Why Poor People Should Invest in Real Estate to Become Wealthy

Houses and Real Estate in Monopoly Are Investing in Real Estate

Real estate is a powerful tool that can be a great equalizer in the world of building wealth. In fact, for those of us that don’t make very much money, it may be the only reliable path to wealth.

So first let me clarify, when I say poor, I don’t mean people who are only making enough money to cover basic necessities and housing. If that’s you, start with my post on increasing your income.

By poor I mean those that can save some money by frugal living, but not thousands of dollars at a time.

You need to be able to put some money away each month or building wealth just isn’t going to happen.

So how do people become wealthy?

Table of Contents
How to Become Wealthy
Investing with Stocks
How to Become a Millionaire with Real Estate
Do Stocks Outperform Real Estate?
What is the Risk of Real Estate?
What is Considered an Advantage to Investing in Real Estate?
When Am I Wealthy?
Conclusion
Definitions

How to Become Wealthy

Becoming wealthy is a really easy formula that can be difficult to practice in real life.

Wealth Building Formula:

Track Your Spending + Spend Less Than You Earn + Invest The Difference
=
Living on Passive Income or Being Wealthy

Pretty simply right?

Now let’s look at it in a real investment situation.

Investing with Stocks

Becoming wealthy from stocks follows the wealth building formula exactly.

You start with tracking your spending and spending less than you earn.

Then you smartly invest the money you save in the stock market. Preferably through index funds or other ways that diversify your investments well.

Let compound interest take control and watch it grow.

Become a millionaire over time and live on the passive income from your portfolio.

Easy right?

But how much money do I need to invest to get there?

Related: Are you worried about investing during COVID? This post offers great advice on how to handle investing post COVID-19.

How Can I Get 1 Million Dollars Investing in Stocks?

So now you want to become a millionaire investing in stocks because that sounds easy. Well, here is the hiccup. According to the investor.gov calculator, at the reasonable interest rate of 6%, you will need to invest just about $1,000 every month for 30 years to make 1 million dollars.

While it is amazing that compound interest can turn the $360,000 that you contributed into 1 million dollars in 30 years, that is a long time to invest to become a millionaire.

So how do you become a millionaire faster?

Own Real Estate!

How to Become a Millionaire with Real Estate

I don’t know about you, but investing $1,000 a month for 30 years can be a daunting task. That is a lot of money to put away for a future retirement that you may not live to see. Real estate, on the other hand, can take that same money and build wealth much faster.

First, spend less than you earn and save money for a down payment. Then get a loan to cover the rest of the purchase price of the property.

Rent out the property and each month the tenants will pay you cash, called cash flow, which you can reinvest into your real estate portfolio. You use this to scale or compound the effects of real estate over time until you are wealthy because your cash flow covers your expenses.

But don’t stocks outperform real estate?

Do Stocks Outperform Real Estate?

The short answer is no. While there are many benefits to stocks over real estate, it is hard to make the case that stocks outperform real estate when you invest in real estate smartly.

For example, let’s say that you invest $20,000 in the stock market. At an average 6% return over the long run, you will get about $1,200 a year back on our investment.

On the other hand, if you invest that same $20,000 as a down payment on a rental property and cash flow $200 a month (which is a very average amount to get back on a property after all expenses) you will get an annual return of $2,400. That is twice as much money!

How Are Rental Properties Better than Stocks?

Rentals are better than for many reasons, but here are a few highlights.

First: You don’t need all of the money to get the benefit.

Through a system called leverage, you can get a loan to cover most of the value of the property. Usually you have to pay 20% of the value and a loan can cover the rest.

This is huge because you can only invest your money in stocks. No bank is going to loan you money to invest in the stock market. They’ll just make money themselves investing in the stock market instead. But in real estate you can invest other people’s money for a higher return.

Second: At the end of 30 years, you own the asset.

You can actually own the asset (most likely a house) because you pay off the bank over time. Once you own it, all of the money coming in for rent goes into your pocket and you are that much richer.

Stocks on the other hand will only ever pay a small dividend, or you will have to sell them to make money. Therefore real estate is much easier to make generational (meaning you can give it to your kids) and its upside is much bigger than stocks.

Third: You can control how your real estate is managed.

You are the CEO of your real estate portfolio. If things aren’t going well, you can step in and make things work again to get your cash flow back up.

Stocks on the other hand are entirely out of your control. If you invest in Coca Cola you have no control over how that money is used or how that company is run. Unless you are the CEO of Coca Cola of course. Some people prefer investing in stocks because it is hands off, but the lack of control can be very nerve racking during times of economic struggle.

What is the Risk of Real Estate?

Every investment opportunity has its risks. The risks of real estate investing can have huge consequences if you are not careful. So it is important to be careful when investing in real estate.

Risk 1: Losing Your Asset

You can very easily lose real estate if you don’t pay. The mortgage is always due. And if your house is paid off at least taxes are always due. If you don’t pay you’ll lose your asset.

Stocks on the other hand just sit there. You don’t feel like buying more? Don’t. There aren’t taxes on them until they’re withdrawn. It can just sit there and make more money without any thought at all.

Risk 2: Damage to Your Asset

There are any number of things that can damage your asset from tenants to weather. You have to pay for any damage to your property (or your insurance company, which means you are still paying for it through your premiums).

Stocks won’t get damaged by tenants or weather (unless the entire economy is damaged). Basically the only way a stock will go bad is if the company goes under. This isn’t really a problem though if you invest in index funds.

Risk 3: Greater Impact on Your Credit Score

Getting loans to pay for real estate is very dependent on your credit score. That means that your credit score can help you get real estate, but it also means that if you don’t pay your credit score will be impacted considerably.

Since stocks don’t require a credit check there will be no impact on your credit score one way or the other.

There are more risks associated with real estate than with stocks, but that is what allows for a greater return.

What is Considered an Advantage to Investing in Real Estate?

Now that we understand the difference between stock investing and real estate investing, we can understand the advantages to investing in real estate. Especially for low income earners. There are three main advantages to investing in real estate.

First: Leverage Allows you to Get a Better Investment for Less Money

As we discussed above, using leverage lets you invest as if you have 80% more money. You put 20% down and the bank funds the extra 80%.

There is still a lot of effort and saving that goes into this, but once you get the ball rolling it can become much easier.

Each property you buy can help you pay for the next one. Through increased cash flow, or a home equity line of credit, or a 1031 exchange when you sell your property and buy another, and so much more.

It’s okay if you didn’t understand that last part, but if you want to, then start learning now! The best place to learn about real estate is biggerpockets.com.

Second: You Can Build “Sweat Equity”

The idea of sweat equity is basically that you can fix up a house or property yourself for a comparatively low cost which will make it appraise for a much higher value than the money you put in to fixing it.

In other words, let’s say you have a $100,000 property. You are a little handy (or really good at watching YouTube videos about being handy) and you are able to fix up a property entirely for $15,000 (it still costs money because you need to buy materials). Because of how well you did the value of the property jumps from $100,000 to $150,000. You have just added $35,000 in equity that wasn’t there before.
($150,000 – $100,000 – $15,000 = $35,000)

$15,000 might sound like a lot of money, but keep in mind that as an investor you continually find ways to reuse the same money you’ve already invested.

The other option is to invest $15,000 in the stock market and make $900 in a year ($900 is 6% of $15,000.

$35,000 of equity is a much better return.

Third: You Can Partner With Real Estate

If you still think $15,000 sounds like too much money, or you are worried about not having the funds to buy a property in general, real estate has a great option called partnerships.

Real estate, as an actual tangible thing, can have multiple owners. That is really nice because each owner of an investment can bring different things to the table. You can bring time or ability to work (sweat equity) and they can bring the money or their credit score or whatever.

This is powerful for low income earners who are just starting out. No one is going to partner with you on buying stocks, they’ll just do it themselves or hire a broker.

Put It Together And What Have You Got?

Bippity Boppity Boo…I mean you have the ability to invest and get a lot of money back without a $100,000 salary.

For example, you have $5,000 that you have saved for investing. It isn’t much, but you’re trying. You meet a partner who has $30,000, but they are quite busy with their own projects.

You decide to buy a $100,000 property together. You bring your $5,000 and they bring $15,000 for a down payment of $20,000. That’s 20% of the $100,000 home.

Then you put in the sweat equity and use your partner’s remaining $15,000 to renovate the home a bit. You update the bathrooms and kitchen, repaint the walls, put in nice flooring, etc.

Because of this the home is now worth $150,000. You go to a bank and get a cash out refinance for 70% of the current value of the home. That means they give you a new loan for the amount of the mortgage and cash for any money on top of that. So they pay you $105,000. (That is 70% of $150,000).

So instead of having $20,000 stuck in equity as a down payment you only have $10,000 stuck in the house. The math on that being the original value of the home ($100,000) plus the cost to renovate ($15,000) minus the money you got back in your refinance ($105,000).

$100,000 + $15,000 = $115,000
Money in before the refinance
$115,000 – $105,000 = $10,000
Money in after the refinance

And now you and your partner are getting cash every month from renting out the home, and you have invested in real estate without making $100,000 a year or more.

When Am I Wealthy?

Wealth sounds like having a private jet, a fancy yacht, and swimming through piles of money. That isn’t the case. Being wealthy is simply when the money coming in from your assets covers all of the money going out from your liabilities.

In other words, you are wealthy when the money you get from investing covers all of your expenses so you don’t have to work any more if you don’t want to.

How Long Will it Take to Become Wealthy With Stocks?

This depends entirely on how much you put in and how much you spend every year. But a rule of thumb people often mention is the 4% rule.

If your expenses are $40,000 a year then you will need to have 25 times that much in stocks ($1 million) so you can take out 4% of you portfolio every year to cover the $40,000 of expenses.

That is way over simplifying the 4% rule, make sure you talk to a Financial Advisor before acting on this information, but it will help us compare stock investing to real estate.

So to be wealthy in stocks, you would need to have 1 million dollars (assuming your expenses are $40,000 a year) to be considered wealthy.

As we discussed earlier, it will take you thirty years to become a millionaire if you invest $1,000 a month and let that compound upon itself.

How Long Will it Take to Become Wealthy with Real Estate?

Now let’s say you have the same expenses, $40,000 a year, and you can contribute the same $1,000 a month.

To simplify this, I’m going to exclude emergency funds, closing costs, and a few other factors that you need to consider when purchasing real estate, but note that I also excluded fees on stocks.

It will take you 20 months to save enough for a $20,000 down payment on a $100,000 dollar house. You buy it and that house cash flows $200 a month.

You now can contribute $1200 dollars a month towards investing. You will be able to buy the next property in 17 months. And you now you can contribute $1400 a month towards investing. And so forth.

By following this pattern, saving your money to buy a $100,000 house that cash flows $200 each month, you will be able to cover your yearly expenses of $40,000 a year with only the cash flow from you real estate in just over 13 years.

Months to Save for 20K Down Payment
(approximate months)
Dollars Saved Each Month
($1,000 initial + cash flow)
201000
171200
141400
131600
111800
102000
92200
92400
82600
72800
73000
63200
63400
53600
54000
54200
All Expenses Covered
(You can stop saving for a down payment)
4400
($3400 covers $40,000 a year,
not including the original $1,000
Total Months Saving and Buying Real Estate
157
157 months = 13.0833 Years
How to Become Wealthy with Real Estate

This is way over simplified of course. Cash flow can be much higher (or lower) depending on what you buy. You might want to buy a more expensive house. You might use a home equity line of credit to buy more houses quicker. You could sell a few properties and roll the profits into a bigger property that has more cash flow. And so much more.

The point is that once you get the ball rolling with real estate, it is much faster than stocks AND it will cost you less money than stocks. The total amount you would have invested into real estate to become wealthy is $157,000 dollars, not including the cash flow you reinvested. For stocks you would have invested $360,000, not including the interest accrued.

Conclusion

Stocks are a great investment option if you have a lot of money and don’t want to be bothered thinking about it. The minimum to be able to reach a million dollars within a career is $1,000 a month. More than that is even better.

Stocks are a great investment option if you want to have truly passive income. Once the money goes into an investment account you don’t have to mess with it ever again if you don’t want to. In fact, people that never mess with it do better than people that do.

Real estate on the other hand is a slightly more active investment option. You have to actively look for the assets to buy, you have to either manage the property or pay someone to do most of the work for you. You have to negotiate with lenders. And so forth.

But, nothing builds wealth like real estate.

If you don’t have the money or the patience to invest in stocks, real estate is your best bet. So get out there and do it.

What is your investment strategy? What other benefits to real estate are there for low income earners? Tell me about it in the comments below.

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Definitions

A list of definitions used on this blog can be found here.

Real Estate: An asset made of either land or buildings.

Index Funds: A way to invest in stocks that puts a little bit of your money into every company listed in that index or list of companies. For example, the index could invest in all companies in the S&P 500 or all publicly traded companies, etc.

Diversify: Spreading your investments to multiple DIFFERENT types of investments/companies/assets. This can include owning some real estate, some stocks, and some other investment options. Or it can be as simple as investing in technology companies and food companies. Diversifying lowers risk.

Compound Interest: When interest builds upon interest over time. So a 10% compound interest rate would start with $1,000 becoming $1,100, like simple interest, but then it continues and $1,100 becomes $1,210 and so on.

Passive Income: When your money or work, through investments, or royalties, or other means, continues to make money for you without any (or very little) additional effort on your part.

Portfolio: All of the assets that are your own. Usually listed out with the money in each investment and each assets percentage compared to what you own in total.

Cash Flow: Money coming into your pocket from investing (either through stocks, real estate, or other assets). This is NOT the same as income because it doesn’t necessarily require you to work for it.

Annual Return: The amount you will receive back on an invest each year, usually in the form of a percent. So if you have a 10% annual return on $12,000, you’d get $1,200 every year, or $100 every month.

Leverage (Loans): Using what an asset is worth to get a loan against the value of the property.

Sweat Equity: Using your own labor to add value to a property by fixing it up. If the amount of money you put into it is less than the new value of the home you have created equity or additional value in the property.

Appraise: To give a property an official value as determined by an appraiser. For homes appraisers use other properties that are comparable to yours that have recently sold in your area.

Equity: How much your property is worth versus how much you owe on it. So if your property could sell for $100,000 and you owe $40,000 then you have $60,000 of equity.

Cash Out Refinance: Getting a new loan against the value of the home where the amount of the loan is higher than the amount currently owed so the additional cash is given to the owner.

Asset: Things that put money into your pocket every month (or year). Sometimes equity in your house is also included as an asset, but I prefer not to include it. A car loses value every year (depreciates) so it is NOT an asset.

Liability: Things that take money out of your pocket. This includes all of your monthly and yearly expenses. You will often hear that a home is your biggest asset (the opposite of a liability), but it takes money out of your pocket each month in the form of a mortgage, taxes, and insurance, so it is a liability.

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