Stocks vs Real Estate Returns: Which is the Better Investment?
People want to know the type of investment opportunity that would bring the best returns within a reasonable time with less risk. Investing in real estate and stocks are two common opportunities; each has its advantages and disadvantages and their returns are different as well as their risk. Before you make a decision, it is good you know their tax implications, risk, required capital, and many other factors that may help you make an informed decision. If you want an answer, both real estate and stock returns are good; but one may be better for you more than another.
In this article, we will give the pros and cons of stocks and real estate investments, and you will make a decision on which investment is best for you.
Review: Stocks vs Real Estate
The decision to invest in stocks or real estate is a personal one that is influenced by your financial situation, risk tolerance, objectives, and investment style. It is safe to assume that more people are stock market investors, possibly as a result of the fact that stock purchases don’t require as much time or money. A tiny portion of the company is what you purchase when you buy stocks.
You will need to put a sizable amount of money down if you plan to purchase real estate. Real estate purchases result in the acquisition of actual land or property. Most real estate investors profit from collecting rents (which can generate a consistent income stream) and appreciation as the value of the asset increases. In addition, since real estate can be leveraged, you can increase your holdings even if you are unable to pay cash upfront.
Real estate is appealing to many potential investors because it is a controllable, tangible asset with the added advantage of diversification. When real estate investors acquire property, they become the owners of a tangible asset for which they are liable.
When deciding whether to invest in real estate or stocks, investors must take a number of factors into account. These factors will be explained subsequently.
Why real estate investment is better than stocks
- With real estate, you have more power.
- Make money by leveraging other people’s money in real estate.
- Real estate is more tax-efficient.
- Real estate is a tangible asset.
- Real estate is less difficult to analyze and quantify.
- Real estate is less volatile than stocks.
- Real estate provides a greater sense of accomplishment and fulfillment.
- Real estate is more resistant to exogenous variables.
- The government is on the side of real estate investors.
- Real estate is less risky than stocks.
With real estate, you have more power
Every physical real estate investment you make elevates you to the position of CEO. As CEO, you have the authority to make changes, cut costs (refinance your mortgage now that interest rates have returned to historic lows), raise rents, find better tenants, and market accordingly.
If you are the type of person who likes to be in charge, you will probably prefer real estate to stocks. Just be cautious about believing you know too much for your own good. Of course, you are still subject to the economic cycle, but you have far more leeway in making wealth-maximizing decisions.
When you buy stock in a public or private company, you are a minority investor who trusts management. Coupled with the fact that you have managers who occasionally commit fraud or blow their companies to smithereens through rash acquisitions of stocks.
But in the case of real estate investment, nobody is more concerned with your investment than you.
Make money by leveraging other people’s money in real estate
In a rising market, leverage is a wonderful thing. Even if real estate only tracks inflation over time, a 3% increase on a property with a 20% down payment is a 15% cash-on-cash return. At this rate, you will have more than doubled your equity in five years. Stocks, on the other hand, generate around 10% per year after dividends. Leverage also kills on the way down, so always run the worst-case numbers before making a purchase.
Real estate is more tax-efficient
In addition to being able to deduct the interest on up to $750,000 in mortgage debt on your primary residence as of 2020, if you live in the property for the final two years of a five-year period, you can sell your primary residence for tax-free profits of up to $250,000 for singles and $500,000 for married couples.
Real estate is a tangible asset
A piece of real estate is an object that you can touch, feel, and use. Living is what life is all about, and real estate can give you a better quality of life. The pandemic has caused us all to spend a lot more time at home, increasing the intrinsic value of real estate.
You can take refuge in your home if the world were to end. One of the three essentials for surviving, along with food and shelter, is real estate. Real estate significantly outperformed during the March 2020 stock market crash. If you had stocks at the time, you may have sold them in a panic. But you have most likely kept the property and kept collecting rent.
Real estate is less difficult to analyze and quantify
When it comes to determining a property’s value, all you really need to know is how to estimate reasonable expenses and rental income. You’ve probably struck gold if you can borrow money at 3% and earn a yield of 6% or more from renting it out. If you have the financial resources to invest in real estate, you can immediately profit from it.
In stocks, companies can manipulate their financial data in a variety of ways, including adding one-time gains, adjusting accounts receivables, and using different amortization or depreciation strategies, to name a few. But using the right data tools, you can know the worth of a real estate property, unlike that of a stock. In summary, researching real estate is much simpler than researching stocks.
Real estate is less volatile than stocks
Your home’s value could be plummeting and you’d have no idea because there is no daily ticker symbol. During difficult times, the utility of your home can help soften the blow by allowing you to enjoy your home and create wonderful memories.
For example, during the March 2020 stock market crash, real estate outperformed significantly. Money was moved away from stocks and into more tangible, less volatile assets that generated income. As of November 2020, real estate prices in the United States were still rising.
Real estate provides a greater sense of accomplishment and fulfillment
Making money for the sake of making money is a pretty empty feeling after a while. When you check your stock portfolio to see if it’s up, you don’t feel as much pride or satisfaction.
In contrast, every time you drive by your rental properties, you are proud to have purchased them years ago. In fact, you frequently plan your route so that you can drive by your rental properties on purpose because they make you happy.
By so doing, you know your money is working as hard as it can so that you don’t have to. Real estate is a constant reminder that calculated risks pay off over time. Nobody tells you about the indescribable feeling you get after closing on your home.
Even though the bank most likely owns the majority of it at first, you literally feel like the King or Queen of your castle. When you pass away, you can leave your pride to your children or closest companions, allowing them to create their own memories.
Furthermore, there is a “step-up” function that allows your heirs to inherit the property based on its value at the time of death, resulting in a higher cost basis and lower tax liability if the property is ever sold.
Real estate is more resistant to exogenous variables
Real estate is a local business. If you made a wise decision to buy in a prosperous region, you will be more protected from the national or global economies. The fact that Spain is exploding is unlikely to affect the rent you can charge. Brexit actually lowered mortgage rates by encouraging foreign investors to buy safe US Treasury bonds.
More people are looking to buy homes with COVID-19 because they are spending more time at home. In fact, as investors seek the safety of bonds, mortgage rates tend to fall as bad things as COVID happens. As a result, not only does real estate provide comfort during times of uncertainty, but it also becomes more affordable. As affordability improves as mortgage rates fall, demand rises, pushing prices even higher.
The government is on the side of real estate investors
Not only do you receive generous mortgage interest tax deductions and tax-free profits, but you also receive bailouts if you are unable to pay your mortgage. The government also pursued banks aggressively in order to compel them to extend loan modifications to both bad and good creditors.
During the 2008–2009 financial crisis, for example, people received a free loan modification from 5.875% to 4.25% on a 30-year fixed mortgage. The government went after Bank of America, and the bank was forced to give many of its customers free mortgage rate breaks.
There are many non-recourse states, such as California and Nevada, that will not pursue your other assets if you stop paying your mortgage and squat for months. When was the last time the government bailed out individual investors who were losing money on their stock investments?
The government forced banks to provide mortgage relief to homeowners during the pandemic. Although it is unclear whether mortgage forgiveness will be offered in the future.
Real estate is less risky than stocks
Because real estate is a tangible asset that provides utility, it is inherently less risky than stocks. You won’t wake up one month and discover that your real estate is worth 32% less than it was in March 2020.
Despite the fact that real estate is less risky, real estate investors can make more money because investors are more willing to buy with debt. Returns are magnified by debt (and losses). However, over time, real estate tends to increase in value by at least 1% more than the Consumer Price Index.
What are average real estate returns?
The average real estate investment returns depend on the type of property you own. Because real estate investment has the ability to generate cash flow through dividends.
The ability of real estate investment to generate cash flow is critical (ie. dividend). Single-family homes do not generate cash flow for investors and thus do not qualify as investments.
We should consider the actual return on investment property to its investors, which is calculated using capitalization rates. The capitalization rate is the ratio of a property’s income to its price after deducting all operating costs.
Capitalization rates make it simple to compare the stock market to real estate. If you want to outperform the stock market, look for a property with a cap rate of 7.2% or higher. Also, if you use leverage to exceed the cap rate, you can have a lower cap rate. (One of the benefits of real estate is its low cost and long-term leverage.)
Now that we’ve explained why real estate is an asset class, we hope that you can now answer the question: is real estate the best investment?
Why stock investment is better than real estate
- Stocks have historically provided a higher rate of return than real estate.
- Stocks are significantly more liquid than real estate.
- Stocks have significantly lower transaction costs.
- Stock ownership necessitates far less effort than real estate.
- Stocks provide more variety.
- Stocks make it easier to invest in what you need.
- Stocks are also taxed more favorably than income.
- Stocks are easier to hedge than real estate.
- Stocks have lower ongoing taxes and fees than real estate.
Stocks have historically provided a higher rate of return
Over the last 60 years, stocks have historically returned 10% per year, while real estate has returned 4%.
Stocks are significantly more liquid than real estate
You can easily sell your stock holdings and get paid in three days if you don’t like a stock or need cash right away. A home equity line of credit may be available to you if you need to sell your property (HELOC). HELOCs are expensive, though, and the setup process may take a month or more. If a home is mispriced, selling it could take as little as 14 days or as long as never.
great uncertainty. Humans are emotional beings. It only makes sense to try to protect your capital by selling when you see the value of your stocks drop 30% in a single month. Unfortunately, panic selling has historically been a mistake.
Stocks have significantly lower transaction costs
Today, all online stock transactions, regardless of size, are free. The real estate market is still oligopolistic, and the selling commission ranges from 3.5% to 6%. Now that the internet has lowered costs for every industry, it is outrageous how much it now costs to sell a house. Don’t sell your home if you don’t have to. As long as you can, keep your house.
Stock ownership necessitates far less effort than real estate
When you purchase stock, you are purchasing a piece of a company. If a company has 1,000,000 outstanding shares and you own 10,000, you own 1% of the company. Unlike running a small business, owning stock in a company requires no work on your part other than researching each company to determine whether it is a good investment. You benefit from the company’s success but are not required to work.
Stocks provide more variety
Stocks, particularly mutual funds, allow you to diversify much more easily than real estate. You can buy stocks in several companies so that if one fails, you can still profit from another. Mutual funds carefully select stocks to ensure proper diversification.
Unless you have unlimited funds, you will most likely only have a few properties when you invest in real estate. This makes diversification more difficult, but you can diversify even within real estate by carefully selecting the locations and types of properties you buy.
Stocks make it easier to invest in what you need
The ability to invest in things you already use is one of the stock market’s most enjoyable features. Consider a scenario in which you are an avid consumer of Apple goods, McDonald’s cheeseburgers, and Lululemon yoga attire. Simply purchase AAPL, MCD, and LULU. If you did over the previous ten years, you have done well. Additionally, you got to enjoy the goods.
Stocks are also taxed more favorably than income
In comparison to the top four W2 income tax rates (32%, 35%, and 37%), long-term capital gains and dividend income are taxed at rates of 15% and 20%, respectively. Depending on the laws in effect at the time, you might be able to lower your marginal tax rate by as much as 20% if you can grow your business to the point where the majority of your income is generated by dividends.
Stocks are easier to hedge than real estate
Insurance can help you safeguard your real estate investments. However, if a disaster occurs, it can be difficult to get your insurance company to cover damages because you have to provide evidence to support your claim. To protect your portfolio from downside risk when investing in stocks, you can easily and precisely short stocks or purchase inverse ETFs.
Stocks have lower ongoing taxes and fees
For just $5 per trade, you can create your own portfolio of individual stocks and bonds. There are no ongoing costs if you own individual stocks. There are only management risks, pressures from the marketplace, and other dangers. Only when you invest in actively managed portfolios will you begin to notice management fees, which can occasionally rise to 1%.
However, property taxes must typically be paid annually in the amount of 1–3% of the property’s value. Then there are expenses for repairs, insurance, and property management.
What are average stock market returns?
It is widely accepted that stock market returns average around 10% per year, or around 7% when adjusted for inflation.
A $100 investment would have grown to $2,522.54 within a short period of time. With an average annual return of 7.195%, you would more than 25x your money during this time.
Stocks vs Real Estate: Pros and cons
- Pros and cons of real estate
- Pros and cons of stocks
The pros and cons of real estate investment
|Leverage||Involves A Chunk of Money|
|Potential for appreciation||Time / Learning Curve|
|Rental property tax benefits||Longer Wait For Returns|
|Cash Flow / Passive Income||Tenant Challenges & Vacancies|
|Builds Equity||You May Not Qualify for All Tax Benefits|
|More Stability & Control||More Liability|
|Diversification Lowers Risk||Fewer Exit Strategies|
The pros and cons of stock investment
|Stocks are highly liquid||Stock prices are much more volatile than real estate|
|It’s easier to diversify your investment in stocks||Selling stocks may result in a capital gains tax|
|There are fewer (if any) transaction fees with stocks||Stocks can trigger emotional decision-making|
|You can grow your investment in tax-advantaged retirement accounts|
Conclusion on real estate vs stocks
Stocks and real estate both have rewards and risks. For those who regularly make contributions to tax-advantaged accounts like a 401(k) or individual retirement account, investing in stocks is a popular retirement investment option (IRA). But also, diversification is crucial, especially when making long-term investments. In order to lower risk, investors should choose a variety of asset classes or industries, like real estate. Real estate investing is the best way to diversify your portfolio because it provides lower risks and higher returns.
Having understood what lies in investing in stocks or real estate, I hope you can now make an informed decision on which investment suits you the most. If you have enough capital, go for both.
Why stocks are better than real estate?
Stocks are extremely liquid, selling quickly and easily. They are also adaptable and can be transferred tax-free into a retirement account until you begin to withdraw the funds. Furthermore, many stocks can outperform real estate in a single year.
Can real estate make you rich?
Buying real estate has been one of the best ways to accumulate wealth for hundreds of years. Sure, there have been real estate boom-and-bust cycles in recent decades, but owning real estate has made thousands of people wealthy across the country.
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