It’s one of the oldest questions in the book: to invest in real estate, or to invest in stocks? The truth is, the answer really depends on your portfolio, your personality, your risk tolerance and your investing goals. For professional traders and institutional investors, stocks often make more sense. For high net worth individuals or the everyday person, real estate often makes more sense. Let’s take a look at why.
Differences in Cashflow
The way cash works in regards to real estate is very different than how it works with stocks.
With real estate, you’ll see an immediate improvement to your cashflow. If you have tenants, you’ll start having rent money coming in. If you used to rent and now live a home, you’ll now see your rent payments go directly towards improving your net worth (instead of disappearing). Depending on your down payment, your mortgage payment can frequently be less than your rent payment.
Stocks on the other hand will not affect your cashflow. The cash you invest is tied up, and you generally don’t see any cash return. Instead, the majority of your gains will be in the form of growth or capital gains. Even high paying dividend stocks don’t pay more than 4%.
Return on Investment
At the end of the day, when we’re talking about an investment, what really matters is the return – right? In reality though, comparing real estate investment returns with stock market returns is quite difficult. Here’s why.
In terms of raw return on investment, between 1978 and 2006 real estate returned just under 9%, which the stock market returned just over 13%. Based on these numbers, it’d seem like the stock market is the clear winner.
However, that doesn’t take into account a number of things. First, real estate brings enormous tax breaks. You get to deduct $1.1 million of mortgage debt from your first home. You don’t get taxed on your first $250,000 to $500,000 on profits from selling your first home.
Furthermore, you get big breaks on capital gains. In the stock market, you have to pay capital gains every year. With real estate, you don’t pay capital gains until you sell. And when you sell, if you buy a similar class property through a 1031 exchange, you don’t have to pay capital gains at all.
In short, the actual comparison in return is more difficult to calculate. Most experts agree that real estate and stocks, when all is said and done, are about comparable investments.
What’s it worth? by Alan Cleaver, on Flickr. This work is licensed under a Creative Commons Attribution 4.0 International License.
Volatility and Stability
This is where real estate investing really takes the crown. Real estate markets are generally quite stable. They go up over time. Yes, there’s some up and down, but it’s generally a straightforward path.
Stock markets on the other hand are extremely volatile. A 13% return over 30 years doesn’t tell the whole picture. In one year, you might lose 25% of your net worth. In the next, you might gain 10% back. Then you gain 2% the next year. Then you lose 7% the next year. And so on and so forth.
Most people have a very difficult time sticking with an investment when it tanks. That’s why a lot of people end up selling stock when the stock market goes down. This is precisely why so many people lose money in the markets – they sell when it’s low, and buy when it’s high. While it seems foolish from a distance, the reality is it’s extremely hard to stay faithful to an investment when you just watched 30% of your net worth go down the drain.
With real estate, you don’t have to worry about these up and down roller coasters. You just get to enjoy a persistent year-over-year increase in property values.
Investing to Your Advantage
In the stock market, it’s very difficult to invest to your advantage. You’re competing with hedge funds, professional traders and high speed trading robots. Everyone is out looking for that slight edge, and trades are executed at fractions of a second. It’s extremely difficult to buy an undervalued stock. And, trading with insider information is illegal.
On the other hand, there are many ways you can get an advantage with real estate. You can buy undervalued property. You can buy from trustee sales, from FSBOs or from foreclosures. You can use insider information. Your knowledge of the neighborhood, of rent prices and of comparable properties can be immensely valuable.
In other words, you can get a clear advantage on the real estate market. On the stock market, that’s next to impossible.
Choosing Your Investment Vehicle
Professional investors generally choose to invest in stock, because it’s more liquid. They can get in and out of positions quickly. Stocks are also easier to report on, so they can share their performance with shareholders. Also, most professional investors can’t benefit from the enormous tax breaks the government gives to home buyers.
Real estate on the other hand is easier to manage, less volatile and has more tax breaks. The average investor has a far higher chance of finding an advantage, or buying below market. All things considered, most investors would be better off by investing in real estate, rather than in the stock market.
You may want to visit NAI Maestas Albuquerque Real Estate to learn more about investing in real estate.
