The S & P Is Up Over 16% In 2006!

by Jeff Brown

Real Estate Investments Broker

Author website

Over the last half century or so the S & P has averaged, give or take, about 8% growth annually. Pretty impressive. A lot of folks are very impressed, especially those who’ve invested into vehicles tied to the S & P index. They did better than ok this year, don’t you think? Twice the average for the last half century ain’t bad by anyone’s calculations. As a matter of fact let’s say the S & P annual growth rate for the five year period) averaged 10% annually, which is still 25% better than the average since Eisenhower was president. For those already retired and receiving income from investment grade insurance vehicles, many of which are tied directly to that index, 2006 has been a banner year. If you’re wondering why the grandkids made out like bandits at Christmas this year, that could very well be the answer.

For the same period of time let’s have two investors, one in the S & P, the other in real estate. They both have a hundred grand to invest. The real estate guy is at a little disadvantage though because he’ll need to hold some of his cash back as reserves. The S & P investor can afford to put his entire hundred grand into his investment.

So the real estate guy finds three duplexes for $200k apiece. (Remember, even though it’s San Diego, it’s 2001.) He puts 10% down on each one. His total investment including closing costs was about $75k. He put the remaining $25k in the bank as a cash reserve account. The duplexes all provided about $100 monthly positive cash flow, though our investor was just hoping they’d at least break even.

Note: My office structured transactions like this a few times a month back then, month in and month out.

Even though the real estate appreciation rate was three times what we’re assigning to the S & P for these five years, we’re going to limit it for this example to 10% a year for the real estate also. This results in a value of roughly $254k half way through the five years. It’s now the summer of 2003 (June) and I’ve advised him buying in San Diego no longer makes sense. This isn’t because I don’t believe the area will continue appreciating, but that the ability to buy with 10% down is still doable, but very difficult. Therefore I advise him to exchange into Phoenix, where the median home price is now about $150k.

He nets about $146k from the sales of the three duplexes after all selling costs. (8%) He then completes his tax deferred exchange into eight Phoenix homes averaging $150k each. He used the same 10% down approach. It’s the end of July 2003 and he now owns $1.2Mil in real estate. He also has managed to use only $3k of his reserves. During the sale the buyers wanted him to buy some new appliances, and do a little painting. Not counting negligable interest, he now has about $22K left.

It’s now the last quarter of 2005 and his eight homes are worth $1,524,000 give or take a few bucks.

He’s seeing that Phoenix is on the front end of a breather, and he likes what he sees in Boise. He sells his eight homes for $1.5Mil, and after paying all selling costs (8%) he nets $280K. Over the five years he made use, of course, of the depreciation from his properties. The first three duplexes gave him about $60k total depreciation for the 2.5 years he held them. (The buildings + the personal property.) His income puts him in the combined state/fed tax bracket of 33.3%. When he traded to Phoenix his depreciation increased by about $21k due to his increased debt. The total tax savings he enjoyed over the five year period amounted to somewhat over $50k. He put these tax savings into his reserve account, preparing to add some of the cash if needed to his Boise purchases.

It’s time for the final tally. Let’s go the the scoreboard and see what’s happend to these guys.

S & P guy put his entire $100k into the S & P. He made 10% a year growth (pretty dang good) for the five years. His original capital has grown to roughly $161k. There were no tax savings.

Real estate guy invested just 75% of his original capital because he wanted a strong cash reserve. His ending balance was about $352k. (22k remaining in reserve + 50k accumulated tax savings + $280k net proceeds from sale of Phoenix properties headed tax deferred to Boise.)

Since neither guy has chosen to sell and pay taxes, we’ll look at what each has actually earned as a simple annual return. Since both of them are sane, and pack three digit IQ’s, they’ve decided not to sell and pay taxes. Duh

S & P guy made a 10% annual return on his money.

Real estate guy made 28.62% on his money. If he’d thrown caution to the wind he’d have bought an additional duplex in the first year and come out significantly better than he did opting for the wiser approach.

Now, imagine how wide this gap becomes over 10, 20, or 30 years. Some of those years will be down years. Some will be flat or just slightly up. Some will be up 10% or more. Over any particular decade you can count on one moderate to large spike in property value. You can also count on a downturn. Pick any particular 10 year period in the last 35 years, and your numbers won’t be much different than this example, relatively speaking.

Again, take the time to apply these numbers for 10-30 years. Real estate investors not only retire better, they retire sooner much of the time.

The majority of long term real estate investors live a more financially abundant life than they did while working. Allow me to say that more clearly. They enjoy more after tax income in retirement than they ever did before retirement.

The S & P went up 16% this year!