Comparison of Rental Property with Other Investment Alternatives

Should you invest your hard-earned money in rental property or other types of investment alternatives? To answer that question, let's take a look at some of those other investment options and see how they compare with rental property. We'll classify the investment options as either "fixed" or "non-fixed" investments.

Standard "Fixed" Investment Alternatives

Standard fixed investments include bank savings accounts, certificates of deposit, and bonds. They are termed fixed investments because they behave exactly as their name implies - they earn a fixed rate of return (or interest) on invested capital. This return is locked-in (or guaranteed) and does not fluctuate with changes in the economy. Because of this, they are thought to be "safe" investments as far as preservation of original capital in concerned.

Standard "Non-fixed" Investment Alternatives

The value of non-fixed investments is controlled or driven by "market forces" such as supply and demand that exist in the economy. These types of investments can either increase or decrease in value at any given time depending on the condition of the market. The standard non-fixed investment options include stocks, mutual funds, commodities such as gold and silver, and real estate.

The "Twin-Adversaries" of All Investments

All types of investments, both fixed and non-fixed, fall victim to the detrimental affects of taxes and inflation. Of the two categories of investments, fixed investments can be more adversely affected because their "fixed" rates of return may not be enough to keep pace with inflation after income taxes are factored in. In this case, fixed investments may lose value (actual purchasing power) even though their absolute dollar values (account balances) may have risen as a result of earned interest.

On the other hand, the values of non-fixed investments have a better chance to keep up with inflation over time. This is because of the supply / demand domino effect of the economy. Increased demand of non-fixed investments that is created from a strengthened economy causes their values to rise, and this results in an increased rate of inflation.

Meanwhile, fixed investments such as savings accounts sit stagnant and lose ground to the rising rate of inflation. However, non-fixed investments are exposed to a double-edged sword. Decreased market demand will cause their values to drop, sometimes significantly.

Comparison of Investment Alternatives

The following chart shows how three separate investments compare over the course of a twenty-year period. The investments consist of a fixed-investment savings account earning 2.5% annual percentage rate (APR), a stock index fund producing an average annual appreciation of 8%, and an investment in a $250,000 Duplex rental property with 3% annual price appreciation. The "fourth" bar on the chart indicates the value of the investments needed to keep pace with the 3% annual inflation rate.

The three investment alternatives each start with $50,000 of invested capital and the following conditions are applied…

• Each of the three investors are in the same 25% tax bracket, and annual inflation is 3%,
• After the initial $50,000 investment, no additional contributions are made to the savings account,
• The stock fund investment consists of an average annual 10% total return, with 2% being dividend yield and the remaining 8% being price appreciation,
• The after-tax dividends are added (re-invested)into the stock index fund account balance each year,
• The total return produced by the Duplex investment over the 20-year period consists of positive cash flow, equity buildup, income tax shelter, and the 3% annual appreciation. A 30-year fixed rate mortgage of $200,000 at 6% interest is used, and first year net operating income of the property (with 5% vacancy) is roughly $17,000. This income will increase yearly at 3% (the same as inflation).
• The results for each investment are "after-tax" results using a 25% tax bracket.

The after-tax results shown in the above chart show that the Duplex rental property has outperformed the stock index investment by more than 2 to 1, and the fixed savings account investment by almost 7 to 1. Now that’s pretty compelling evidence on the benefits of investing in rental property!

For more in-depth information about rental property and investment alternatives, please visit The Landlord's Library book collection. It's a terrific, one-stop source for practical, comprehensive information on the entire subject of residential landlording.

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