Lately I’ve been looking at various apartment houses for investment purposes. Some of them seem to offer quite decent returns without too much risk. The alternative investment that I’m comparing with is of course dividend stocks, and I would like to share my thinking on this one with you.

One of the houses I’ve been looking at has five apartments; three one-room and two two-room apartments. It is located in a medium sized Swedish community within reasonable commuting distance to labour markets of approximately 100,000 people in total. The house itself is located 300 meters from the train station and within walking distance to the community center.

The annual rental income is about 170,000 SEK and the annual operating expenses amount to 70,000 SEK. The house is for sale for about 1,500,000 SEK.

Let’s assume I would put 300,000 SEK down and loan 1,200,000 SEK. The return on my investment before capital expenses would be 30% (100,000 SEK profit on 300,000 SEK down payment)! Most likely I would not get a fixed interest loan but one with a variable interest rate. Today these are offered for about 2%, but let’s say that it is 4%.

With a 4% loan of 1,200,000 SEK the annual interest to be paid would be 48,000 SEK, which of course is taken off the operating profits of 100,000 SEK. That leaves 52,000 SEK left for maintenance and amortization. 52,000 SEK on a 300,000 SEK investment is still a 17,3% yield. However, not all maintenance adds more value to the house, it simply maintains it. Let’s say that 20,000 SEK of no-value-added maintenance is needed each year. I’m left with 32,000 SEK to amortize the loan with. Since amortization increases my ownership of the house (since I gradually pay off the bank), my yield would be 10,6%.

However, it doesn’t stop there. Being a landlord can be a time consuming role to play. Washing machines will break, carpenters need instructions, tenants will move in and out, bills need to be paid and accounted for. I could pay someone to take care of it for me, but that would consume most of the profits.

The house is in decent shape and it is attractively located within the community. The vacancy rate is practically zero and has been so for decades. The rents in this house are somewhat lower than the average, which is also a cushion of protection against vacancies. But there are macro risks of course. For example, the interest rate could (it will…) go up dramatically from the extremely low levels of today. Each extra percent of interest rate costs me 12,000 SEK from my operating profits. Another macro risk is if some of the major employers in the community close down or leave, which could increase the vacancy risk.

To sum up, if I invest 300,000 SEK I would get a 10% yield if I’m ready to do quite a bit of work. The investment would be reasonably safe and inflation-adjusted, but there are macro risks.

Let’s compare this with me investing the same amount in E.ON, which I put up an analysis of the other week. If we use the figures from the analysis, the stock yields 6,9%. The average dividend growth is 19,8%. So, the first year a 300,000 SEK investment in the E.ON share would yield me 20,700 SEK. The year after, 24,799 SEK. The third year, 29,708 SEK. Even if the dividend growth was to decrease somewhat (which would be reasonable to expect) I would be quite happy.

An investment in E.ON would be inflation-adjusted and the company-specific risks are reasonable due to the size and diversification of the company, plus the essential nature of the products it delivers. Macro risks could be a double-dip scenario (which I expect) or a serious accident in a nuclear power plant. I’m not afraid of stock price fluctuations, in fact I’m looking forward to a major dip as an investment opportunity.

There are some major aspects that differ between these two courses of action. Firstly, a dividend stock doesn’t require me to put down any work other than occasionally read an annual report. No bills, no phone calls, no maintenance, no nothing.

Secondly, the only reason to why the apartment house would yield slightly higher (at least the first years in this simplified calculation) is that the investment is leveraged. That is, I’ve only put in 300,000 SEK of my own money to acquire an apartment house worth 1,500,000 SEK. Without leverage (that is, without any loans), the yield of the house would be only 5,3% (170,000 rental income – 70,000 operating expenses – 20,000 maintenance expenses = 80,000 profits on a 1,500,000 SEK investment). Of course it is possible to loan money to buy E.ON shares in the same fashion, although I never do it.

Thirdly, E.ON has succeeded to increase its earnings by 11,6% on average the last five years. There is no chance I would be able to do that with the apartment house, the rent and value appreciation taken together. It is rather logical, E.ON is one of the major businesses on earth with a professional management and tens of thousands of highly skilled employees. I would be a normal person running an apartment house alongside my ordinary work.

Moreover, while the apartment house requires one major investment all at once, stocks can be gradually scaled into. I doubt that I would invest 300,000 into one and the same stock. I also doubt that I would invest that big a sum at the same time. However, I wouldn’t have to! I could put some of it into E.ON through several purchases spread out over time, while diversifying into some of all the other tempting dividend stocks out there (see the American and European dividend aristocrats and the dividend calendar)!

So, after all, I think I’ll stick to dividend stocks. They let me sleep well, have more spare time, have professionals working for me and give me better returns with no leverage and more diversification. What would you choose?