Retirement Accounts Vs. Real Estate Investing

We’ve all heard the question: Would you rather have $1,000,000 today or have a penny double every day for 30 days?

What if we changed the question to: Would you rather contribute $200 per month for 30 years to a retirement account or $200 per month toward real estate?

Would your answer change if we also said it would take you more than eight years to secure your first rental property (i.e., cash-flowing property) when saving at just $200 per month?

People know they need to save for retirement, but many don’t start when they should. Many delay starting for a number of reasons—they’re paying off debt, waiting until they start a family, ensuring they have a stable job. Or, they simply think they have time to start.

Investing in a Retirement Account

There are lots of different ways to fund retirement accounts, but for the sake of this example let’s focus on Roth IRAs. If we contribute $200 a month to a Roth IRA from the ages of 35-65 (assuming an average rate of return of 8%), we will end up with close to $271,879.71. We can see the power of compounding in this example. Our out-of-pocket contribution was only $72,000, but the interest we gained was $199,879. Pretty remarkable!

Many people focus solely on retirement accounts and what retirement accounts can provide. If this was our primary method for retirement, using the 4% rule, we would have an annual income of $10,875.16 in retirement, or $906.26 a month. (The 4% rule is a general rule when considering how much retirees can withdraw with a level of comfort their funds will last more than 30 years.)

Investing in Real Estate

Now, let’s look at an alternative strategy for saving for retirement: real estate investing.

Real estate investing (REI) can include a multitude of endeavors, but for this discussion, let’s focus solely on single-family buy-and-hold rentals. When we talk about REI, we are talking about purchasing a property and renting that property out to someone else. In doing so, we receive rental income that should cover the mortgage on the house, potential maintenance and repairs, large expenses (capital expenditures), and potentially a property management company (if desired).

If the deal is executed correctly, our rental income should be more than all our expenses. So as the investor, we are creating passive income, known as “cash-flow,” on a monthly basis. The cash-flow generated is extra income that can be used for paying bills, entertainment, savings, or buying more real estate!

Let’s reconsider the previous example in which we saved $200 per month for 30 years. This time, we’ll purchase real estate instead. So, we save $200 a month until we achieve enough for a down payment on our property. We’ll combine the cash flow we generate from the monthly rent on the property with our ongoing $200 monthly contribution to allow us to purchase more properties in a timelier fashion.

Let’s see how it plays out!

We assume all properties cash-flow $200 per month, a $20,000 down payment (20%) on a $100,000 property.

• Property 1 takes 8.3 years to save the $20,000. We receive $200 monthly in extra cash-flow.
• Property 2 takes an additional 4.2 years. We are now up to $600 monthly in cash flow ($200 original savings, $200 from Property 1, $200 from Property 2).
• Property 3 takes 2.8 years, and we have $800 monthly in cash flow.
• Property 4 …

I’ll save you the agony of the math and just show you the total at 30 years.

At 30 years, we will have a rental cash flow of $4,000 per month and own 20 properties.

Let’s just wrap our heads around that: $4,000 per month in cash‑flow—even though we didn’t get to purchase our first property until 8.5 years into our savings.

Compound interest has a way of exponentially increasing your retirement accounts. But real estate investing can outperform compound interest.

What We Didn’t Consider

We made some obvious assumptions in these examples both for and against real estate investing:

All rental properties cash-flow

for $200 and the purchase price was only $100,000. What we didn’t even dive into was property appreciation or rental income increases. Rem-ember rental income has the potential to increase by around 2-3% each year.

The average rate of return on the retirement account was “only” 8%. Even if we allowed for a 12% return, which is likely unrealistic, our retirement account would be $579,198. Using the 4% rule, that would lead to $23,167 a year, or just under $2,000 a month. That’s still substantially less than the returns on real estate.

We didn’t incorporate any large expenditures on our buy-and-hold properties, which would likely occur if we held them for more than 30 years. Although we do consider capital expenditures for large issues (e.g., roof, HVAC, appliances), holding a property for this long will likely impact our cash flow. We also didn’t evaluate what selling our properties (using the equity created from debt pay down and appreciation) and purchasing larger properties with higher rent would lead to.

We didn’t look at all the tax benefits and potential securities that come from real estate investing.

We didn’t account for our net worth if we were to sell the properties. We also didn’t evaluate taxes on selling properties.

Although we are receiving rental income from all 20 properties, we do not own most outright and will have a mortgage on a vast majority—but we are still receiving that income.

Although it is impossible to consider all the potential variables with real estate, it’s clear the potential upside of real estate investing far surpasses that of investing in your typical retirement accounts.

Real estate, like saving for retirement, is a long-term play. However, it can set you up for a future that you could not imagine.

The best thing is to learn about real estate investing to find out if it is a suitable strategy for achieving your financial dreams.