Barring fluke markets rental real estate can significantly outperform bonds for most people, no matter whether they are investing in corporate or government debt securities.
Risk vs. Return
If you’re considering whether to invest in bonds, real estate, and rental properties, you’ll want to consider the risks versus the returns. Bonds are relatively safe, but the safer the bond investment, the lower the interest rate of return. Government bonds are considered almost risk-free and have meager yields that are frequently below the rate of inflation. Government bonds are easier to buy and sell than real estate, but if you’re earning 2% and the inflation rate is a mild 1%, your return on investment (ROI) has been cut in half. Rental property investing consistently yields in the high single digits and sometimes results in double-digit returns. You’ll get equity appreciation over time coupled with monthly cash flow. This is because rents generally come in at higher levels than the combined costs of your mortgage and maintenance expenses.
Bonds and Income Taxes
Many government bonds—such as municipal bonds—are not taxed at the federal level. If you opt to move to higher-yield corporate bonds, you’ll get higher interest rate returns. However, you’ll have a greater risk of default of the underlying company. You’ll also be paying regular income taxes or capital gains taxes on that interest, depending on how long you hold the investment. Real estate, on the other hand, gets some great tax breaks, with the depreciation deduction being one of the best. You get to deduct a portion of the value of the property every year against the income it produces. You didn’t spend any money, but you get a tax deduction. Combine even a nominal rate of inflation with an income tax burden, and you can take a beating with bonds.
Inflation Reversal
Bonds pay a fixed rate of interest over the life of the investment, so purchasing power with that interest drops with inflation over time. Inflation can decimate your returns on even the safest bond investments. Investment properties can generate higher rents in periods of inflation. Higher costs of materials and labor generally translate into higher housing costs and thus higher rents. Purchasing power doesn’t erode in this scenario. Inflation normally drives up real estate prices across the board. You’re reaping your cash flow rewards but also building appreciation over time, which inflation can help.
The Bottom Line
The value of the bond is static, while real estate can increase in value through appreciation. When you think about all the other ways in which rental property can generate returns, it would appear that real estate investment is superior in many respects to investing in bonds. While bonds, especially government bonds, are a straightforward and safe investment, they come at the cost of meager returns. If you’re looking for a means of growing not just your annual cash flow, but also your assets over the long term, real estate investment is a better bet than bonds. As long as interest rates don’t return to the double-digit numbers seen in the 1980s, you’ll have a property you can sell for far more profit than the interest rate on bonds would have earned you over the same period of time.
