Investing In Real Estate vs Stocks (Own A Property Or Paper?)
A highly debated topic that many investors are quite passionate about is real estate vs stocks. Here is our take…
Jump Ahead to
Real Estate vs Stocks: Which One Should You Choose?
Stocks vs real estate, real estate vs stocks–that is the question. The short answer is if you have enough capital, you should invest in both and create a diversified portfolio of secure long-term investments; however, there are plenty of successful investors who swear by investing in just stocks or just real estate. In deciphering between the two, you need to consider your risk tolerance, preference on liquidity and whether owning a tangible asset matters to you–amongst other investing criteria that we will cover in more detail.
Advantages of Investing in Real Estate vs Stocks
You have probably heard the saying “slow and steady wins the race?” Well, that’s kind of how real estate investing works. In considering real estate or stock market, first, think about duration: Real estate tends to attract “patient” investors, since the cash turnover (the time when you start the project until the time you sell it) is long. At the same time, since the projects are big, the payout tends to be big as well—thus, the whole “winning the race” thing.
When you invest in Real Estate, you are buying a tangible asset. If there were an unfortunate turn of events, this finite asset (i.e. the land) will be there to protect the original investment. Moreover, it’s an asset capable of generating cashflow through the form of rent from tenants, while also simultaneously appreciating in value.
Real estate has long been considered a sound investment, and for good reason. Before the 2008 crash, housing prices appeared as they would continue to climb indefinitely! With few exceptions, the average sale price of homes in the U.S. increased year-over-year between 1963 and 2007. Since the crash, the housing market has displayed its resilience, showing steady recovery: By 2013, the market had fully rebounded to pre-crises prices, and as of 2021, real estate is booming. Inventory in many regions has hit record lows. Days on the market are now measured in hours and home prices are up 15.8% nationally on average compared to 2020, according to a recent National Association of Relator’s report.
But rest assured this boom is not built on a house of cards, like that of the boom preceding the 2008 crash. The key difference now vs. the housing bubble created in 2008, is that back then it was built on easy credit (loans taken out that people actually did not have the financial ability to pay back), whereas this boom is fueled by cheap credit (from 2008-2020 interest rates were at 0%).
Disadvantages of Investing in Real Estate vs Stock Market
The same advantages I just mentioned can be seen as disadvantages for some investors. Unlike a stock or bond transaction, which can be completed in seconds, real estate transactions are years in the making–from purchasing the property, to renovating or developing the property, to finding the right buyer for the property. Moreover, it is only generating cash flow if rent covers the mortgage, insurance and property taxes, as well as any repairs. And while it is a tangible asset, it probably entails debt in the form of mortgages, as well as the capital invested in renovations or development. All this means that real estate is an illiquid investment. For those who want to be able to retrieve their cash with the click of a button, real estate is not for them. Nevertheless, whether it be your choice to invest in real estate or stocks (and regardless of their liquidity), successful investing is predicted in letting the accumulation process work over a long period of time.
Benefits of Investing in Stocks vs Real Estate
Investing in stock vs real estate–The primary reason you invest in a stock is because the company is making a profit and you want to participate in its success. When you buy a stock, you are buying a piece of the company: its business, operations, the big salary paid to the CEO, its liabilities (disclosed and undisclosed), its culture, etc. In a nutshell, you are buying a piece of everything. If you are buying a stock when the company is not making a profit, then you are speculating, a form of financial gambling, where you make an educated guess about which way the stock price will go.
While stocks are volatile compared to real estate, if you understand that your stock going down is simply a paper loss (i.e. you are not loosing money unless you sell at that moment), and you are not loosing sleep during these dips, then you are a good candidate to invest in the stock market. Again, successful investing is about letting the accumulation process happen over a long period of time. So, it does not matter if your stock is down for the year of 2020. If the long term trend over the 5 to 10 years in which you hold the investment is appreciating, you’re good to go. Not to mention, if you create a well allocated diversified portfolio of stocks, your poor performing stocks will be offset by your high performing stocks.
Lastly, in evaluating stocks versus real estate think about dividends. Dividend paying stocks, companies that distribute a portion of their earnings to investors on a regular basis (usually quarterly), allows you to generate cashflow (similar to tenants paying rent with your real estate investment). Only in this case you are not dealing with the hassle of being a landlord.
Risks of Investing in Stock Market vs Real Estate
In your deliberation to invest in stocks or real estate, consider this: Stock prices rise and fall second-by-second. This is called volatility. Investors biggest mistake: buying high out of greed and selling low out of fear.. You should not constantly look at the price fluctuations. If you are someone that would do this, stock marketing investing is not for you.
It is difficult to identify specific factors that influence the stock market, as it is a complex web of large and small investors making uncoordinated decisions about a wide array of investments. In short, movement of stock prices, can be chalked up to consumer expectations. By this I mean people’s confidence in whether they think the economy will boom or recede, and of course, this is dependent on a myriad of political, environmental and even just cyclical factors. These expectations fuel demand, and like real estate, when demand increases and supply remains the same, prices go up. However, unlike real estate, if the price goes down, you do not have a tangible asset to hold on to while you ride out the storm.
Real Estate vs Stock Market Comparison Table
Still feeling lost in your “Should I invest in real estate or stocks” journey? Below explain the key investment criteria you can use when comparing the two.
Real Estate vs Stocks Key Investment Criteria
Volatility
Stocks: High
Real Estate: Low
Capital Risk
Stocks: High
Real Estate: Medium
Liquidity
Stocks: High
Real Estate: Low
Tax advantages
Stocks: Low
Real Estate: High
Leverage availability
Stocks: Low
Real Estate: High
Potential returns
Stocks: High
Real Estate: Higher!
Stock Market vs Real Estate: Criteria based Comparison
Volatility
Volatility is the name of the game in the stock market and as we’ve previously touched on, volatility means the liability to change rapidly and unpredictably.
That excitement to see the ticker on CNBC going green and calculating how much money you made while a guy is yelling at you through the TV screen is invigorating. Many stock market investors have been there… They have also been there when the guy is yelling “SELL, SELL, SELL,” while helplessly watching their money evaporate amongst a sea of red. As we also previously mentioned, the movement of stock prices, can be chalked up consumer expectations. For some, that’s too hard of a pill to swallow.
In real estate investing vs stocks, however, you can estimate your potential return using capitalization rates. Cap rates are calculated by dividing a property’s net operating income (an investment property’s profitability after factoring in any costs from financing or taxes) by the current market value (an opinion of what a property would sell for based on current market conditions)–No crazy ups and downs, which is something to consider in assessing whether to invest in stocks or real estate.
Winner: Real Estate
Capital Risk
While the stock market is more volatile, which translates to risk, all investments involve risk. If you invested money that causes you to loose sleep, you have probably invested too much. There is no crystal ball to see into the future. Regardless of whether it’s stocks or real estate, anything can happen that could cause an investor to loose all the capital he or she invested. That is the risk that you must take in order to grow your wealth–Stuffing your money in your mattress or leaving it in you savings account is a sure way to loose money because of inflation risk.
With that said, when looking at the stock market vs rental property, the capital risk is lower on real estate. You always have the value of the land (the tangible asset), as collateral against your initial investment.
Winner: Real Estate
Liquidity
In looking at the rental property vs stocks, hands down, stocks win the liquidity investment criteria. You can cash out your invested stocks with the click of a button; whereas, you would have to find a buyer for your real estate investment property.
For some this illiquidity can be an advantage, as it facilitates a long term investment and prevents the temptation to dip into your investments
Winner: Stocks
Tax advantages
Taxes are an important factor to take into consideration when investing. Owning real estate is accompanied by many tax advantages, whereas the stock market–not so much. If you are looking to make a quick buck buying and selling stocks–think again. If you go to sell a stock after holding it for less than a year, you will pay short-term capital gains tax on your profit (your short term gain). The percentage depends on whichever tax bracket you would normally fall under according to your annual income. If you are lucky enough to make significant gains, to the extent that your annual income takes you to the next tax bracket–well, then congratulations your capital gains tax on your stock sale (or at least part of it) will be taxed according to that higher bracket. Long term capital gains (holding the shares for longer than a year) are lower than short term capital gains, but nevertheless take a decent chuck of your profits (15%-20%). For this reason, unless you have millions in the market, it can be difficult to actually make money buying and selling stocks.
Buying and selling real estate, however, is a different story. You can build a real estate portfolio with massive tax advantages, like doing a 1031 exchange. The 1031 exchange, allows investors to defer taxes by selling one investment property and using the equity to purchase another property or properties of equal or greater value. This exchange must occur within a specified period of time.
Even better? You can deduct your expenses directly tied to the maintenance and management of the investment property, such as: property taxes, property insurance, mortgage interest, property management fees, and the cost to maintain and repair the building. Even expenses related to running your investment business can be tax deductible like office space, advertising, legal/accounting fees and travel. Just be sure to keep meticulous records and receipts in case you were audited.
An additional deduction: deprecation. You can begin taking depreciation deductions as soon it’s available to use as a rental (even if its not yet occupied). You’re allowed to take the depreciation deduction for the entire expected life of an investment property (currently set by the IRS as 27.5 years for residential properties and 39 years for commercial properties). Let’s say the value of your investment property (excluding the land it sits on) is $200,000. If you divide that value by the 27.5 years, you can deduct $7,272 in depreciation each year.
Winner: Real Estate
Leverage Availability
Here we are talking about whether you can use your investment to borrow capital to increase the return on your investment (i.e. improve the property) or just simply because you need the cash. Investors who have accumulated sizable equity in their personal home or investment property can refinance their property or properties to pull out equity. Regulations vary by state, and of course credit score, income and debt are taken into consideration; however, typically a lender will loan 80% to 85% of your equity.
Winner: Real Estate
Potential Returns
Comparing real estate vs stock market returns is an apples-to-oranges comparison. The factors that affect the prices and returns of these assets are very distinct. While a heavily debated topic, real estate historically beats the stock market in returns. How can we compare this if the factors dictating these returns are so different? Look at the performance of the S&P 500 ETF vs. REITs. Since REITs will have much higher management fees than a deal facilitated for your investment property; as well as, have high correlation to the financial markets than your property; even slightly beating the stock market, means your real estate investment portfolio definitely is. The data shows that over the last (almost) 50 years, REITS have produced higher returns than the stock market: 13.3% returns vs. 12.1%.
Winner: Real Estate
Real Estate or Stocks: Which is Best? Our Key takeaways
Having your assets allocated in both real estate and the stock market is the objective overall consensus to diversification of assets and successful long term investing. Nevertheless real estate has its advantages. Commercial real estate was historically restrictive of small investors, as the regulatory framework favored the heavy hitters. The Jumpstart Our Business Startups Act (JOBS) allowed for new ways of raising capital. Thus real estate crowdfunding was born–opening the door for small investors to participate in a market that beats stock market returns with less volatility. You can dip your toes in the waters of commercial real estate investing with School of Whales.
Since we were kids, they told us, “the higher the risk, the higher the reward.” Although in some cases this is true, it all depends on how you measure the risk. To invest in real estate or stocks is a personal preference. Some investors don’t mind volatility, others are terrified of it. You need to find out where you fall on that scale. In my personal experience, volatility becomes less important if you are invested for the long run—Remember: slow and steady wins the race!