REITs vs. Rental Property: Here’s Which Strategy Made Me Earn More Money

II’ve been investing since I was 14. In a way, it’s the last 18 years (how can I be 32 already?). During this period, I have always had a job and saved, read hundreds of books on investing, paid attention to stock market news, obtained degrees in finance, etc. TL;DR: I spent a lot of time, energy and money in the stock market.

The amount of money I’ve made investing in stocks during this time (thanks to two full-fledged bull markets) pales in comparison to the amount I’ve made from rental real estate. Of course, it’s not because I’m a genius real estate investor. This is largely due to timing and luck, but also due to the leverage inherent in rental property investing.

To illustrate this concept and show how some of the principles I followed in real estate investing would have improved my stock market returns, I’m going to compare two investments I made around the same time. In December 2014, I purchased a 600 square foot condo with the intention of renting it out after living there for at least a year. In February 2016, I bought 100 shares of Annaly Capital Management (NYSE: NLY), which is a mortgage REIT that often has a dividend yield above 10%. We’ll start with Annaly.

Image source: Getty Images.

Annaly

Annaly is a mortgage REIT (real estate investment trust). It borrows money and invests it in mortgage-backed securities which are usually guaranteed by the government. He makes money on the difference between the two rates. As long as its borrowing rate remains low and the mortgages it purchases are not prepaid, it generates cash to distribute to shareholders.

I bought the REIT as a source of income. It had a high dividend yield and low volatility, so I sold covered calls on the position to increase the dividend yield. Here’s a chart showing all the transactions I’ve had on Annaly since that first purchase:

Transaction Sum of amount
To buy ($7,845.21)
Current position $1,621.90
Dividend $566.82
Option premium $204.39
Sale $6,243.35
Total $791.25

Over the years, I’ve earned $566 in dividend income and $204 in options premium income from Annaly. I’ve been reminded of the stock several times, and I’ve usually redeemed it soon after, except for a two-year period when I didn’t own it (and missed out on good dividends). It is certainly possible that if I had abandoned the covered call strategy and held the stock all along, I might have made more money. Here’s what Annaly’s total return has looked like since February 2016.

NLY Total Performance Level Table

NLY total performance level data by YCharts.

Rental property

I bought the condo in December 2014 for $90,000 with about $5,000 down payment (note that I am using all round numbers for this example to make it simpler). I lived there for more than a year, which is necessary to buy it as a residence, then I started renting it out.

Since I started renting the property it has generated just over $12,000 in cash. My total investment is around $24,000 if you include the down payment and all the mortgage payments I made before I rented it. That’s a 50% return in about five years. But there’s more on the way back.

The real estate market has become gangbusters in Utah, where I live, over the past five years. According to an appraisal I got in 2021, the condo is worth around $229,000 now. That’s good for capital appreciation of 154%, or 14.3% per year. But wait, there’s more!

I paid off the mortgage the whole time. For the first few years, I paid personally, and that amount is included in the total investment of $24,000, but since he started renting, the tenant has actually made those mortgage payments. Currently the total debt on the property is $72,000. This means there is $157,000 in equity.

If you add it all up. I invested $24,000, received $12,000 in cash, and have $157,000 in equity. That means my $24,000 investment turned into $169,000. That’s a return of 604%, 48% annualized. Note that if I sold the property and had an average tax rate of around 20% on the sale, the taxes would reduce that annualized return to 39%.

The comparison

Of course, if 48% annual returns were common in real estate investing, no one would invest in anything else. There were a few factors that worked in my favor that won’t always (or even often) happen. Let’s review them:

  • Capital appreciation: It is not normal for the market price of a condo to increase by 14% per year. A combination of low interest rates, Utah’s growing population, and limited supply all contributed to this price move.
  • Interest rate: Interest rates have helped me in two ways. They contributed to the price appreciation and also reduced my mortgage payment. This means that I was able to keep more cash each month and more of my payment was allocated to reducing principal.
  • Other expenses: Interest wasn’t my only relatively small expense. During the rental period I replaced the AC unit, washing machine and garage door. There were no other significant expenditures. For a 40 year old condo I could have had a lot more problems and probably more vacancies too.

Besides getting lucky on a few rental factors, Annaly hasn’t been a great investment. Even if I hadn’t traded around the position with options, a 39% total return over six years is a big meh.

We’ll end with a slightly more reproducible modified scenario. Let’s say you buy a rental condo for $90,000 that receives $10,000 in cash and has a market price of $150,000 after five years. Let’s also say that instead of investing in Annaly, you invest in Prologis (NYSE: PLD)an industrial REIT that performed better.

Prologis’ total return would be 270%, and it peaked at over 300%.

NLY Total Return Price Chart

NLY total return price data by YCharts.

The $24,000 investment in the condo turned into $10,000 in cash flow and $78,000 in equity ($150,000 – $72,000), a total of $88,000. That’s a total return of just under 270%.

Both strategies can be very profitable, as long as you hold on. Going in and out of my Annaly position probably halved the total amount of dividends I earned over the period. With Prologis, subtracting dividends would reduce the yield to 210%.

Now an investor a nice return by selling the condo. But then what? You’ll have to pay capital gain taxes, miss months of rent, and then invest the proceeds in a new investment. In stocks and rental real estate investments, it generally makes sense to hold for the long term.

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Mike Price holds positions at Annaly Capital Management. The Motley Fool fills positions and recommends Prologis. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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