I'm a fan of both stock dividends and rental property income, my two favorite sources of passive / semi-passive income. When younger and less wealthy, rental property income may be preferable. As you age and accumulate wealth, you'll likely appreciate stock dividend income more for its simplicity.
However, stock dividend income's main drawback is that it requires significantly more capital to generate an amount equal to rental income due to lower yields. Rental yields are often higher than dividend yields, making stock dividends more meaningful for wealthier individuals.
While managing a rental property requires more work than earning stock dividends, this effort can be rewarding during your journey to financial independence. Remodeling and expanding properties for greater rental income was one of my favorite activities in my 20s and 30s.
In retirement, you might even appreciate having productive tasks in managing rentals. As long as the properties aren't too difficult to maintain, the rental income will likely be more impactful in covering life expenses than stock dividends.
In this post, I'll argue why rental property income is superior to stock dividend income, focusing on how much an asset's value is affected to generate the income. It’s a unique point of view I don’t see anybody tackling.
The Source Of Stock Dividend Income
Dividends are distributed from a company's net income, which is income remaining after all expenses, including taxes, have been deducted. This means a company must first pay corporate income taxes on its earnings, and then it can distribute the remaining profits to shareholders in the form of dividends.
When a company pays a dividend, it reduces the cash on its balance sheet by the amount of the dividend payout.
A dividend isn't free money for shareholders, nor does it come out of thin air. This idea that dividend income is “free money” is one of the biggest misconceptions in finance.
The main reason a stock doesn't permanently decline by the value of its dividend payout is due to the expectation the company will continue paying a similar dividend going forward. If there are expectations for a decline in dividend payouts, the company's stock price will suffer.
The Source Of Rental Property Income
Now let's look at a rental property that generates rental income. The rent comes from the utility (shelter) the property provides. Instead of reducing a rental property's balance sheet after every rent payment, the property's condition gets slightly more worn over time. Eventually, the landlord will have to paint the walls, replace appliances, and so forth.
But unlike the $1:$1 decline in cash for dividends paid to shareholders, the decline in a property's condition each month is far less than the rental income it generates. A landlord might have to paint the interior walls once every 5-10 years. Appliances might need to be replaced every 10-25 years, and so forth.
As a result, after let's say five years of renting out the property, 70%+ of the rent can potentially be captured as “profits.” Here's an example explaining why rental income is superior to stock dividend income.
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Stock Dividend Example
You own 70% of a company valued at $1 million that pays a 2% dividend yield each year, or $20,000. The company generates $40,000 a year in net profits and retains all $40,000 of it. The company therefore has a 50% dividend payout ratio.
After five years, shareholders earn $100,000 in dividends ($20,000 X 5), and the company is left with $100,000 in cash on the balance sheet. If the company didn't pay a dividend, it would have $200,000 in cash after five years.
This extra $100,000 in cash, if it wasn't paid out in dividends, is real money. The company would be valued at $100,000 more if sold with the cash.
Rental Income Example
You own a $1 million rental property that has a net rental yield of 4%, or $40,000 a year. After five years, you collect $200,000 in rental income after all expenses, but before taxes.
Your tenant moves out after year five, and you spend $5,000 painting the walls and replacing some appliances. Your $200,000 in rental income declines to $195,000 in net profit. If you want to take out property taxes too, you can by $60,000. We’re now at $135,000 in net profit.
In five years, your rental property can still generate at least $40,000 a year in net rental income. But due to inflation and a strong economy, you might be able to charge 10% – 20% more in rent.
In other words, the cost to pay dividends equaled a 100% decline in equivalent cash for the company, but only a 2.5% decline in the condition of the property, which was rectified through new paint and appliances. If we include property taxes, net profits decline by about 32.5%. As a result, rental income is superior to stock dividend income.
The Changing Value Of The Company And Rental Property Is The X Factor
Although rental income is superior, another variable to consider is the change in value of the company and rental property over time. Historically, stocks tend to appreciate at slightly more than double the rate of real estate (~10% vs. ~4.5%).
As a result, from an unlevered perspective, an equal amount invested in dividend stocks should provide a larger overall profit (returns plus dividends) than an equal value invested in rental properties.
However, the math changes once you introduce leverage when buying real estate versus unleveraged stock purchases. In a bull market, with leverage, owning real estate usually creates a higher cash-on-cash return. Higher absolute returns is one of the main reasons why I prefer real estate to stocks.
The reality is, comparing unleveraged stock ownership with leveraged real estate is the most common scenario. Most people buy real estate with a mortgage, while most stock investors don't buy stocks on margin for the long term. It’s easier to acquire a $1 million property after putting 20% down than acquiring $1 million of dividend stock, even with margin.
Remember, we're comparing dividend stocks, which tend to be more established companies with slower growth, to rental properties. Investing in growth stocks that pay no dividends is for capital appreciation, which is a different comparison.
Qualified Dividend Income Tax Treatment
Both dividend income and rental income are taxed favorable compared to W2 income. However, non-qualified dividends (also called Ordinary Dividends), is taxed as ordinary income at your marginal income tax rate.
Qualified dividend income receives preferential tax treatment in the United States. Here's how it's taxed:
- Tax Rates:
- 0% for individuals in the 10% and 12% ordinary income tax brackets
- 15% for most individuals in middle to upper tax brackets
- 20% for high-income taxpayers (those in the top tax bracket)
- Income Thresholds (for 2024):
- 0%: Single filers with taxable income up to $47,025; Married filing jointly up to $94,050
- 15%: Single filers with taxable income between $47,026 and $518,900; Married filing jointly between $94,051 and $583,750
- 20%: Single filers with taxable income over $518,900; Married filing jointly over $583,750
- Additional Tax:
- Net Investment Income Tax (NIIT) of 3.8% may apply to high-income taxpayers
- Qualifications: To be considered “qualified,” dividends must:
- Be paid by a U.S. company or a qualified foreign company
- Not be listed as an unqualified dividend with the IRS
- Meet certain holding period requirements
- Holding Period:
- You must have held the stock for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date
- Reporting:
- Qualified dividends are reported on Form 1099-DIV in Box 1b
Although qualified dividend tax rates are favorable, there is double taxation. Double taxation occurs when a corporation pays taxes on its profits and then its shareholders pay personal taxes on dividends or capital gains received from the corporation.
Remember, tax laws can change, and individual circumstances vary. Always consult with a tax professional for personalized advice.
Rental Income Tax Treatment
Rental property income is taxed differently from dividend income. There is no double taxation. Here's an overview of how rental property income is taxed in the United States:
- Income Classification: Rental income is generally considered “passive income” by the IRS.
- Tax Rate: Rental income is taxed at your ordinary income tax rate, not at the preferential qualified dividend rates.
- Reporting: Rental income and expenses are typically reported on Schedule E of Form 1040.
- Deductible Expenses: You can deduct various expenses from your rental income, including:
- Mortgage interest
- Property taxes
- Insurance
- Repairs and maintenance
- Property management fees
- Utilities (if paid by the landlord)
- Depreciation of the property
- Depreciation: You can deduct the cost of the property over its useful life (27.5 years for residential properties, 39 years for commercial).
- Net Income: Your taxable rental income is the net amount after subtracting all allowable expenses from your gross rental income.
Depreciation Example To Reduce Tax Bill
As a rental property owner, you can often pay a 0% tax rate on your rental income due to the deductible expenses plus depreciation, which is a non-cash expense. Isn't 0% tax better than paying double tax? You bet!
Let's say you purchase a rental property for $800,000.
Step 1: Determine the value of the building. Assume the property assessment shows that 80% of the value is for the building and 20% for the land. Building value: $800,000 × 80% = $640,000
Step 2: Calculate annual depreciation Annual depreciation = Building value ÷ 27.5 years, $640,000 ÷ 27.5 = $29,090 per year
Step 3: Deduct depreciation on your tax return. You can deduct $23,273 each year from your rental income. That's a large tax shield.
Additional considerations:
- If you buy the property mid-year, you'll need to pro-rate the first year's depreciation.
- When you sell the property, you'll need to recapture the depreciation, which means you'll pay taxes on the amount you've depreciated over the years.
- Depreciation can create a paper loss on your rental property even if you're cash-flow positive, potentially reducing your overall tax burden.
Rental Income Will More Easily Support Your Retirement
If you are a competent rental property owner, the rental income will better support your retirement. Rental yields tend to be much higher than stock dividend yields. Over time, you'll benefit from the inflation wave by earning higher rents. Additionally, your rental property should also appreciate in value.
If you want to retire or retire early, investing in rental properties will make achieving your retirement goals easier. You'll have to put in occasional work to find tenants and maintain your rental property. However, you'll gladly do so in your 20s and 30s to find a way out of working forever.
Once you've actually retired, you might not mind dealing with your rental properties as much, given it's nice to have something productive to do. Any work you do on your rental property will see immediate results, like landscaping, which is always gratifying.
Of course, your rental property could face catastrophic damage, wiping away profitability. But that's why you have insurance. Companies can also face existential crises too that can wipe away shareholder value instantly.
My Rental Property And Stock Dividend Ownership Plan
I plan to keep my rental properties for as long as possible. They are our main source of passive income, allowing my wife and I to remain unemployed. However, I will not be buying any more physical properties until we relocate to Honolulu. When that time comes, in 2030 or later, I might sell one or two rental properties or my primary residence, to have enough capital to purchase a new primary residence.
In the meantime, I'm dollar-cost averaging into a private real estate fund to diversify into the heartland and generate more passive income. Ideally, I'd like to have 30% of my real estate exposure outside of San Francisco and Honolulu. I just got another passive $7,900 real estate capital distribution which was a nice surprise.
Additionally, I'll continue to dollar-cost average into the S&P 500, which pays a ~1.6% dividend yield. I'm not focused on buying high-dividend-yielding stocks since my income exposure comes from real estate. With stocks, I'm more focused on capital appreciation.
Ultimately, my goal is to own rental properties, private real estate funds, and the S&P 500 for the next 20+ years. I'm investing not only to fund our retirement but also for my children, who currently lack the capacity to invest. I'm confident that in 20 years, our children will be grateful we decided to invest today.
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“In retirement, you might even appreciate having productive tasks in managing rentals.”
I’m not the biggest fish out there, but as a landlord for more than a decade, it’s important to remember my time to perform any productive tasks in managing rental should not be considered free. Hiring a property manager, handyman/woman to perform maintenance and repairs etc. is part of the cost of operating the “business”. As individual owners, by all means tackle all the tasks to the degree one wishes, but dont count your profit without subtracting the value of the work you put in.
Too many times I see people investing in properties that are non-income generating if it’s not for doing all the work themselves. If that the case, the real estate isnt making them money. The basically bought themselves a an underpaying job.
Long time reader, first time responding to article here. I agree with the leverage advantage for rental property. Stock dividends have big advantage as they yield passive income and there are no ongoing expenses you need to worry about when holding the stock. On the flip side, rental property is not passive income and there are expenses which need to be taken into account: property taxes, maintenance (repainting walls, replacing/repairing appliances, fixing plumbing, roof leaks, yard maintenance, deep cleaning during tenant turnover etc), HOA (if applicable), vacancies (depends on local market and competition), property management fees (if applicable). In your example above, $5000 for repairs across 5 years is very conservative estimate especially for HCOL regions. I would budget at least twice that amount given the inflation and high hourly rates charged by handyman/plumber/electrician etc. Also, you haven’t included mortgage interest and home insurance costs for those 5 years.
From pure cash flow perspective, rental income is monthly whereas dividend is typically paid quarterly. Dividends can be reinvested immediately which helps w/ compounding. In summary, I think it’s better to have both which helps w/ diversification of assets.
You’re probably right on the $5,000 being conservative. But I’ve spent less in 5 years on multiple properties I own. And any damage comes out of the rental deposit. It’s mostly just paint, changing a leaking pipe, changing a dishwasher.
I don’t like doing work on rental properties. But I’ve realized that doing work on them while not having a job gives me something purposeful to do. And that feels good, especially when I have this void to fill once both children go to school full-time in September 2024.
Enjoy all your articles.
We just had the same drawn out discussion with family yesterday at a BBQ. The majority are well off equity investors, but now wish they had the foresight years ago to acquire rental property/passive income.
At one point we had 50 rentals that we self managed with a couple of retired maintenance guys on call when needed. But we quickly learned to buy properties cash at tax lien auctions, do nothing to them, then sell them for 2-3x our cost. We would then hold the notes for fellow investors @ 12-13%. Making that APR significantly higher than the 12-13% & blows away any of my family member equity returns or current financial status. All still work & we retired very early.
We still have investors, (one bought 6 from us), paying us 10-14 years after they bought the properties from us. These are our RE annuities & we currently hold 42 in escrow accounts at the bank. Our kids also have their share of the same, & all graduated without student loans & own their homes that are being paid down with passive rental/note income.
After 40+ years we are downsizing & sold off another 5 more recently, but again hold all the financing with 5yr balloons, thus spreading the capital gain over that period.
Sure we had a few bad tenants, had to rehab a few & took back some properties ‘deed in lieu of’ & 3 foreclosures. But we never lost money on any of those properties after reselling & again holding the notes. On those we still own the capital appreciation/depreciation recapture has been significant, so a 1031 exchange is in the works.
Our 401(k)-solos were all RE invested & now as we cash out they are invested to collect dividends, but still ready to jump on another flip.
We live between 3 homes & have not had a mortgage or any debt since 1998 & we have ‘deducted’ every truck/SUV we’ve owned using Sect. 179 or bonus depreciation.
Yes I have survived 2 extensive IRS Audits the last one was this year.
RE is not for everyone but the returns can & have been be exponential.
Thanks for sharing your experience managing rentals. 50 is a lot! I’m assuming your investments in rental properties have made you a multi-millionaire with tremendous cash flow as a result.
What do you think triggered these IRS audits? Given you mentioned it was extensive, did a person come to your house?
Many of the 50 properties were multi-2-4 units & they sold well. Those who bought seller financed from us, always had enough rental income to justify our high rates. Cash flow was indeed exceptional & still is.
The 1st IRS audit was of my 2012 return. It was triggered by a very high mileage deduction because of construction work/repairs/rehabs etc. Once that was ‘justified’ the IRS Agent then decided to go back from 2012 to 2005. I spent 3 hours a week over 6 weeks at their offices submitting documentation & explaining everything. They finally decided I owed $9800 in taxes & penalties on what they deemed was earned income. 2 years later without any input or dispute from us they sent me a check for the $9800 plus interest admitting they made a mistake.
The 2nd audit was of my 2019 return triggered by high cell phone/WiFi expenses. These costs were linked to first responder security systems mandated by code on several rental commercial & apartment building properties that we own. Once that expense was ‘justified’ the audit then became a weekly 2-3 hr phone call from the IRS Agent. The duration was from 3/18/22-5/24/22.
She then proceeded to investigate all property purchases/sales/dispositions/repairs/expenses etc etc from 2019 back until 2012. Again I represented myself with my wife retrieving all the required ledgers, receipts, closing statements & deed/title documentation. Close to 1000 pages were scanned & emailed along with a detailed explanation of what was done & why.
In the end it was a wash, no taxes owed, so my wife was convinced it was a training exercise. However, the Agent admitted they were surprised that we had such compete & detailed documentation/records that could not be disputed.
Unlike equities there are so many legitimate nuances in the tax code that allows a large passive income stream from real estate to be ‘deducted away’ to a very low taxable threshold & that I think bothers them.
From a retiree standpoint I tend to somewhat disagree with you, Sam. Not sure if in retirement I’d like to work as a handyman to maintain our rental properties especially if for 7 months a year we are living 1000 miles away. Some people want to continue being landlords in retirement but many don’t especially when health issues become a problem. Our problem was we had properties in 4 states so those far away we were afraid to rent and kept them for personal use. So rather than cash inflow we had a significant cash outflow on those. After selling them we have had a significant NW increase from stock appreciation and cash inflow from dividends. During our 20-year rental experience we had one bankruptcy, two court evictions, and one devastation. Somehow during covid our rents came in time. We also had a couple of good tenants who wanted to become landlords and bought properties from us. We still have one leased property with an option to buy that generates tax free income for the next 10 years structured not as rent but as cost of capital where the potential buyer is also responsible for HOA fees and property taxes.
There is one aspect of dividend income that has not been discussed. Unlike rental income which before retirement we needed to supplement our salaries, all our dividend and interest income (which is more than 2x our former rental income) is reinvested after paying taxes even though we keep yield below 1,5% due to growth preference. It is true that real estate provides great wealth building tool for younger investors with only 10-20% money down. It is also true that dividend income requires significantly more capital than real estate to generate the same amount of income but it all becomes irrelevant after FI has already been achieved. Rather than property maintenance our biggest headaches in retirement are federal taxes, high Medicare payments, and RMDs, which we send to charity to lower our tax burden.
“ Our problem was we had properties in 4 states so those far away we were afraid to rent and kept them for personal use. So rather than cash inflow we had a significant cash outflow on those.”
This sounds tough to manage and definitely not an ideal situation. All my rental properties are within 5 to 25 minutes away.
Yes, as we get older, we want to simplify life more. Which means less rental properties.
Except the capital gains at time of sale on rental property (since not primary shielded 500k appreciation) at ordinary income rates if you sell
I wrote about this exact subject on Quora many years ago and came to the same conclusion! I don’t often post online but my article got a lot of attention and I was surprised to see so many comments and upvotes.
My wife and I currently work in big tech and own 25+ units and self manage all of them. We started from nothing many years ago and slowly bought 1-2 properties every year (the RE version of dollar cost averaging). It took a few years, but we reached our goal of 7 figures in net worth. Then came the pandemic and we doubled down and bought even more properties. We also refinanced our entire portfolio into sub 3% loans. The combination of rapid appreciation and cash flow pushed us over 8 figures in net worth. We are now FI and no longer need to work (we still do since we love our jobs). The only regret we have is not starting sooner.
The best part is the satisfaction we get after fixing up the places and adding a ton of value (big fans of the BRRR strategy). We are taking it a step further by using our existing portfolio and subdividing the land and building new structures to either sell for profit or keep as rentals.
We own stocks too (for diversification) but the possibilities when it comes to physical RE are endless! Especially in high appreciating markets like Seattle where the tenant pool is mostly responsible tech workers like ourselves. Yes, we have tenant horror stories but those are the exception. With experience, we are getting better at filtering out bad applicants. And as you mentioned, once we quit our W2 jobs, having something to focus on part time will be the perfect transition into retirement.
The community is fun too. We participate in a bunch of local area meetups and on occasion travel with other investors across the country to evaluate opportunities. Learning from others and networking is invaluable.
For new (and experienced) investors, one thing to keep in mind are regulatory changes. Staying up to date on these is critical and can have a BIG impact on your investment strategy.
https://www.quora.com/Is-it-better-to-invest-in-rental-properties-or-dividend-stocks/answer/Ryan-Thurston
Would love to see your additional analysis of rent growth versus dividend growth factored in and also dividend reinvestment plan versus equity harvest in rental properties.
I might have missed this point. But the biggest difference to me is isolation from the stock market. That is more volitile than real estate. And as an individual, you have no control. Rentals also shift with factors you can’t control, but not as much? And you do have some ability to manage your rentals.
Yes, one of the benefits of owning rental properties over stocks is less volatility. When the S&P 500 is down 2% one day, it’s nice to know that your rental properties just keep chugging away.
I remember reading Peter Thornhill’s book, Motivated Money, who disagrees around volatility. His premise is that stocks being more volatile isn’t actually true; it’s just we don’t get daily reporting’s of our house’s valuation (from actual buyers) like we do in the stock market. This gives a false impression of stability and is actually due to lower liquidity (which is not actually a good thing).
It’s been a long time since I’ve read Motivated Money, but he has a whole chapter on why he cites dividend stocks as being better. I can’t remember all of the arguments, but he cites publicly traded REITS (Real Estate Investment Trusts – which buy, manage and derive income & capital gains from rentals), and shows over several decades they have not kept pace with the rest of the market. And he goes into depth on explaining why ‘on the face’ yields are deceiving – it’s really yield growth that’s far more important.
The other factor is horror tenants. Worst was my brother, who despite his property being professionally managed, and having landlord insurance basically ended up tens of thousands out of pocket. His house was being used as a drug lab – and everything (even the kitchen cabinets and carpets) being stolen (and sold). It took months for the courts to throw out the tenants. The payout from landlord insurance only covered a fraction of the overall cost.
Good Article. I went through this exercise couple of months ago when 2 of my rentals were vacated. I did the math of sell vs hold and selling and investing in S&P500 gave me 3% more returns and less income taxes. In my case I was getting 7% returns on rental vs the 10% on S&P500. We are high W2 family and it made sense to opt for high capital appreciation in stocks vs rental income. It all depends on rental yield in my opinion. Prior to covid bump, i was getting about 13% rental yield but not anymore with the house appreciation. I am interested to see the case against selling as investing in S&P500 is more tax efficient, less hassle and more total returns.
If you have decent tenants that don’t add to your daily misery. Haha, lucky landlords with rental income are like those with a goose that lays gold eggs consistently. A lot of people choose not to be landlords because they don’t fit in the business and they don’t want to deal with tenants and various house issues. It is a good source of income but only fits certain group of people. Whatever income stream you choose, bottom line is you don’t want to sacrifice your physical and mental health for anything.
Have you had a difficult tenants in the past? If so, what happened?
What about hiring good property managers to take the hassle out of managing properties? I know it adds additional cost but the tradeoff is less day to day hassle.
Your question:
Do you think rental property income is superior to stock dividend income? If not, why? What is your ideal split between rental properties and dividend stock exposure in your investment portfolio? How, if at all, does it change over time?
I think Sam you have absolutely knocked it out of the park with your information/income from your blog. Thank you and congratulations!!
For sure cash flow from income producing properties are superior to Dividend paying stocks.
I don’t own any income producing stocks. Your only advice/mistake is that you have not invested in triple net properties.
You have maintained a buying style that allows simplicity
…buying single-family homes and renting them out. It minimizes returns and also maximizes work.
Had you bought warehouses/grocery store/dealerships/medical buildings that were triple net you would’ve minimized your and maximize your turn much greater.
JJ
Hi Sam! Another great article. Curious if this would apply to Airbnb rentals? We’re seriously considering purchasing a rental in Hawaii – something small like a 2/2 condo. We want to live in it about 2-3 months out of the year hence the Airbnb vs a longer term tenant. I know you used to live in Honolulu (was just there two days ago) and are moving back so would love to hear your thoughts! Thank you! Big fan.
I would check the latest short term, rental news and long-term rental news in Hawaii. Sounds like you know the changes going on there.
Personally, I’m not a fan of offering a short term rental, because the amount of turnover and work required. I don’t know how many people would be willing to run for over a month at a time as well.
In general, I am against owning rental properties.
Short term rentals come with their own set of challenges but in my own experience, they produce 3-5x the income, and they are far less damaging to the property. Long term renters treat places like their own — and that’s not always a good thing. Short term renters don’t “move in” — they have a light footprint, the house gets cleaned on a regular basis, and it stays in great shape. Of course there are exceptions and nightmare party stories, but those are very much outside of the norm.
That’s great perspective on short term renters not “moving in” per se. I never thought about it that way.
At my age, with the number of rentals, I’m mad at myself, I just don’t want that much turnover anymore.
I certainly hear you. But the turnovers are done entirely by our housekeeper. We give her our rental calendar for the month and she cleans accordingly. We simply pay her the cleaning fee that our Airbnb renters pay.
Or you could go the property management route if you really wanted to avoid thinking about it at all.
What % of home value should one expect to gain in rent if the home is paid off?
My thought is that, if one was investing for retirement, you would aim to be mortgage free when you needed the money so that most of the rent would go into your pocket.
Hi Sam – thank you for your work as always. Your piece here definitely hits as we make our money off these two as well! One thing that might be missing yet could be very applicable to your readership is the tax treatment for “owner operator” landlords that was implemented in Trump’s Tax Act (yet also set to sunset in 2025 if not ratified):
https://www.nolo.com/legal-encyclopedia/landlords-must-be-in-business-to-claim-the-20-pass-through-tax-deduction.html
Of course some nuances involved income thresholds, but likely still applicable to most families like us.
This also applied to REITs which are typically treated as non-qualified dividends – but do qualify under this same section (IRS 199A)
-Adam
Hey Sam, this was great read and full of interesting insights! I really enjoyed the in-depth breakdown of figures and your thought process behind the math.
I just wrote a blog post on my blog, Wealth Orb, comparing dividend income growth from the Vanguard total market index (VTI) to average annual salary increases in the US, across all industries. I had some key findings that made me view this article from a different lens.
What I found in my own research was that dividend income growth from VTI (from 2002-2023) grew with an 8.42% CAGR. Salaries grew at just 3.15% CAGR over the same time according to the SSA’s Average Wage Index. What was also interesting was that I found median rents increased at 3.11% CAGR between 2000-2023, very close to mirroring the growth of wages for the US over a similar time period.
The CAGR of income growth on VTI was more than double the median rent growth across the US, despite it being harder to use leverage to buy stocks when compared to real estate and total yields on stocks being lower.
Another call out I’d add about investing in stocks is the easy diversification across geography, something you don’t necessarily get with personal real estate investing, especially if you own just one physical property.
VTI gives exposure to around 3,700 different companies, hundreds (if not thousands) of which pay a dividend. There’s a lot more risk in something happening to a single rental property that stops you from collecting rent, at least in the short term. It’s very unlikely that something will happen and stop you from collecting dividend income from 1,000+ companies in an index.
I’d also argue it’s much easier to reinvest your dividends into your portfolio in stocks compared to real estate properties, outside of a REIT. With a rental property, you’d likely need to wait between tenants to make significant improvements and reinvest in a single property in ways that would improve rent income. With DRIP and stocks, you will start earning more dividend income after reinvesting your dividends just one quarter after the reinvestment.
Data I found shows that from 1960-2023, dividend reinvestment of the S&P 500 accounts for 85% of the cumulative total returns of the index. It’s critical for long-term investing success to be able to reinvest dividends and that’s something that’s inherently more difficult in investing in single real estate properties.
I’m in the same boat as you. I love both real estate and stocks as part of my investment portfolio, and I’m going to continue to invest in both!
Thanks again for the great and thought-provoking article.
– Drew Cordell
Man, I just found out about the Passive Income Rule. Was hoping to deduct losses from active income beyond deductions generated for rental income. Was going to purchase a house and have daughter pay majority of the mortgage. Then, help her buy a house in a couple years. Passive Income Rule is a monkey wrench.
Another fantastic article! I’ve been reading since 2018 (don’t think I’ve commented previously) and have benefitted greatly from your perspectives. Lots of helpful insights and I’ve been utilizing Personal Capital/Empower and Fundrise ever since because of you. Keep up the great work!
What are your thoughts on selling stocks gains as a source of income? Stock returns, on average, outperform real estate. There is generally a trade-off between dividend and capital appreciation. I prefer to look at it from a total return perspective, in which case dividends and capital gains are an equivalent source of passive income.
I have a current rental property and two others that are in preparation for rental, along with crowdfunding and private investments. The current rental property experience is making me me consider getting out of the actively managed side of real estate. We’ll see how the crowdfunding and private investments turn out in 3-5 years…
Bumping this question^. Math says you will likely end up with more money in retirement if you focus more on Capital appreciation than income Investments during your working years. Why not just appreciate Capital in growth stocks over the decades, then start selling it off when you no longer have W-2 income to buy more (retirement)?
Counterpoint: some of us who are younger are worried about the long-term collapse of the American economy if the dollar would eventually no longer be the world’s reserve currency and/or other nation’s call in our debts. Real estate would obviously be hurt by this as well… But people still need places to live so probably, less of a disaster than if all your wealth was in the stock market?
My dividend stocks have never called me in the middle of the night to fix the plumbing. Personally that’s worth the difference in returns you cited. However, on a strictly financial analysis you are correct.
As a small rental property owner, (I own 4 SFH rentals) I have been comparing the ownership of SFH vs Stock Market investments. And as I compare my life and lifestyle
as opposed to my peers who have invested in the Stock market I don’t have sleepless nights about the constant movements of the Market. Altho’ I have seen many small property owners take the first applicant who has money in hand, and without doing the proper checks of history, and they live to regret it. Over the past 46 years I have only one family I have had to ask to leave. Then again I have many families who have chosen to stay for 10 plus years.
Yes, there have been expenses (professional painting and carpet cleaning) but over the course of time, and amortizing, the cost has been minimal. And thru the use of many 1031’s I have been able to upgrade the SFH’s to larger and more desirous locations.
Let’s not forget, the residents pay the property taxes, Maintenace and insurance for us thru their rental payments. Give me the worst home in a much better neighborhood, that is where your make your money. And a 5 gallon bucket of the worst paint (lasting 2 years) and the best paint (lasting 7 years ) is about $150. The painter charges to same regardless of the quality of the paint. Provide a quality residence, and you get quality residents.
Wow thanks Sam. This is such a helpful analysis and demonstrates your writing prowess at its best. I certainly have never compared stock divs and rental income side by side. So thanks for doing the hard part for us and making it easy to compare the differences! Very helpful to look at everything from capital, level of involvement/maintenance, changes in value, taxes, and depreciation. Thank you!
I think the main issue with this article is that it’s not an apples-to-apples comparison. Just your first sentence alone…
“I’m a fan of both stock dividends and rental property income, my two favorite sources of passive income.”
We all know that rental property income is NOT passive income.
True. Rental property is semi passive income. But it’s actually quite fulfilling to remodel a rental property for greater rental income. In addition, I found that once you’re retired, you better appreciate the productive task of maintaining your rental property.
Do you own rental property? And if not, has dividends stocks, been able to take care of your basic living expenses? It would be great to know your background and story so I know where you’re coming from.
If you don’t own rental property, I encourage you to expand your point of you with this article. Because I have on both for over 20 years now. And only rental properties has by far can a greater contributor to being able to retire early.
It may be fulfilling to you (and others), but not at all to me. That’s why I exclusively invest in REITs and from crowdfunding sources (per your recommendations).
I do not. Never say never, but I’m 99% certain. At this point, piling into truly passive investments is my one and only investment vehicle to reach financial independence. The goal is another 10-15 years or so…not there yet.
I have previously expanded my point of view, and have done so many times via multiple iterations. Your positivity has provided me with the “best case scenarios”, but I have also taken my nature and views into consideration. For me, it’s passive all the way.
Sounds good. You have to do what’s best for you. It’s hard to keep track of everyone I corresponded with. The count is in the thousands.
Did you have a particularly bad rental property owning experience, which is why you sold it and haven’t returned?
I did in 2017 so I sold my rental property to simplify when my son was born. But I’ve rebuilt my portfolio as I saw Opportunity and gained back more purpose for why I’m investing (for them).
I can imagine!
Not me personally in terms of me owning, but with me as a renter for sure. I put myself in the owner’s shoes many times, and this is without me being a real pia. Just normal stuff. And then, of course, I have close friends with horror stories. I’m also more of a “glass half empty” person in general, so the positive stories don’t move the needle as they do with some people.
Good for you admitting your half-empty temperament and moving forward with achieving your goals accordingly!