Rental houses vs. stocks: a 25 year portfolio projection - The Darwinian Doctor (2024)

Today, I’ll compare a hypothetical portfolio of rental houses vs. a portfolio of stocks and show you a detailed projection over 25 years.

My inspiration for this post came from a post I saw on Passive Income MD (PIMD) from late 2017. This explored the concept of buying 1 rental property a year for 10 years. It was a great post, and one that galvanized my desire to start my rental real estate empire.

But given that it’s easier to invest in stocks, there had better be compelling evidence to invest in real estate to make it worth the extra hassle.

It took many hours of spreadsheet work and data crunching (like more than 12 hours), but I finally completed the projection! The results are very interesting! I hope you enjoy!

Note: After astute comments by readers, I updated my calculations in February 2020. Thanks for your great comments!

Key assumptions: the stock portfolio

• Every 6 months, invest $25,000 into VTSAX
• VTSAX = Vanguard total stock market index funds
• Total investment = $225,000 over 5 years
• Assume 8% return annually
• Allow returns to compound

Key assumptions: the rental house portfolio

• Every 6 months, buy a $100,000 rental house
  • This will cost $25,000 ($20k downpayment, $5k closing costs)
  • Houses are mortgaged at 5.5% interest fixed over 30 years
• Total principal invested = $225,000 over about 5 years
• Final cash flow after all fees and financing will be $100/month per house
• This continues until 9 rental houses are purchased
• Returns are used to pay off the mortgages
• Houses appreciate at 2% a year
• Rent increases at 2% a year

Tax assumptions: both

• I’m going for a moFIRE (morbidly obese) level of financial independence
• This is > $200k / year of expenditures
• The 24% tax rate used in these calculations is the long term capital gains rate based off of that level of income in California as of the Tax Cut and Jobs Act.
• This is a tax rate of 15% federal and 9% state taxes

I’ll list some charts summarizing my results below. Please keep on reading below for some reasoning and analysis.

• Strict value is the paper value of the portfolio (stock value for VTSAX, and combined equity for the rental portfolio).
• Total value is the same for VTSAX, but for the rental portfolio includes 25x the cash value of the extra annual cash flow provided by the rental portfolio vs the index funds, plus the extra rental income lying around from the rentals at the end of the time period.

VTSAX index funds portfolio, explained via the Socratic method

Why do you assume an 8% return?

• The historical return of the US stock market has been between 7-9%, making 8% a reasonable expectation for future average returns.

Why is the possible cash flow 4% of the portfolio value?

• The Trinity study states that over a 30 year period, a 100% stock portfolio can support a 4% withdrawal rate about 95% of the time.
• This is the basis of “the 4% rule” or the “25x rule”.

Where are you getting the exact cash flow number?

• This is based on how much principal versus appreciation is represented in the final VTSAX value.
• After 25 years, the principal is only 18% of the total.
• The rest of the value is from appreciation, which means that this part needs to be taxed 24%.
• See this chart for more details:

The 9 rental house portfolio, explained

Why are you getting a mortgage on the rental houses?

• The use of leverage in real estate has the potential to supercharge appreciation returns.
• It also lets you collect more rental houses in a shorter time frame.

Why is the return from each house only $100/month?

• This figure will vary wildly based on the type of rental home purchased.
• But based on the turnkey house options I’ve recently explored, $100/ month after all costs seems like an achievable, realistic, and conservative number.
• Yes, this includes reserves of 8% for vacancy, 8% for capital expenditures, and 9% for full time property management.

Why only 9 rental properties?

• Current mortgage law lets each borrower have up to 10 government backed (“golden ticket”) home loans at a time.
• These loans are backed by the mortgage industry, and give you the best interest rates and terms.
• Your primary home loan counts, so that leaves room for 9 more houses at a time.

Why set the appreciation at only 2% a year?

• In cash flow markets, houses often do not appreciate much more than the national inflation rate.
• The federal reserve traditionally aims for a 2% inflation rate.
• While perhaps 2% is conservative, I don’t have evidence to assume a higher inflation rate.

Why set the rent increase at 2% a year?

• Based on the data I found, this is the average annual rent increase in Alabama.

Where is the final cash flow number coming from?

• This is based off of the final rent in year 25, after a depreciation deduction and taxes of 24% on the remainder.
• See this chart for more details:

Conclusion

Let’s look at that side by side comparison chart again where I compare rental houses vs stocks:

After 25 years, a 9 property rental portfolio beats the equivalent capital investment into VTSAX on cash flow by about 21%.

When you compare the strict (pre-tax) value of the VTSAX funds (Vanguard total stock market index funds) versus the appreciated value of the 9 houses, these assets compare similarly. The houses are ahead only by about 8%.

But the basic difference here that makes the rental property much more valuable is what starts happening at year 26.

VTSAX in year 26

With the VTSAX, you start depleting the asset by 4% a year. This is the “safe” withdrawal rate found in the Trinity study to allow the assets to last 30 years with almost 95% confidence. But by definition, the asset’s growth starts to decrease as soon as you start pulling out cash.

The rental portfolio in year 26

With a rental portfolio, extracting the cash flow is part of the asset’s structure (rent), and doesn’t deplete the asset.

Edit: While I previously valued the total cash flow of $56,981 of rental income via the 25x rule as worth an additional $1,424,532, I’ve since been convinced that this is inaccurate.

The total value of the rental houses is $1.93 million, or about 133% of the VTSAX assets.This includes the worth of the houses themselves, plus an adjustment for the extra cash flow the houses provide (see above).

But you don’t have to buy this reasoning for the rental portfolio to win.

Even with conservative assumptions, the rental house portfolio comfortably beats VTSAX after 25 years on both cash flow and strict asset worth.

Rental property empire, here I come!

— TDD

Do you agree with my reasoning? Comment below and please share this post!

Go to this link to get the spreadsheet I used to do this projection. It breaks down each purchase and each year of compounding growth for the rental portfolio over 25 years.

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Related posts

• Why I’m investing in real estate over stocks – Part 1
• Tax Benefits | Why I’m investing in real estate over stocks – Part 2
• Leverage | Why I’m investing in real estate over stocks – Part 3
• You can’t buy avocado toast with VTSAX (Why cash flow is king)
• Rental house #1: Purchased!
• My 15 year plan to financial independence, moFIRE style
• What is moFIRE (morbidly obese FIRE) and why do I want it?
  

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