Asking “Which is a better investment—real estate or stocks?” is like asking whether vanilla is superior to chocolate or if a Ferrari is better than a Lamborghini. There’s no one definite answer because it will always come down to one’s personality, preferences, and lifestyle. It also comes down to the specifics of the individual investment. Very few stocks would have beat buying beachfront property in California in the 1970’s, then cashing in twenty years later.
Virtually no real estate could have beat the returns you earned if you invested in shares of Microsoft, Johnson & Johnson, Apple, Berkshire Hathaway, Dell or Southwest Airlines, especially if you reinvested your dividends. So the answer, as with many things in life, isn’t as easy as it may seem.
Let’s begin by taking a closer look at each type of investment:
Real Estate: When you invest in real estate, you are buying physical land or property. Some real estate cost you money every month you hold it – say you own a vacant parcel of land that you hope to sell to a developer someday but in the meantime have to come up with cash out-of-pocket for taxes and maintenance. Other real estate is cash generating – let’s say an apartment building, rental houses, or strip mall where tenants are sending you monthly checks, you pay the expenses and but keep the difference as the profit.
Stocks: When you buy shares of stock, you are buying a piece of a company. Whether that company makes ice cream cones, sells furniture, manufacturers computers, creates video games, or provides accounting services, you are entitled to a cut of the profit, if any, for every share you own. If a company has 1,000,000 shares outstanding and you own 10,000 shares, you own 1% of the company. Don’t let Wall Street make it more complicated than it actually is.
Main Pros of Investing in Real Estate:
Real estate is often a more comfortable investment for the lower and middle classes because they mostly grew up hearing more about real estate rather than stocks, bonds, and other securities. The more people heard their parents talking about the importance of “owning a home” the more they’ll be open to buying real estate in comparison with other investments.
When you invest in real estate, you invest in something tangible. You can look at it, feel it, drive by with your friends, point out the window, and say, “I own that”. For some people, that’s important psychologically.
It’s more difficult to be defrauded in real estate compared to stocks if you do your homework because you can physically show up, inspect your property, run a background check on the tenants, make sure that the building is actually there before you buy it, do repairs yourself … with stocks, you have to trust the management and the auditors.
Using leverage (debt) in real estate can be structured far more safely than using debt to buy stocks by trading on margin.
Real estate investments have traditionally been a terrific inflation hedge to protect against a loss in purchasing power of the dollar.
Main Cons of Investing in Real Estate:
Compared to stocks, real estate takes up a lot of time and effort. From midnight phone calls about exploding sewage in a bathroom, gas leaks, the possibility of getting sued for a bad plank on the porch, and a whole list of things that you probably never even considered. Even if you hire a property manager to take care of your real estate investments, it’s still going to require occasional meetings and oversight.
Real estate can cost you money every month if the property is sitting unoccupied. You’ll still have to pay taxes, maintenance, utilities and insurance. So if you find yourself with a higher-than-usual vacancy rate due to factors beyond your control, you could actually have to come up with money each month!
As The Great Real Estate Myth goes, the actual value of real estate hardly ever increases in inflation-adjusted terms (there are exceptions, of course). This is made up for by the power of leverage: imagine you buy a $300,000 property by putting in $60,000 of your own money, and borrowing the other $240,000. If inflation goes up 3% because the government printed more money and now each dollar is worth less, then the house would go up to $309,000 in value. Your actual “value” of the house hasn’t changed, just the number of dollars it takes to buy it. Because you only invested $60,000, however, that represents a return of $9,000 on $60,000. That’s a 15% return. Backing out the 3% inflation, that’s 12% in real gains before factoring in the costs of owning the property.
Main Pros of Investing in Stocks:
More than 100 years have proven that despite all of the crashes, buying stocks, reinvesting the dividends, and holding them for long periods of time has been the greatest wealth creator in the history of the world. Nothing, in terms of other asset classes, beats business ownership.
Unlike a small business you start and manage on your own, your ownership of partial businesses through shares of stock doesn’t require any work on your part. That’s what professional managers at headquarters for. You get to benefit from the company’s success without having to show up to work every day.
High-quality stocks not only increase their profits year after year, but they increase their cash dividends, as well. This means that every year that goes by, you will receive bigger checks in the mail as the company’s earnings grow. That’s money that just keeps rolling into your account without you doing anything.
It’s much easier to diversify when you invest in stocks than when you invest in real estate. With some mutual funds, you can invest as little as $100 per month. Real estate requires substantially more money.
Stocks are far more liquid than real estate investments. During regular market hours, you can sell your entire position in a matter of seconds. When it comes to real estate, you may have to list for days, weeks, months, or in worse cases, years before finding a buyer.
Main Cons of Investing in Stocks:
Despite the fact that stocks have been proven conclusively to generate more wealth over the long run, most investors are too emotional, undisciplined, and fickle to benefit. They end up losing money because of psychological factors.
The price of stocks can experience extreme fluctuations in the short-term. Your $40 stock may go to $10 or to $80. If you know why you own shares of a particular company, this shouldn’t bother you in the slightest. You can use the opportunity to buy more shares if you think they are too cheap or sell shares if you think they are too expensive.
On paper, stocks may not look like they’ve gone anywhere for ten years or more during sideways markets. This, however, is often an illusion because charts don’t factor in the single most important long-term driver of value for investors: reinvested dividends. If you use the cash a company sends you for owning its stock to buy more shares, over time, you should own far more shares, which entitles you to even more cash dividends over time.
Please remember that this article should not be seen as an explicit recommendation, rather an overview of the main pros and cons (of course there are more) when considering where to put your hard earned money. Happy investing!