One of the first questions investors ask when considering a real estate investment is what kind of returns they can expect for their money. This is a challenging question to answer on a general level since every project is different in the amount of returns it generates and how it generates them (i.e. cash flow vs profit from sale). However, this is certainly a fair and important question to ask when considering jumping in as a passive real estate investor and so today's article will provide a general idea of the differences of returns seen in the stock market vs. real estate and how this differences can greatly impact the growth of your wealth.
Returns in Stock Market
The world of the stock market can be complex with many everyday investors not truly understanding what drives returns in their investments or what they can expect from them in the future. For the purpose of our discussion, we will take a glance at historical data to see what investors have received in the past.
If you start by looking at the average annual return of the S&P 500 over the past several decades you can see that it has produced returns on the order of 10%. The S&P 500 of course represents the 500 leading publicly traded companies on the market and therefore gives a pretty fair representation of stock market performance overall.
If we take one step beyond this and look at the performance of high quality mutual funds, we can find investments with long term historical track records on the order of 12%. This type of return would be achievable by someone willing to invest a little time to uncover mutual funds with this type of track record thereby giving them a return that is a little above the average stock market investor but still not requiring an extensive amount of time or knowledge.
Returns in Multifamily
In multifamily investing, we see a wide range of returns depending on the type of project, market, sponsor experience and risk tolerance of the investors. In recent years, the continued high growth of real estate prices has often resulted in investors receiving returns much higher than expected. However, to give us something to compare with most sponsors will want to see an average annual return of at least 15% to investors in order to consider a project viable. We will therefore use this number in our comparison below even though some investors might be accustomed to seeing returns even higher.
How much difference does it make?
Below, you see a chart which shows the difference the average annual return makes on an initial $50,000 investment over 10 years for a return of 10%, 12% and 15%. Although the initial difference seems minimal, over time it is astronomical (305k vs 430k vs 711k) and is the reason investors should be concerned with the level of return they are receiving. Additionally, this does not account for the difference in taxes levied on a stock market investment which is typically much higher than an investment in real estate.
There are many important considerations when evaluating a multifamily deal and we make it our mission to careful vet each of these items. If you would like to learn more about passively investing in multifamily, please set up a meeting with us through our Calendly link and subscribe to our weekly blog here.