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Should You Invest in Real Estate or Stocks?

Should You Invest in Real Estate or Stocks?

(Maksym Yemelyanov | Dreamstime.com)

By Friday, 18 December 2020 06:41 PM Current | Bio | Archive

The choice between stocks and real estate is a common dilemma faced by investors seeking to build long-term wealth to cover college expenses for a child, save for retirement, or leave as an inheritance. Will they be more successful by putting their money in real estate or the stock market?

Their assumption that one must choose one or the other is incorrect. It is not an either/or decision, as many people own both. Each investment class has advantages and drawbacks, depending on the investor’s unique circumstances, temperament, and interests.

Comparing classes of investments is typically based on metrics such as long-term investment return, risk, liquidity, tax treatments, required expertise, and investment minimums. The following comparison applies to passive investors, not active in either class as a business. This comparison does not apply to those whose participation is a business, i.e., real estate “flippers” or stock traders who regularly buy and sell on a short-term basis.

Investment Return

Investing in real estate is an unfamiliar investment opportunity for most people, even though their homes are often the single most valuable asset they own. According to the Motley Fool, real estate is the most favored investment of the ultra-rich by three to one.

The Fool notes that the average long-term rate of return on real estate favorably compares to the annual return on investment (ROI) of the Standard & Poor (S&P) 500 index of 8%-9%. Returns for individual investors in real estate or stocks can vary significantly from the average.

Advantage: None, returns are comparable

Risk

Neither class – real estate nor stocks – are risk-free. Neither has a guarantee of profits. A real estate investor assumes a greater risk of loss due to leverage (the use of borrowed money) and the costs of diversification (spreading the risk over multiple investments of the same type) required for real estate. For example, a stock investor with $50,000 could buy ten different stocks in $5,000 increments. At the same time, a real estate investor with $50,000 is limited to one or two properties with a typical down payment of 20% of the appraised value ($250,000 total value).

Leverage is a double-edged sword. Used wisely, it can compound returns when the rate of return on an asset is greater than the cost of debt.

Advantage: Stocks

Liquidity

Liquidity refers to the ease by which an investor can turn an asset into cash. According to Zillow, the average time required to put a house on the market and receive cash is 55-70 days in the U.S. Also, real estate values typically vary by season and are especially difficult to estimate accurately, even with tools such as Zillow and Redfin.

By contrast, prices for a publicly traded stock are reported throughout the day so that a stock is easily liquidated with cash received within a five-day settlement period.

Selling stocks is significantly quicker than even the fastest time frame of selling a house.

Advantage: Stocks

Tax Treatment

Real estate has a considerable advantage over stocks due to the availability of accelerated depreciation to shelter investment return and unrelated income from current income taxes.

Conversely, cash received from stock ownership – dividends – are generally taxed at a taxpayer’s regular rate. Long-term capital gains are available for investors in real estate or stocks.

In the case of tax-favored retirement accounts (IRAs, 401ks), stocks have a favored position. While it is possible to invest in leveraged real estate, the rules are complicated, and a misstep can cancel the retirement plan’s favored tax status.

Advantage: Real estate, except in tax-advantaged retirement accounts.

Required Expertise

Both investments require familiarity with the class, generally with the ability to analyze and compare individual investments. The expertise needed to manage real estate successfully is more varied, including the ability to market and maintain the property, deal with tenants, and conform to local housing codes and requirements.

Some suggest maintaining a stock portfolio requires similar expertise to identify, analyze, and monitor the continually changing economic, social, technological, and financial forces that affect current and future prices.

Fortunately, investors in either class can rely on external experts for the necessary oversight and maintenance of the investment, albeit for a price.

Advantage: None. Individuals can develop the necessary expertise in either class of investment or outsource the need to professional advisers.

Investment Minimums

Investing in a single real estate property can require an investment in the thousands of dollars, even with the advantage of leverage.

On the other hand, most financial firms require a minimum deposit of $1,000 or less to purchase a stock. In some cases, no money or assumption of debt is necessary to buy stocks.

Advantage: Stocks

Final Thoughts

Both investment classes are popular choices for those seeking to build their net worth. Both have proven to “deliver the goods” in the right circumstances. Some people combine the two classes by buying real estate investment trusts (REITs), a managed fund of real estate property bought and sold as a security. Unfortunately, the combination carries more guarantee of investment success than an investment in real estate or stocks alone.

For those just beginning the investment stage of their lives, investigation and introspection are recommended before buying real estate or stocks. We highly recommend that you pay off your high-interest consumer debt, especially those with rates of 12% or more annually, before making any investment. An exemplary credit rating will provide multiple financial benefits to you down the road.

Dr. Francesca Ortegren, Ph.D. is a Research Associate at Clever Real Estate where she focuses on helping people understand complex data, real estate, finances, business, and the economy by researching various topics, analyzing data, and reporting useful insights for general consumption.

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DrFrancescaOrtegrenPhD
The choice between stocks and real estate is a common dilemma faced by investors seeking to build long-term wealth to cover college expenses for a child, save for retirement, or leave as an inheritance.
invest, real estate, stocks, risks
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2020-41-18
Friday, 18 December 2020 06:41 PM
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