Why invest in bonds vs rental real estate? They are popular investment options that offer monthly or quarterly cash flow and opportunities for wealth accumulation. While they differ in nature and characteristics, they share certain similarities as investment vehicles.
In this blog post, we will explore the differences and similarities between rental real estate and bonds. Furthermore, highlighting key features, risk profiles, income potential, and considerations to help establish the best way to balance the bonds vs rental real estate debate for investors and their savings.
THE NATURE & CHARACTERISTICS OF BONDS VS RENTAL REAL ESTATE
Rental real estate involves purchasing property, such as commercial, residential, or rural property. These properties have contracts in place with tenants to pay a certain amount of rent for a certain period of time. Commercial and rural property tend to have longer fixed terms than residential.
The contracts on property generate a consistent cash flow through rental payments, which allows owners to budget and forecast. Property offers ownership of a tangible asset with the potential for long-term value appreciation alongside the contractual cash flow from month to month.
On the other hand, bonds are debt instruments that governments, municipalities, or corporations’ issue to raise capital. When an investor purchases a bond, they are essentially lending money to the issuer in exchange for periodic interest payments and the return of the principal amount at maturity. Bonds are fixed-income investments, offering predetermined interest rates and fixed duration dates.
RISK PROFILES
Bonds vs rental real estate differ in terms of risk profiles.
Property investment is generally a higher-risk investment than bonds due to factors such as market volatility. Moreover, there is a risk that tenants will default on their contractual obligations to pay rent. Real estate investments can also come with additional risks related to property maintenance, rental vacancies, and changes in local economic conditions.
Real estate also gives investors the opportunity to use leverage to increase their return on investment (ROI). Furthermore, it allows investors to realise capital appreciation over time without triggering any tax payments. Leveraged rental property increases the risk threshold of the investment, although, if done reasonably, it can create great benefits for your portfolio over time.
Bonds, on the other hand, are typically lower-risk investments. Government bonds issued by stable economies are considered safe as they have the backing of the government. Corporate bonds carry a higher level of risk, as they depend on the creditworthiness of the issuing company. However, bonds in general are less volatile than rental real estate investments and can provide a more predictable income stream.
ONGOING INVESTMENT MANAGEMENT FOR BONDS VS RENTAL REAL ESTATE
As previously touched on, property investments require active management and involvement during ownership. There is no such thing as a “hands-free real estate investment.” Even with a management company to manage the operations, you will have to be involved if significant repairs or rent arrears occur. You will need a network of contractors who can step in when needed.
Bonds, on the other hand, will require no ongoing management, and it is truly a hands-off investment until the bond matures. Once it matures, you take your money or reinvest it and leave it again.
INCOME POTENTIAL & RETURNS
Property investment and bonds offer different income potential and returns.
Property investments have the potential for both rental income and capital appreciation. Rental income provides a regular cash flow, while capital appreciation occurs when the property’s value increases over time. The income potential and returns from property investments can vary based on factors such as location yields and economic factors. The average UK property yield in 2024 will be 4.75% before expenses. When adding capital growth over time, which is 5.5% over the last 30 years, the total return (yield + capital appreciation) of rental real estate before expenses is 10.25%.
Bonds, on the other hand, offer primarily fixed income in the form of periodic interest payments. The interest rate on a bond is determined at the time of issuance and remains fixed throughout the bond’s term. The average 10-year UK bond yield in January 2024 will be 3.91%. To compare the current bond market, the following link to moneysupermarket.com gives you a broad understanding of the products currently available.
The returns from bonds are generally more predictable and liquid compared to property investments in the short term. However, bond returns will be lower than the potential returns from property investment over the long term due to the benefits of capital appreciation.
BONDS VS RENTAL REAL ESTATE SUMMARY
In conclusion, rental property investment and bonds both provide the ability to receive consistent fixed income to budget and forecast. The risk of receiving this cash flow varies between property and bonds, depending on the type of instrument you choose.
With the increased risk that real estate has, it offers the ability to use the benefits of leverage and receive capital appreciation opportunities over the long term. Whereas bonds don’t have this luxury and fall back on the sole ability to produce guaranteed and predictable cash flows.
Understanding the differences and similarities between property investments and bonds is crucial for investors to make informed decisions. This allows them to align their financial goals, risk tolerance, and investment strategies with what best suits their needs.
HOW WE USE BONDS AND RENTAL PROPERTY
Real estate is our cash flow generator into the future for our investment portfolio. We are happy with the risk of property and also leveraging property because, over the long term, the tax advantages, increased ROI, and capital appreciation far outweigh the risk vs reward of bonds.
Bonds are for short-term storage of cash with instant access or short-term maturity dates. Cash is stored in bonds for our emergency funds or until we have enough for our next investment. It allows our money to always generate a return while being relatively liquid, providing flexibility when we invest in more long-term strategies.
