Using Rental Property as an Analogy for Dividend Stock Investing

Stocks are not generally understood by many.  After all, it’s not really something you can see, touch, smell, touch, or taste.  While representing ownership in a company, most think of the trading floors with old guys screaming and waiving their hands or just numbers that flash across a screen.  Stocks are simply invisible, numbers on your computer screen that show some kind of value.

Real estate on the other hand comes across as sexy.  An easier concept for any type of investor to understand.  You can see the building, touch it, smell it (especially an old place), and for weirdos you can certainly lick it.  We know that if you own this building, there are 2 ways you make money on it, rental income and appreciation in the value of the building.  Each month you want to be cash flow positive (more rent coming in than your expenses and mortgage), minimize vacancies, have no problem tenants, increase rent over time, and hope over time the property itself increases in value.  Over time your renter can even pay off your property for you.  Pretty simple concepts really.

If you stop and think about it for a second, is dividend growth stock investing really all that different from being a landlord and having rental property?

Short answer is no, but please read on.

Cash Flows…

One reason people get into rental properties is to build passive streams of income.  Collect your rent, pay your expenses, be cash flow positive when it’s all said and done.  Hopefully nothing goes wrong during the month and your cash flows can be pretty predictable each month during the rental agreement.  When time for renewing the lease, you increase the rent slightly to account for inflation.

Dividend growth investing is very similar.  You buy the stock, collect your quarterly dividend, if there are no issues arising during the year, the company increases the dividend for the following year.  Notice one difference with dividend stock investing, expenses.  You don’t have expenses with your stock investing, so the dividends are pure positive cash flows.

Want to build more passive income?  Under either method, you’d be looking at buying more rental properties or additional stock holdings.  Wash, rinse, repeat…

Taxation on the dividends and rent are treated differently.  With rental income, it is taxed at your ordinary income tax rate.  You can offset some of the income with your rental property expenses and depreciation.

With dividend income, an investor can have a more favorable tax rate ranging from 0% to 23.8% if you meet the holding period for “qualified dividends” (hold the stock 60 days before ex-dividend day and 60 days after) and depending on your ordinary income tax bracket.  For ordinary dividends, your tax rate on dividends is your ordinary income tax rate.  It definitely pays to be a long term dividend investor and pay less in taxes.

Assuming a rental property and investment portfolio of equivalent values, you would expect your monthly rental income to be higher than your dividends flowing from your portfolio.  The trade off, I would argue, more potential risk in the rental property, such as a problem tenant not paying, damaging the property, or worst case having to go through the eviction process.

Something cool with dividend investing, that you can’t immediately do with real estate is reinvest your dividends.  Reinvesting dividends allows you to immediately increase your future dividend cash flows with purchasing those fractional shares.  With rental income, you can’t really take the rent from one month and reinvest it.  You can put the money in the bank or maybe pay down the mortgage a little.

Capital Appreciation…

The second component of real estate and dividend stock investing is capital appreciation, the growth in the value of the asset.  For an investment in a stock, say JNJ, it’s real easy to find the current value of the stock.  Just jump onto your brokerage account, type in the ticker symbol and you have the current market price.  Need to sell to raise capital, click the mouse a few times to sell.  The transaction cost is practically nothing these days thanks to the crazy competition among the brokerage houses.  With stocks, you basically know value of your holdings at any second you want to look it up.

Real estate can be a little trickier.  Want to know your properties value.  A real estate agent will look up comps.  Want to hire an appraiser, yeah, they’ll look at comps too.  They’ll add or subtract value from the property based on features in the house.  Sure you can look at a site like Zillow, but the price they show is based on an algorithm.  Want to raise capital from real estate, then you’re looking at either selling the property or taking out a home equity line of credit, both have high transaction cost involved.

As far as capital appreciation is concerned, real estate is all about location, location, location.  Got a property in a hot market, you’re lucky.  With stocks, the market doesn’t care about where you live.  If the domestic and foreign economies are strong the market goes up.

Regarding taxation of rental property and stock investing, there can be big differences.  With stock investing it’s pretty simple.  Sell a stock that you’ve owned under a year, you pay short term capital gains at your ordinary income tax rate.  Long term holdings over a year depend on your tax bracket, but can be either 0%, 15%, or 20% for the highest earners.  If you don’t sell the stock, you don’t worry about capital gains tax.

For rental property, it’s a little different.  Capital gains tax can be either 15% or 20%.  Some of the sale could be potentially tax free if you are willing to do a little moving into the property.  Hell, you can even really defer the taxes through a 1031 Exchange if you are really willing to work it into your favor.  Figuring our your gains, can be a little more complicated and you will definitely want to keep good records to lower the tax bill.

A big difference between stocks and real estate is expenses.  Holding onto a stock, I run into zero expenses.  With rental properties, you run into property taxes that never go away.  There are also other expenses for maintaining and repairing the property.

Which way should you go for your investing?  I can’t really tell you that.  This is a stock site, I’ve dabbled in landlording for about 7 years.  I can say stock investing has been more enjoyable for me.  Either way, you’re accumulating a financial asset that is generating cash flows and capital appreciation for you versus putting your money in a crap or depreciating asset like a fancy car.  When you look at dividend stock investing or rental property, they both generate cash flows and capital appreciation.  One just is a little easier to understand since it appeals to the senses a little more.

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