Should You Invest in Real Estate or Stocks?
2018-5-8 15:18:29, JOSHUA KENNON
Asking the questions, “Which is a better investment—real estate
or stocks?” is like asking whether chocolate or vanilla is superior or if an
Aston Martin is better than a Bentley. There really isn’t an answer because a
lot of it comes down to your personality, preferences, and style. 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 using a lot of
debt, and 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, Wal-Mart, Berkshire Hathaway, Dell or Southwest Airlines,
especially if you reinvested your dividends.
So the answer isn’t as easy as it
may seem.
Let’s begin by looking at each type of investment:
-
Real
Estate:
When you invest in real estate, you are buying
physical land or property. Some real estate costs you money every month
you hold it — think of a vacant parcel of land that you hope to sell to a
developer someday but have to come up with cash out-of-pocket for taxes
and maintenance. Some real estate is cash generating — think of an
apartment building, rental houses, or strip mall where the tenants are
sending you checks each month, you pay the expenses and 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 motorcycles, creates video games, or provides tax
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. Wall Street makes it
seem far more complicated than it is.The company’s Board of Directors, who are elected
by stockholders just like you to watch over the management, decides how
much of the profit each year gets reinvested in expansion and how much
gets paid out as cash dividends. If you are
interested in this concept, read Investing Lesson 1. It will explain
how a company sells stock in itself and how those shares end up being
traded on Wall Street. You may even
want to check out Investing Lesson 2 – Why Stocks Become Over or Under
Valuedto understand what moves stock prices.
Pros and Cons of Real Estate vs. Stocks
Now, let’s look at the pros and cons of each type of investments
to better understand them.
5 Pros of Investing in Real Estate
1.
Real estate is often a more comfortable investment for the lower
and middle classes because they grew up exposed to it (just as the upper
classes often learned about stocks, bonds, and other securities
during their childhood and teenage years). It’s likely most people heard their
parents talking about the importance of “owning a home”. The result is that
they are more open to buying land than many other investments.
2.
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.
1.
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.
2.
Using leverage (debt)
in real estate can be structured far more safely than using debt to buy stocks
by trading on margin.
3.
Real estate investments have traditionally been a terrific inflation hedge to protect
against a loss in purchasing power of the dollar.
3 Cons of Investing in Real Estate:
1.
Compared to stocks, real estate takes a lot of hands-on work.
You have to deal with the 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 host 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.
2.
Real estate can cost you
money every month if the property is unoccupied. You still have to pay taxes,
maintenance, utilities, insurance, and more, meaning that 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!
1.
As you learned in The Great Real Estate Myth, 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. That is, 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. That is what makes
real estate so attractive.
6 Pros of Investing in Stocks
1.
More than 100 years of research 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 (remember — when you buy a stock, you are just buying a
piece of a business).
2.
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 (other than researching
each company to determine if it is right for you). There are professional
managers at headquarters that run the company. You get to benefit from the
company’s results but don’t have to show up to work every day.
1.
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. As Fortune magazine pointed out, "If you'd bought a single
share [of Johnson & Johnson] when the company went public in 1944 at
its IPO price of $37.50 and had
reinvested the dividends, you'd now have a bit over $900,000, a stunning annual
return of 17.1%." On top of that, you'd be collecting somewhere around
$34,200 per year in cash dividends! That’s money that would just keep rolling
into your life without doing anything!
1.
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. With companies such as ShareBuilder, a
division of ING, you can buy dozens of stocks for a flat monthly fee of as
little as a few dollars. Real estate requires substantially more money.
2.
Stocks are far more liquid than real estate investments. During
regular market hours, you can sell your entire position, many times, in a
matter of seconds. You may have to list real estate for days, weeks, months, or
in extreme cases, years before finding a buyer.
1.
Borrowing against your stocks is much easier than real estate.
If your broker has approved you for margin borrowing (usually, it just requires
you fill out a form), it’s as easy as writing a check against your account. If
the money isn’t in there, a debt is created against your stocks and you pay
interest on it, which is typically fairly low.
3 Cons of Investing in Stocks
1.
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. Case in point: During the most recent collapse, the
Credit Crisis of 2007-2009, well-known financial advisors were
telling people to sell their stocks after the
market had tanked 50%, at the very moment they should have been buying.
2.
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. As Benjamin Graham said,
to get emotional about stock prices that you believe are wrong is to get upset
by other peoples’ mistakes
in judgment.
1.
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. For more information, read the work of Ivy League
professor Jeremy Siegel.
Link: https://www.thebalance.com/real-estate-vs-stocks-which-is-the-better-investment-357992
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