Want Real Estate Wealth? 

Pay off Your Mortgage

There are 44 million rental units in the U.S., 3.2 million — or 7.27% — of which are currently vacant. Because of this, and because of rental income’s historical role as a source of supplemental income, it is often idealized as a stepping stone to wealth-building that has a low barrier of entry.

However, there are some catches. Though ownership of rental properties is highly scalable, its reliability on leverage is an easy way to get caught up in significant debt. 

Additionally, on average, rental units only produce cash-on-cash returns of 7-8%. For comparison, the S&P 500 has returned 49% since Oct. 2022 and historically returns an average of 10%. 

So while generating rental income is often seen as an easy way to grow wealth, you need to be aware of the opportunity cost — or the loss of potential gain when an alternative is chosen — of doing so.

For most Americans who already own real estate, the most logical means of growing their wealth is to simply pay down the mortgage of their primary residence as quickly as possible. 

The Retirement Factor

Beyond wealth building, let’s first take a look at the risks of allocating money to additional real estate before prioritizing your current home’s mortgage. If you’re in a financial position to afford to do so, good for you. Really. 

But we write this newsletter for the average American. The one who is likely to carry a 30-year mortgage for 30 years. The one who earns the median income and carries the median debt load. The one who may want to save every last penny to buy a rundown duplex with the dream of it one day producing enough rental income to offset their personal expenses … but isn’t quite there yet.  

The issue is that, without focusing foremost on your primary residence, the average American risks the following later in life: 

• Last year, Harvard University found that the number of seniors carrying a mortgage into retirement doubled over the past 20 years.
  
• This past summer, an LLC.org study reported that nearly one in five older Americans is still working, largely to support housing needs. Irving, Texas, leads the nation with 30% of its seniors still in the workforce.
  
• And according to the National Alliance to End Homelessness, Americans ages 50 and older represent the fastest-growing demographic of people experiencing homelessness in the U.S., with the figures for that demographic expected to triple by 2030.

We understand that finding a way to generate passive rental income can help retirees on fixed income. However, without paying off the mortgage on your home, the risks of housing insecurity and/or homelessness increase dramatically with age. 

In many instances (based on average mortgage amounts, average interest rates and average monthly payments), committing an additional $500/month to your mortgage principal could shave 12 years off your 30-year amortization schedule (more on that later). 

But importantly, focusing additional funds on paying down your mortgage — rather than speculating on investment properties — builds equity in your home, thereby reducing the long-term risks of homelessness you could face in your later years, and it frees up funds to invest in better-performing asset classes.   

Bigger Returns

People often tout real estate as an ever-increasing asset class. And while that isn’t entirely untrue, it’s not the best bet for growing your wealth over the long haul. 

When evaluating lists of which asset classes have the historical returns, time and time again, the top spot goes to equities. Stocks outperform every single asset over the long term, including real estate, gold and debt securities like bonds. And it’s not even close. Here’s a fun graphic from Visual Capitalist: 

This isn’t to say you shouldn’t be buying a house. Rather, it’s saying that with any disposable income you may have, your money is NOT better spent on passive income properties, no matter how many 20-something YouTubers attempt to sell you on the dream of owning a portfolio of a dozen multi-unit properties, the former of each which pays for the next (through shouldering massive amounts of debt and perpetually pulling equity out of those properties). 

Instead, if you find yourself in the fortunate position of having disposable income (and assuming you own a home and have an investment portfolio), historically, the best way to deploy those funds is (1) paying down your mortgage and then (2) investing that surplus of money into equities. 

But Why My Mortgage? 

Yes, real estate ranks fifth on that list of asset classes by performance. So paying more towards your mortgage rather than buying shares of Dividend Kings or tech ETFs now may seem antithetical to what we’ve just explained. But again, we have to look at it through the lens of opportunity cost. 

More money towards principal now means less money towards interest over the long term, resulting in more disposable income in the future to invest in high-performing equities — even if it’s as simple as investing in an S&P 500 index fund (take it from Warren Buffett, not us). 

Paying interest is the ultimate wealth killer. If you’re carrying a 30-year fixed mortgage on $400,000 borrowed at 6.5%, the total interest you’ll pay over the lifetime of that loan is a ridiculous $510,117.95 — more than you borrowed in the first place.

Now, by using that aforementioned example wherein you pay an additional $500/month towards your mortgage principal and knock off 12 years of a 30-year mortgage, you’re not only freeing up thousands of dollars a month in payments, but saving hundreds of thousands in interest. 

The average monthly mortgage payment in the U.S. is ~$2,500. Amortization schedules will show that those payments can vary somewhat over the course of 30 years. But for easy math, let’s use $2,500/month over 12 years at the S&P 500’s average annual return of 10%, compounded quarterly (which is how often most S&P 500 index funds pay dividends), and the results are really attractive:  

That’s $362,500 you won’t be spending on your mortgage (and its interest). But more importantly, it’s $362,500 that has the ability to compound into $689,625.59 by the end of those 12 mortgage-free years. That’s a lot of extra cheddar to roll into retirement with while also maintaining all of the equity in your home. 
If you want to buy a duplex or two at that point, knock yourself out. But if you’re considering investment properties now, first think about how powerful it would be to put that plan on hold, pay off your existing mortgage and use that disposable income down the line to purchase equities instead.