Can Dividend Stock Investing be better than real estate investing?

While traveling this week and reading some books on investing, I began to draw similarities between investing in dividends and real estate. I began to ask myself, while real estate is referred to as the IDEAL investment (as it provides ‘Income, Depreciation, Equity Growth, Appreciation, and Leverage’) could a dividend investment strategy actually do just as well?

In order to evaluate that question, I began to think about ‘how do you normalize the ‘true’ return of real estate’ to then create a benchmark to target for dividend investing. Then go forward how do you measure dividend investing in a similar way to real estate to get close to a ‘apples to apples’ comparison of the investment vehicles

The Typical Real Estate Investment Return Model (On Paper)

For purposes of this model I’m going to go with a simple single-family home using a long term rental strategy. For multi-family investing the math still holds just multiply by # of units and cost per unit. A typical investment would look like:

• Property Cost – $100,000
• Down Payment – $25,000 (25% for investment property)
• Monthly cashflow after all expenses and mortgage – $150
• Annual Cash on Cash (CoC) return (e.g. Cashflow/Down Payment) = 7.2%
  • This is the component of real estate most similar to a dividend payment
• Tax Favorability of CoC return = 10.28%
  • Real estate income is much more tax-advantaged then dividends due to depreciation and other write-offs, so i’m increasing the return to compare it to dividends assuming a 30% tax rate
• Appreciation – 2%/year on average, but you get the benefit of leverage so $2,000/year appreciation is actually an 8% return on your cash investment (4X)
• Mortgage Paydown – 1.5%/year, (this is very rough math as its lower in the early years of a mortgage (interest paydown is front-loaded) and higher in the later years of a mortgage); $1,500/year on $25k downpayment is 6%
  • I’m assuming the appreciation/mortgage paydown has similar favorability to long term capital gains to keep it simple so I’m not increasing it for any tax benefits
• Total Return – 24%, wow! That’s going to be hard to find in any place in the stock market….but wait a minute….

The REAL Typical Real Estate Investment Return

Owning now over 20 real estate investments, I can say my experience has been average to slightly below average as a real estate investor (I may be a crummy real estate investor, or just late in the boom cycle or probably both) and my total returns do not look like 24%/year, so what does a real real estate return look like in the real world, on average (in my experience, your results of course my vary), we’re going to need to make some adjustments to the above:

• Total upfront costs – $35,000
  • Some closing costs, cash reserves needed, and upfront improvements, your total cash investment is typically going to be higher than just the down payment. Upwards of another 10% of property purchase price isn’t far off of if it needs some improvements.
  • This alone drags down the CoC return to 7.28% and Total Return goes down to 17%
• Cash On Cash often does not materialize to the modeled rate of return in the real world as life happens – more repairs than you expect, more vacancy, an extra cost you didn’t model, etc.; dial that $150/month down to $90/month
  • Income (Dividend Equivalent) is now $1,080 on $35k investment, so 3%, gross it up for tax benefit and you are at 4.28%
  • You typically need significant scale (ex. 100 units) to average out the unexpected cashflow bumps with real estate
• Appreciation/Mortgage Paydown Decay – this is a challenging one to model but your rates of return decay as you pay down more and more of your mortgage as the gains in dollars are staying relatively consistent but on a bigger and bigger equity base so the return goes down over time.
  • If initially you are at 4X ‘accelerator’ due to the leverage benefit, and at the end of the mortgage you are down to 2% and 1.5% respectively for appreciation and equity growth from mortgage paydown, i’m going to spit the difference and give us an appreciation benefit of 5%/year and 3.75%/year for mortgage paydown
• Total Return – 13%…but wait…there’s more…
• A couple more intrinsic headwinds on real estate – transaction costs and time investment
  • Transaction costs to sell real estate are around 5% plus additional fees vs. equity trading is nearly free, now we didn’t put in an expectation of when we’d sell but something to keep in mind that lowers total return when you sell
  • Investing in real estate is more time intensive than firing up the robinhood app and buying some dividend stock and your time has value
• Net/Net – This may be a bit bearish and some of this is using conservative assumptions and back of envelope estimates, so its probably fair to say we want a 5-8%+ dividend stream (Cash on Cash return) and 10-15%+ total return to be comparable to real estate on average.

So…Can Dividend Investing Beat Real Estate Investing Returns?

Dividend earnings typically grow over time on a dollar basis, increasing your yield on a fixed cost basis over time, at a rate typically much faster than rents in real estate increase (typically tied to inflation at around 2-3%/year)

Investing in the S&P 500 won’t get you there from a cash on cash return standpoint (~1.5%) and would hit the low end of the total return range (~10.5%), but we like cashflow so that won’t work.

Some high dividend yield funds/ETFs will pick up a bit more cash on cash yield (~3-4%) and total return can pickup a bit (~11.5%) but that still isn’t quite enough.

But (and more to come if people like this post), if we pick individual high quality/higher yield stocks, REITs, and Closed-End Funds (CEFs); coupled with utilizing some conservative margin (like leverage in real estate!); and throw on top some covered call strategies (like collecting rent in real estate!) and total yield improving with dividend growth; and I think there’s a potential path to 6%-10% yields and 13-15%+ Total Returns. Should I build this portfolio in public on here?