Ultimate Guide to Calculating Stock Market vs. Real Estate Returns

Understand what to consider and calculate when comparing the stock market and real estate investments. Follow along with the Real Estate vs. Stock Market ROI calculator.

Introduction: Understanding how to compare Stock Market vs Real Estate Returns

Choosing between investing in the stock market or real estate is a complex decision. As much as there are tons of articles talking about it, only some calculators exist that can guide your 10-year return on investment (ROI) by diving deep into the different financial factors.

While comparing historical returns is expected, that single % figure does not give a realistic picture of your actual ROI for real estate. For stocks, it’s straightforward because you can buy, hold, and not have any recurring expenses. However, with a property investments, you must consider your down payment, upfront fees, leverage (or the loan), mortgage, and monthly cash flow.

To make it even better – you can use the openly available Real Estate vs Stock Market calculator to create personalized plans, and then send copies of the business case results to yourself. That way, you’ll have a copy to review with your financial advisor or accountant, who you should consult before making any major decisions.

Theory is good, but numbers matter. Let’s dive in.

1. How to Compare Stock vs Real Estate Returns

Do not use historical returns in isolation

Here is an example to illustrate. The S&P 500 group of stocks returned about 10% over the last 50 years, and the Real Estate housing market returned 3% – 5%, depending on which Canadian or US city you are targeting. At a glance, you might say you should invest in stocks instead of real estate; however, those returns would not indicate your actual return on investment (ROI) over the next ten years. Follow along to find out why.

Let’s assume you have $100k to invest in either option.

For the stock market – the 10% return is not far off because you can buy an exchange-traded fund (ETF) that mimics the S&P 500 for a meagre cost and with very low management fees through your brokerage. So your $100k returns about 10% per year, or slightly under $10k, net of fees. In short, you invested $100k, and made $10k, therefore your ROI is 10% ($10k/100k).

For real estate – the 5% return is inaccurate. This is because of leverage.

• You use $100k as a down payment as leverage to secure a loan of $400k, which means you can buy a $500k investment property ($100k + 400k).
• When the $500k property grows 5% annually, that gain is $25k.
• To measure your ROI, you must compare it to the amount you invested out of pocket, which was $100k.
• In short, you invested $100k and made $25k; therefore, your ROI is 25% ($25k / $100k)
• The real estate scenario is simplified to get the point across. Historical returns on the total property value serve as only one data point when calculating investment returns.

Factors you need to consider

Stock market investments are straightforward when following the buy-and-hold mantra for an S&P 500 broad stock market index. You usually have minimal fees from your brokerage when purchasing the stock ETF. Afterwards, the only other factors are the annual return and the annual management fees, also known as the MER or Management Expense Ratio.

Real estate investments are much more complicated and have many factors at play. You must consider the following criteria to help you make the best possible financial decision.

• Down Payment amount
• Mortgage interest rates
• Mortgage insurance
• Legal and regulatory fees
• Realtor fees
• Land transfer taxes (local, state, provincial, etc.)
• Property taxes
• Rental rates
• Maintenance fees
• Repairs
• Occupancy rate (will your unit be rented 100% of the time?)
• Utilities (does the landlord pay or the tenant?)
• Insurance

Lucky for you, the Real Estate vs Stocks financial calculator includes all of these factors to help you get a complete picture of your impacts, and minimize future surprises.

Death and Taxes

As the saying goes, these are the two things in life you can’t avoid. For this guide, I’m only addressing the dreaded taxes.

Selling the investments and taxes are not factored in. There are a variety of treatments to minimize taxes on an annual basis or at the point of sale. Those situations are personal and need professional accounting help.

It is worth noting that many value-driven investment gurus and pundits recommend buying any asset intending to hold it indefinitely. And find ways to leverage that asset to pull out additional investment funds without selling the underlying asset.

2. Using the Stock Market vs Real Estate Investment Calculator

First: Pick a budget, and search for property listings

For this example, let’s assume you have $100k ready to invest. Your options are

1. Invest $100k in an S&P 500 stock ETF, or 
2. Use the $100k for a down payment in an investment property, allowing you to secure a $400k loan and buy a $500k property.

You need to be aware that there are other upfront real estate expenses beyond the down payment, which are also covered below.

So with a $500k budget, you search for properties around $500k in Toronto, Ontario, Canada, which happens to be one of the hottest markets in North America at the time of writing. I found a 1 Bed, 1 Bath, 1 Garage unit for $500k at Yonge and Finch. It is north of the downtown core but directly on the subway line with healthy rental demand. Here are the financial details for this 500-600 square foot unit you will need to gather.

• Upfront Costs
  • List price: $500k
  • Down Payment: $100k
  • Land Transfer taxes: $12,950 (Toronto has both a City and Provincial land transfer tax (yikes!), I used this calculator to create an estimate.)
  • Legal and Regulatory fees: $3000
  • Home Inspection: $0 (I’ll skip this since it’s a condo, but I would verify all of the building certificates and their financial standing)

• Recurring Costs and Benefits
  • Rental Rate estimate: $2,450
  • Property taxes: $1561
  • Condo Maintenance fees: $458
  • Utilities: $0 (In this case, the tenant will register all their utilities in their name)
  • Property Management fees: $0 (If you can manage the condo on our own.)
  • Fee to Find a Tenant: $0 (If you can post through social media such as facebook marketplace, and show the listing yourself.)
  • Insurance: $0 (I will be covered for major structural issues under the building insurance. However I will make sure my tenant has content insurance.)
  • Mortgage Rate: 4.5% (I’m assuming this is the average rate over the next ten years, it’s always good to err on the higher end of the range. Check out RateHub for some estimates).
  • Real Estate Appreciation Estimate: 4% annually

Regarding the Stock ETF inputs – the S&P 500 ETF information is already entered in the calculator. You can adjust the return and expenses for any other ETF you prefer.

Second: Plug in the information into the Stocks vs Real Estate Calculator

Head over to the Business Case Guy calculator to start plugging in all the information you’ve captured. Some assumptions for Real Estate and Stocks are inputted. You can change anything in the Yellow Cells and see your live updates. Below is an example of the ‘Enter Info Here’ section.

For the stock ETF investment amount, you’ll see below that the total amount is $116k instead of matching the $100k for the property down payment. Comparing equally requires that all upfront real-estate spending is included in the stock investment.

Third: Review Your Stocks vs Real Estate Calculator Results

Continue to the next section so we can jump into the numbers.

3. Understanding the Results of the Stock vs Real Estate Calculator

The Business Case Summary

This information is available on the Business Case Summary tab. It will show you a snapshot of how your equity will change from year 1 to year 10. Here are the four cost and benefit areas outlined.

1. Down Payment
2. Transaction Fees and Expenses
3. Operations Cash Flow: If positive, then 
4. Appreciation & Principal

In this specific case, based on all the inputs entered, you will be ~$100k ahead with real estate at Year 10.

The Cash Flow Summary

For the first few years, you will have negative cash flow, meaning you will have to pay out of pocket to cover some expenses. However, over time, your cash flow position will improve as rental rates increase, and you contain your expenses. By Year 10, your cumulative cash flow can turn positive, $8k in this scenario.

The Return on Investment or ROI

When it comes down to the annualized %, you can see Real Estate is ~5 percentage points higher than Stocks, based on this scenario.

• Real Estate Investment Annualized ROI: 15.3%
• S&P 500 Stock ETF Annualized ROI: 10.4%

The Break Even Analysis (Monthly cash flow = $0)

If negative cash flow is a big concern, then these numbers will help you understand how much has to change for you to break even on your monthly and annual cash flow in your first year. Based on all the data entered, you can see below that there are two ways to break even if all other expenses remain the same.

1. Reduce your offer by $117k (from 500k down to $382k) or
2. Increase your rent by $589 each month (from $2400 to $2989).

These are only guidelines, and the market may not allow these price adjustments. However, you now have an understanding of which factors need to change. Maybe compare a different area or city to see if the results are more favourable.

4. 16 Exhaustive Pros and Cons of Investing in Stocks vs Real Estate

In this scenario, you can see there is more upside to Real Estate. However, that doesn’t mean that is the right decision. You have to ask yourself, is the added investment gains worth the extra effort and risk involved with managing a property? Here are the Pros and Cons you need to carefully consider before deciding to invest in Real Estate.

Item	Stocks	Real Estate
Financial Entry Costs	Investing in the S&P 500 ETF saves money compared to buying individual stocks, allowing for a smaller initial investment in the market.	Real estate can be challenging due to the high cost of entry. You not only need to have the upfront down payment but also have to get approved for a mortgage at a reasonable rate.
Transaction Costs	Investing in the S&P 500 ETF by buying and selling shares usually involves low transaction costs, such as brokerage fees. This makes it a more affordable investment option than the expenses involved in purchasing real estate.	Additional costs like agent commissions, legal fees, and closing costs can impact the profit made from real estate investments.
Leverage	Leverage for stock purchases is not recommended for retail investors. It is high-risk and typically only used by  professional investors.	Using borrowed funds to purchase a property will allow investors to control a more significant asset value using a smaller portion of their capital. This can offer higher returns.
Recurring Expenses	The Management Expense Ratio (MER) refers to the annual fees for holding an ETF. These fees are fixed percentages, usually less than 0.5%, and remain consistent throughout the holding period. The MER is deducted from your holdings, so you don’t have to pay it out of pocket.	Managing an income property consists of recurring monthly expenses that can vary. These expenses include property taxes, maintenance fees, and utilities. Preparing for unexpected increases in costs is crucial by having a buffer in place.
Unexpected Expenses	Holding an ETF does not have any unexpected expenses.	Investment properties can come with unforeseen costs, such as broken appliances or leaky faucets. It’s essential to budget for emergency repairs just like you would for increases to recurring costs.
Cash Flow	An investment with an S&P 500 ETF can yield a small dividend, typically less than 2%. This dividend is re-invested and considered when calculating the 50-year average annual returns.	If the revenue from rental properties exceeds the expenses, it can generate monthly cash flow. However, initially, there may be negative cash flow for the first few years.
Appreciation	Over the long term, the S&P 500 has historically demonstrated positive price appreciation. Only twice in history was there a negative 10-year period. Your preference is limited to the amount invested, $100k in this case, given leverage is not used.	As the earlier example shows, your growth is amplified due to the leverage (i.e., a $100k down payment can equal a $500k property purchase). Therefore your appreciation, as % of your investment, is generally much higher than the stock market option.
Time and Effort	Holding a stock market investment is passive because you are not picking the underlying stocks. The ETF will automatically rebalance the stock weighting to match the S&P 500 market index.	You may have to handle various tasks like maintaining the property, screening tenants, collecting rent, and dealing with unforeseen issues. These responsibilities can be time-consuming and exhausting. However, if you possess the necessary skills, you can cut costs by carrying out some of these duties yourself.
Complexity	Choosing individual stocks is complex. However, in this situation, we are comparing it to investing in an S&P 500 ETF, which involves purchasing and holding the stocks.	For novice investors, navigating the complexities of the local market, property regulations, financing options, and property management strategies can take time and effort. It’s helpful to have an experienced agent or property manager to assist you, though they may come with their fees.
Taxes	Selling your ETF holdings may  generate taxable events. You may have options to own in a tax-sheltered account. Although less complex than real estate taxes, you should still review your options to minimize taxes with your financial advisor or accountant.	Each tax situation varies; therefore check this with your financial advisor or accountant.
Inflation Protection	An S&P 500 ETF offers consistent long-term growth and acts as a hedge against inflation. As the underlying companies grow and generate profits, the value of the ETF tends to appreciate.	The value of properties typically increases along with inflation, which can help maintain purchasing power and lead to long-term growth.
Liquidity	The top S&P 500 ETFs are highly liquid, allowing investors to buy or sell shares on major stock exchanges throughout the trading day. This provides fast access to funds, and the ability to liquidate only what you need.	Property holdings are not very liquid and require a long sales process. Even if you only need half of your cash, you still have to sell the entire property.
Volatility	The S&P 500 ETF is subject to market volatility. It will experience fluctuations in price due to various factors, including economic conditions, company performance, and investor sentiment. Investors need to consider their risk tolerance and long-term investment horizon.	Real estate markets experience less volatility than ETFs and stock markets. This means that real estate prices are more stable over time, allowing you to build equity and benefit from long-term price cycles.
Using Growth as Collateral	Investing in the S&P 500 ETF does not directly allow you to use your equity as collateral, as it is a separate investment vehicle. However, the potential returns from the ETF can increase your overall net worth, providing additional financial flexibility for collateral-based borrowing in other areas.	As you build equity through appreciation, cash flow, and having someone else pay down your mortgage, you can use this equity as collateral, letting you access your equity for other investment opportunities. For instance, if your property has added $150k in value after five years, you can work with the bank to reassess your value, and provide you with access to that $150k.
Exit Costs	When selling your ETF, most brokerages provide this service with a small trading fee attached. These fees are typically less than $100 even if you sell a $100k investment. Compared to real estate, the exit costs are practically negligible.	Exit costs associated with a property sale, such as agent commissions and capital gains taxes, should be factored into the overall investment strategy. Exit costs can eat from 2% – 5% of your sale price, which doesn’t include tax implications. For example, a $600k sale could have up to $30k in fees. As noted in the line above, avoid selling, and try to leverage your equity.
Bad Tenants	The S&P 500 ETF does not carry tenant risks. Your only risk is if your stock brokerage is insolvent and goes out of business. Although it’s low-risk, make sure to pick a reputable company.	Dealing with difficult tenants can lead to financial losses, legal expenses, and wasted time resolving issues such as missed rent payments, property damage, unauthorized subletting, lease violations, eviction proceedings, and finding replacements. The importance of validating your tenant’s history, credit checks, references, employment, etc., cannot be overlooked.

5. Stocks vs Real Estate – Making a Decision

Now that you’ve read this guide, you should be more knowledgeable and can decide if you are choosing to invest in the Stock Market vs Real Estate. This customizable business case guy calculator will increase your understanding when comparing real estate vs stocks.

If you pick stocks, the following steps are straightforward: open a stock account and buy an S&P 500 ETF. If you want to go down the path of real estate, then keep reading.

Six (6) Real Estate Investment Questions to Review with Your Advisor or Agent

1. What are the total costs to purchase and close the real estate transaction?
2. Will my rent revenue cover my expenses, or will I be out of pocket each month?
3. To break even each month, what’s the maximum price I should pay, or how much rent will I need?
4. What % can I estimate the property to appreciate over the next ten years?
5. What will my equity position be by Year 10?
6. Can I accept or mitigate the risk of these significant items not going as planned?
   • Lower occupancy rate
   • Bad tenants
   • The rental estimate is lower
   • Expenses are higher
   • Major repairs

When choosing between real estate and stocks, thorough research based on all available data plus your best estimates is vital. It is essential to evaluate and estimate upfront costs, recurring expenses, appreciation, and other key factors to make an informed decision. 

When reviewing with your financial advisor or agent, you can present this information and determine how well they understand the scenario. If they are a qualified professional, they will not shy away from diving into these details with you.

Seven (7) Steps to Make an Informed Real Estate Investment

1. Learn the benefits, costs, pros and cons of real estate investing (Step 1 is complete if you have read this far already 👍).
2. Know what you can afford on an upfront and monthly basis, including emergency funds.
3. Identify properties of interest by searching through online listings. Using websites that let you see the sold price for sales and leases will improve the accuracy of your estimates.
4. Use the business case guy calculator to compare each property. This article’s based on a comparative calculator for stocks vs real estate. For a real estate investment-only calculator, click here)
5. Present the results to your advisor or agent (and ask them to use the calculator).
6. Once you identify a target property, work with your agent or lawyer to make an offer and close the sale. Good luck!
7. Monitor your results by tracking your actual numbers against your plan. Continuously review and keep learning to prepare for your next real estate investment.

 

Disclaimer

This guide is for informational purposes only. It is not meant to decide for you. All figures are inputted based on your best estimate and can fluctuate based on the variety of risks outlined. Business Case Guy is not responsible for the outcomes, good or bad, of any decisions made using this guide. Please review all financial choices in detail with your financial advisor, real estate agent, accountant, or any related, qualified professional.