides by investing as part of a real estate investment club. By splitting the minimum investment, each member can invest with just $5,000. That makes it much easier to diversify than either solo syndication investing or traditional rental property investing.
Another option for passive investing is real estate crowdfunding.
Like real estate syndications, you can buy fractional ownership in properties or buy into a fund similar to how REITs work. Some crowdfunding platforms offer ownership in properties, others offer loans secured by real estate.
You typically collect both distributions and earn appreciation. Each platform works differently, however, so do your homework.
As for returns, they vary all across the spectrum. Low-risk, liquid investments like Stairs by Groundfloor or Concreit typically pay 4-6 percent returns and work like a savings account alternative. Higher-risk, lower-liquidity investments like Fundrise, Groundfloor, Streitwise and Arrived might occasionally lose money or could pay returns between 10-25 percent. Do your homework to find platforms that suit your risk tolerance and investing goals.
I want my real estate investments to pay at least as well as stocks’ 7-10 percent average annualized returns. Ideally, I want them to beat my stock holdings by a hefty margin.
I invest in stocks for diversification, liquidity and long-term growth. I invest in real estate for passive income, stability, tax benefits and a hedge against inflation.
In fact, real estate serves a similar role in my portfolio as bonds, but pays double or even triple the returns. It’s precisely why I replace bonds with real estate in my own portfolio, as an investor in early middle age.
Whether you can or should do likewise depends on your age, your risk tolerance and your comfort and expertise with real estate investing. If you’re new to real estate, start with passive investments, such as crowdfunding, syndications or REITs. Only switch to direct property investing if you have a passion for it and want to pursue it as a side hustle. Landlording and flipping houses is far from passive, despite what it looks like on TV.
Do it right and you can earn enormous returns. Do it wrong and you can lose your shirt.