Dividends or Rents?

"Dividends or rents? Which is better if you've got money to invest?" This is a question that often runs through the minds of investors. Generally speaking people seem to divide into two camps, and stick with what they know. 

But just supposing you don't have any clear preference and haven't yet reached your own conclusions, we'll assess this question on this page in view of what we consider the most important criteria income stability, growth potential, the ability to borrow, hassle factor and taxes. 

Every investment you make has an opportunity cost. In other words, what might you lose by turning down the next best alternative? If you buy a particular stock then the opportunity cost was the next best stock that you didn't buy. There is also opportunity cost between asset classes. If you buy stocks then you are passing up the opportunity to use that cash to purchase real estate. 

The passive income generated by stocks come in the form of dividends. You can read about dividends here what are dividends. If you purchased an investment property then the passive income you receive comes from rents paid by a tenant to live in the property. Below we compare dividends to rents and give our verdict on the winner.

Mike - six-figure dividend earner


1. Dividends or Rents - Income stability

Dividends are almost certainly more volatile than rents. Typically an agreement is made for the tenant to pay a certain rent over the life of the contract. You know how much cash will pitch up in your bank account every month.

That said, there is always a chance that the tenant does not pay or you have void periods where your property is empty. You also need to take off your expenses (such as repairs and agency fees) from this income.  

Dividends are likely to be more volatile. As they are paid from company profits and the sustainability of the dividend depends on the company's profits. Those profits can be very volatile because they depend on so many different factors.

They depend on the economy, the particular company's competitive position, their products, their sector, their market share, their pricing power, inflation etc etc. As a result, if there is a sudden downturn in trading then the dividend could be cut dramatically or even eliminated. 

Winner: Rents

2. Dividends or Rents - Growth Potential

Over a long period of time good companies are almost certainly going to grow their dividends faster than a landlord can raise their rents. 

Rents, over time, should increase significantly but the rate at which they rise is unlikely to be much faster than inflation (or wage inflation at best) as otherwise tenants will likely refuse to pay and move elsewhere. 

Good stocks, however, should be able to use their retained earnings (earnings not paid to shareholders) to re-invest in the business and lead to future dividend growth. Good companies should be able to increase their earnings faster than inflation and this should lead to (sustainable) dividend increases that are faster than inflation.

Take a look at our case studies on the likes of Disney, Coke, and Unilever, to see how far dividends can rise over time. 

Winner: Dividends 

3. Dividends or Rents - Ability to borrow

Borrowing against a property in the form of a mortgage is very simple form of loan. After a down payment (or deposit), the monthly payments repay both the initial sum borrowed and the interest. If the value of the asset falls then you just keep paying and the property will be yours at the end of the mortgage period. 

Borrowing against stocks is possible but can result in difficulty. This is because, generally, you need to borrow on margin. This means that if the price of the asset (the stock) falls then you may need to post collateral (either more stock or cash payments) against the asset. This is in order to protect the lender so they have more collateral to liquidate in the event you don't pay. 

This can make borrowing against stocks very dangerous as large market falls mean that you may be required to write some big checks. Fail to come up with the cash and you may become a forced seller of assets at potentially a terrible time. As a result, we think you should use extreme caution if you are to borrow on margin to buy stocks. 

Winner: Rents

4. Dividends or Rents - Hassle factor

With property, you can either manage the investment yourself. This means you'll need to fix things that go wrong (or at least call out the electrician, plumber, etc). You'll also need to find tenants and negotiate the rent amount. This can result in a lot of work. You can, however, hire a manager to look after your property. This will result in the removal of most of these hassles but the cost can be very high (probably around 10-15% of your rental income). This (plus the cost of repairs) can really eat into your net rental income. See William's blog post on property for a personal experience of being a landlord here.

The news is far better from dividends. Buying a share on the stock market mean there will already be a management to look after your interests. Of course they are paid to do this, but the cost of this has already been taken before you receive your dividend. This means you don't need to send back a payment to the company to pay for the management. 

There is no hassle to owning stocks at all. We do advocate that you read the company releases and annual report every year but otherwise you can just sit back, relax, and let the dividends flow into your bank account!

Winner: Dividends

5. Dividends or Rents - Taxes

Which gets taxed more highly - dividends or rent - will depend on where you live and how you hold the assets. If you own the property in taxable accounts then most developed countries will tax your rental income as ordinary income. This effectively means you need to add your rental income on top of your other income and you will be taxed at your marginal rate. 

You are probably likely to be able to deduct certain expenses. These could include interest, tax, depreciation and general maintenance costs. What you can deduct will depend on the laws of where you live. If you are a US resident then you can find more details at www.irs.gov. More details of the UK regulations are available in our blog post or by visiting www.gov.uk.

Many countries tax dividends at more favorable rates. For example, if you are a US tax resident and your dividend are "qualified" then your federal tax rates will be nothing if your income is in the 10-15% tax brackets, the rate will be 15% if your income is in the 15%-39.6% tax bracket, and your rate will be 20% if you are in the 39.6% tax bracket. You may also need to pay a 3.8% medicare surcharge and state taxes on top. Unqualified dividends are taxed at your ordinary tax rate. For more information, have a read on our article on tax on dividends

You may be able to put both stocks and property into tax sheltered accounts. Due to the superior liquidity of stocks, it is likely to be far easier to do this with stocks than property. 

Winner: Dividends

William - rookie investor

"So then Mike, which one is it - dividends or rents?

I think I know which side you're going to come down on, but I'd like to hear your reasons!"

"Both dividends and rents are very useful forms of passive income. Over time you should probably aim to build up income from both sources. Diversity of income is important as it will allow you to take advantage of market dislocation.  You won't know where that market dislocation will occur so to have income coming in from various sources is hugely beneficial.

That said, I don't think you want me to sit on the fence on the dividends or rent question!

If I had to choose one then it would be dividends due to their huge potential to grow over time and the lack of hassle factor."

Mike - six-figure dividend earner