Investing in Real Estate vs. Stocks: The Pros & Cons of Each
January 31, 2023
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Trying to decide whether investing in real estate or stocks is the best choice for your financial portfolio? With a volatile stock market and growing interest in real estate investing, choosing which investment strategy is right for you can be difficult.
In this article, we’ll dive into the difference between investing in real estate versus stocks, discuss the pros and cons of each, and help you decide which may be the better avenue given your financial goals.
Investing in Real Estate vs. Stocks
Investing in real estate or stocks can be risky when markets become volatile. Understanding the difference between stock and real estate volatility is helpful for successful investing.
Volatility refers to how quickly prices move up and down, which causes large swings in value over short periods. Stock markets are historically more volatile than real estate, making them riskier investments.
Recent stock market volatility has been due to the uncertainty caused by the coronavirus pandemic and rising interest rates over the past year. Other periods of high volatility have included the dot-com bubble, the 2008–2009 financial crisis, and the 2011 European debt crisis.
The Volatility Index (VIX), created by the Chicago Board Options Exchange (CBOE), measures the implied volatility of S&P 500 index options. The VIX is often referred to as a "fear gauge" because it tends to increase when stock prices are down and decrease when stock prices are up. The following chart illustrates how the VIX has changed over time.
Source: Yahoo Finance
Real estate investments tend to be less volatile than stocks due to their long-term nature. Real estate is a physical asset, so its value can't change as rapidly as a stock since stock prices are based on the stock market and its fluctuations.
(Red Line = S&P 500, Black Line = Case Shiller Home Price Index)
Real estate investments hold their value more reliably over time since they are generally not affected by trends in the same way that stocks are. In addition, the costs associated with real estate purchases tend to be fixed, such as obtaining a 30-year fixed-rate loan, while stock prices vary depending on the market.
Source: St. Louis Fed
If you're looking for quick gains, then stocks may be your best bet. If you’re seeking stability and security, investing in real estate might be a better option.
The difference between the two has important implications for investors. Knowing the risks associated with each investment will help you decide what works best for your financial goals.
Pros and Cons of Investing in Real Estate
Real estate has long been a popular investment with many potential benefits and drawbacks.
- Growth potential: With real estate, there is the potential to increase your total return on investment over time as property values can appreciate.
- Tax benefits: Investing in real estate often comes with attractive tax breaks that can reduce your overall tax liability.
- Long-term investment security: Real estate investments can offer more security than stocks or other investment classes due to their inherent value and generally longer lifespan.
- Hedge against inflation: Real estate can act as a better hedge against inflation than stocks due to its stable price over time and the fact that prices tend to rise with inflation.
- Cash flow opportunities: For those who rent their properties, real estate provides opportunities for positive cash flow over time, depending on the performance of the rental market in their area. Investors may also act as lenders and receive debt payments from borrowers looking for financing opportunities related to real estate investments.
- High initial costs: Investing in real estate requires a significant amount of capital upfront, which may be more difficult for some people to access (although companies like Concreit are making it possible to invest in real estate without a minimum investment amount).
- Long-term commitment: Real estate investments are typically long-term, making them less suitable for investors seeking short-term gains.
- Risk exposure: All investments involve some degree of risk, and real estate is no exception. The risks associated with owning a property include market fluctuations and tenant default, which may lead to financial losses.
- Management overhead: Owning rental properties requires ongoing management, monitoring, and upkeep, potentially involving considerable cost and effort on behalf of the owner.
- Market downturns: If the real estate market takes a downward turn, property values can plunge quickly, leading to a loss on the original investment.
- Liquidity: Converting real estate into cash if needed isn’t easy, unlike other investments such as stocks.
Options for Investing in Real Estate
There are several ways to invest in real estate. Real estate investing falls primarily into two categories: equity and debt.
- Direct ownership: Purchasing real estate outright gives you greater control of your investment decisions but also requires more capital upfront.
- Fractional ownership or "crowdfunding": This method involves investing in property with other people. You own part of the property rather than all of it.
- REITs (real estate investment trusts): REITs can be an easy and low-cost way to start investing in real estate without actually buying a property.
- Closed-end funds: These mutual funds are similar to REITs but involve higher fees. They allow investors to take on more risk by buying individual stocks or options.
- Syndications: A syndication is a form of collective ownership that allows multiple investors to come together and purchase large properties like office buildings or apartment complexes.
- Mortgage-backed securities (MBS): MBS are bonds backed by mortgages. They allow investors access to diversified portfolios without needing direct ownership of real estate assets.
- Closed-end funds: Some closed-end funds include debt investments such as mortgage securities.
- Hard money lending: This is a loan that involves lending money to borrowers at higher interest rates than banks typically offer.
- First-lien mortgages: High-yield first-lien mortgages allow investors to leverage their portfolio against stable income streams with minimal risk.
Pros and Cons of Investing in Stocks
Now, let’s look at stocks and discuss some of the pros and cons of investing in the stock market versus real estate.
- Accessibility: Stocks can be purchased with small amounts of money, making it an accessible option for those unable to invest large amounts of capital.
- Diversification strategies: Stocks allow you to diversify your investment portfolio by purchasing different types of stocks from diverse industries and international markets. Diversification opportunities also exist in real estate but typically require more capital.
- Liquidity: If needed, stocks can be sold quickly, making them more liquid than real estate investments.
- Low maintenance: Stock investments can generally be managed with minimal supervision, unlike real estate investments that require time and effort. Investors only need to check in on the performance of their stocks occasionally.
- Volatility as an opportunity: Stocks can give investors the potential to benefit from changes in the market. Quick shifts in stock prices can present opportunities to capitalize on trends, seek returns, and mitigate losses faster than long-term property investments.
- Volatility as a risk: Sudden shifts in stock prices can lead to losses, leaving investors vulnerable and unable to mitigate their losses as quickly as they could with long-term property investments.
- Investor confidence: The success of a stock investment relies heavily on investor confidence. If investors lose confidence in a stock, its price can drop significantly regardless of other factors such as research or timing.
- Lack of control: With stock investments, investors have no control over how their money gets used; they simply own the share or fractional part of the company. Real estate investors have much more control over when they buy and sell, what renovations they make, and even who rents their property.
- Risk of obsolete industries: Stocks expose investors to the risk of investing in companies or industries that could become obsolete due to technological advancements or economic shifts.
Comparing Returns on Investment (ROI)
Some investors look for a balance between safety and returns with their investments. Building a diversified portfolio is a great way to ensure an investor isn’t limited to one type of investment. Having stocks and real estate in their portfolio may be an appealing option for many investors.
ROI: Stocks vs. Real Estate
(Red Line = S&P 500, Black Line = Case Shiller Home Price Index)
The historical ROI from stocks and real estate display significantly different trends over time. Generally, stocks have historically yielded higher returns faster, with gains occurring more quickly than those associated with real estate investments.
However, over the long term, real estate has usually demonstrated more consistent and less volatile returns than stocks due to its more stable nature and potential for appreciation.
How Portfolio Diversification Varies by Age
When building a diverse portfolio, you want to consider how much of your money should go into each asset class. This decision will largely depend on what stage you are at in life.
For example, investors who are young and still earning income may choose to allocate some of their capital toward investing in stocks for higher short-term returns. Investing part of their money into real estate equity or debt can provide a balance between reward and risk with potential future appreciation and less exposure to stock market volatility.
Lower-risk investments, such as real estate, may be preferable for people nearing retirement age or already retired. Real estate can offer a steady rental income stream with lower volatility and reduced risk of loss. Long-term investments in real estate can provide both passive income and the potential for future appreciation while protecting against stock market volatility.
Investing in real estate debt can also help balance reward and risk, potentially delivering higher returns and the possibility of future appreciation than low-risk investments like certificates of deposit or government bonds. It lowers an investor’s exposure to stock market volatility while giving them access to growth opportunities since a physical asset secures real estate debt.
The 100 Rule
The "100 rule" is an asset allocation strategy designed to reduce risk as an investor ages since stocks tend to be more volatile than fixed-income investments over the long term.
Investors subtract their age from 100 and invest this percentage of their portfolio in stocks and the rest in fixed-income investments such as high-grade bonds, CDs, and real estate equity and debt. For example, if you are 40 years old, the 100 Rule suggests investing 60% of your portfolio in stocks and 40% in fixed-income investments.
After considering the pros and cons of investing in stocks versus real estate, it’s clear the best option for an individual’s financial goals depends on various factors. While stocks may be more liquid and offer faster returns, real estate may provide reliable income through rental payments and has the potential for capital appreciation over time.
Real estate is an attractive option with considerable benefits for investors diversifying their portfolios. If you’re interested in allocating part of your investments to real estate debt, learn how Concreit can help you reach your financial goals.
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