When you think about investing, the first thing that comes to mind is probably the stock market. It’s the traditional and most popular choice when thinking about ways to invest money. But you may not know about another investment opportunity: real estate. Yes, real estate is an investment just like buying stocks and bonds. And in fact, when approached correctly, it can be a great low-risk, high-yield, highly diversified investing alternative to the stock market.
Everyone needs a financial plan and an investment strategy. We all have things we’re saving for, whether they’re long term goals like retirement or shorter term like increasing our income or saving up for a big purchase. Let’s explore how real estate investments, as compared to stocks, might help you achieve your goals.
In this article, we’ll talk about why you might want to invest in real estate depending on your personal situation and preferences, as well as the differences between real estate and stocks in risk, return, choices, time frame, liquidity, and more. In general, real estate will require a larger investment up front and requires time and patience, while stocks are far simpler to buy and sell without spending large sums, but tend to be more volatile.
More people invest in the stock market because it has a lower barrier of entry. It’s easy to buy stocks, and it doesn’t require large sums of money to get started. Real estate requires down payments that can be substantial. So choosing real estate investments over stocks will depend on your personal preferences and financial situation.
The stock market allows you to buy and own pieces of companies called shares. When the share price increases after you’ve bought them, your investment is worth more. Some stocks also pay out dividends.
Buying real estate is easy to understand, because land and buildings are physical, tangible things that you own. Much like a stock’s share price, when the value of real estate goes up, your investment is worth more. You can also make money by collecting rent on properties. And even if you can’t afford to buy a property outright, most real estate purchases can be leveraged, so owning more real estate is possible.
Real estate can be used to diversify your investment portfolio, as well as owning something real and tangible. Although some real estate investments can resemble stock market investments as well. Real estate investment trusts (REITs) are an alternative way to invest in real estate that work similarly to buying and selling stocks.
Let’s dive into some of the other differentiators between real estate and stock market investing and why you might choose one over the other.
There are certain times when choosing the stock market over real estate make more sense, like when you’re increasing your returns through benefits like a company match 401(k). But you won’t always have those benefits at your disposal, and when you invest in the market without them, it’s hard to predict what will happen with your money and you may not get the returns you hoped for.
When it comes to return on investment (ROI), it’s impossible to directly compare the stock market with real estate. The things that determine return in each are completely separate. But they are often affected similarly by large changes in the economy, like the COVID-19 pandemic and the 2008 recession. One way to get a general idea of how their ROIs compare is by looking at the S&P 500 ETF (SPY) and the Vanguard Real Estate ETF Total Return (VNQ).
Despite seeing similar effects from the havoc wreaked by the 2008 housing and bank crises and the more recent COVID-19 pandemic in 2020, the day-to-day risk factors for real estate and stocks are quite different, as well shall see.
Let’s take a look at some risk factors for real estate investing.
For one thing, you can’t dive into real estate without being armed with knowledge and research. There’s no way to be a casual real estate investor, hoping to make a quick buck while putting in little thought and effort. Not to mention, liquidity can be an issue for real estate. If an investment is not working out or needs to be unloaded, it’s not easily or quickly done. There are no convenient, quick exits when it comes to real estate.
When it comes to owning property that you don’t live in, it’s a very hands-on affair. Whether you’re renovating to flip a house, maintaining and repairing rental units, or dealing with the many aspects of having tenants, there is always something to be thinking about—and paying for—when you own real estate. Not to mention, when renters’ well-being is involved, some expenses simply can’t wait when there’s an urgent need.
The more property you own, the more likely you’ll need to hire people to help you, whether they’re property managers who can deal with tenants and rental property maintenance or professional contractors who can oversee upgrades to homes you’re renovating. Of course, hiring people costs money, and that eats into your return on investment. But as they say, time is money, and the less time you have to spend dealing with the details, the better. Especially if you own multiple properties.
The risks of stock investments are quite different. Stocks are beholden to the market, and the ups and downs of the market will translate to ups and downs in stock prices. Recessions and inflation are always things to keep an eye on. And it’s not just the U.S. economy that influences the market. Many large companies have an international presence, so the economies of other countries will also have an effect on stock prices. That means foreign political unrest can mean a change in the value of your investments. Government policies in any country can also be a factor, including interest rates, regulations, tax laws, and more.
Not all risk factors are out of your control. You may have heard people talk about how important diversification is. If you choose not to have a diverse portfolio, you will run a much higher risk if your stocks don’t perform. Diversifying can help mitigate your risk as an investor.
You may think that dividends are the answer when it comes to stock investing, and indeed they can be consistent and predictable. However, for them to be a significant source of income, you’d need to invest a large amount of money into stocks that have high-yield dividends. And while this can be a great addition to your income, high-yield dividends often mean less growth potential in the long term.
Comparing Disadvantages and Advantages of Real Estate and Stocks
There are pros and cons to both real estate and stock investing. Let’s take a look at both, starting with real estate.
Advantages of real estate:
- Leveraging allows you to buy property that you can’t pay for in cash up front. – Many real estate purchases come with significant tax benefits.
- Can provide long-term passive income.
- Real estate values tend to appreciate over time.
- Locking in payments now can be protection against inflation over time.
Disadvantages of real estate:
- Not as liquid as stocks, so not a reliable way to get quick cash when it’s needed.
- Usually requires large sums of money up front, even when leveraging.
- Must be able to secure financing.
- Time and money spent on property management, maintenance, upgrades, repairs, and dealing with tenants and renters.
- Requires more research, time, and effort than stock investing. – Not all real estate investments appreciate in value.
Now, let’s look at advantages and disadvantages of stocks. Advantages of stocks:
- Does not require a large investment up front to get started in stock market investing.
- Very liquid, easy to quickly buy and sell when you need to (like in the case of emergencies). – Easy to reduce risk and diversify with so many options for stocks and ETFs to invest in.
- Transaction fees are affordable.
- Excellent for tax-advantaged retirement investing.
Disadvantages of stocks:
- Volatile and sometimes unpredictable, depending on the market, economy, inflation, international events, policy, etc.
- Ease of selling means it’s easy to sell in a panic rather than staying the course, resulting in losing money.
- Capital gains tax can eat into your earnings if you sell stock.
- May take a long time for some stocks to increase in value.
- While it’s easy to get started, if you don’t have a significant investment, your growth may be limited.
There are a few other things worth considering when deciding between stocks and real estate investments.
While it’s true that real estate requires a larger up front investment than stocks, mutual funds, and REITs, it’s important to remember that you are able to use leverage to purchase assets that are more valuable than if they had invested the same up front sum into stocks. For example, if you invest $30,000 in the stock market, generally the initial value of your investment is $30,000. But investing $30,000 as a 20% down payment on property will get you a $150,000 asset (with a mortgage and tax-deductible interest).
A mortgage, insurance, taxes, and maintenance may be effectively zeroed out by rental income from tenants. But when done right, this income can also come out to a profit rather than simply breaking even and letting the property appreciate in value. Other things to take into consideration are depreciation and other tax write-offs.
Additionally, property with rental income can increase in value with inflation. This applies even if the real estate is rent controlled. And don’t forget that real estate capital gains can avoid taxation if they are used to buy another property, whereas stock sales can incur capital gains taxes. This tax deferral tax code is 1031.
It’s also worth noting that mortgage lending discrimination is a crime. It is illegal to discriminate on a mortgage based on religion, race, gender, nationality, disability, age, marital status, or the use of public assistance. If you believe this has happened to you, you can file a report with the U.S. Department of Housing and Urban Development (HUD) or the Consumer Financial Protection Bureau.
There are many pros and cons to investing in real estate vs. investing in the stock market, and your preference will come down to your own priorities, abilities, and financial plans. When talking about investing, most people think about the stock market first, particularly their own 401(k) or IRA (individual retirement account). But real estate can help with the ever-important diversification of your investment portfolio and is often an excellent long-term investing decision.
When reducing your investment risk, maximizing your returns, and diversifying your portfolio, a variety of assets should be the primary goal. Considering the different advantages and disadvantages to both stocks and real estate, it makes the most sense to include both in your investment plan. In fact, this is the strategy for many successful investors. If you’re still hesitant about managing property in real estate, at least consider adding an REIT to your portfolio.