Stocks versus Real Estate Investments
When the stock market crashed in 2002 many people gave up on stocks and started putting their money in real estate. At that time home prices were increasing at a fast rate and stocks seemed to have nowhere to go. Five years later things look a lot different. Stocks have been growing at a fast clip, with many market indexes hitting new highs. On the other hand real estate has hit a slump, and many people are having difficulty getting rid of their investment properties.
People naturally lean towards the investment vehicles that have been doing well. They tend to chase performance. The problem is that by the time they realize that the wind is blowing in a different direction it is already too late, and they end up buying at the worst possible time when the market has just peaked.
Many people that invested in real estate in the last growth cycle are now under water, meaning they can’t sell the house for what they bought it for, and in many cases, they owe more on the mortgage than the house is worth. Since they can’t sell the properties, many have opted to rent them until the market turns. But the reality of dealing with tenants is that it can be a lot of work. First you have to find qualified tenants that are likely to pay the rent on time. Then you have to deal with repairs, which could cost quite a bit of money if you don’t have the skills necessary to make the repairs yourself. And last but not least, getting calls in the middle of the night from tenants is not what many people had in mind when they dreamed of becoming real estate moguls.
It is obvious that investments go through cycles and what is hot today may not be so hot tomorrow. But in the long run, which investment is best, stocks or real estate? According to a study done by Ken Winans, president of investment research firm Winans International, stocks have always been a better investment than real estate. From 1920 to 2006 the average new home appreciated from $4,030 to $276,400, an investment gain of 6,759%. However, in the same period the Dow Jones Industrial Average gained 17,210%. The same applies to the last 20 years where home prices gained 268% and the Dow gained 1,193%.
So are stocks always a better investment than real estate? The study above confirms what other studies have shown, that in the long term stocks perform better than real estate. However, performance is not the only factor that should be taken into consideration. Let’s take a look at how the two compare on other parameters:
Leverage – One area where real estate beats stocks is leverage. This is due to the fact that you typically borrow a significant portion of your real estate investment, so the return on the money you invested out of your pocket is higher than if you had not used any leverage. You can use leverage in stock investment by buying on margin, but you are limited to 50% of the investment, and the interest rates are usually not as favorable as the rates on a mortgage. Other leverage instruments are available for stocks, but they usually involve significant risks.
Taxes – In the United States real estate also beats stocks when it comes to taxes. Mortgage interest on your home is tax deductible, and the first $250,000 is free from capital gains. With stocks you have to pay capital gains taxes on the appreciation when you sell the stock, and dividends are taxed at your tax rate.
Volatility – Real estate is a lot less volatile than stocks. The price of real estate is unlikely to move rapidly in either direction. On the other hand, changes in stock prices of 10% or more can happen in a very short period of time.
Despite of the advantages above, real estate requires more work to manage and is not as easy to diversify as stocks. One good alternative for real estate investors who want to take advantage of the benefits of real estate investment but do not want to deal with its negative factors is Real Estate Investment Trusts (REITs). REITs are companies that invest in real estate, and they behave like stocks, except that they have to pay dividends on a regular basis. REITs give you diversification and eliminate the liquidity and high maintenance headaches usually associated with real estate investments.
As you can see, both stocks and real estate have advantages and disadvantages. The best approach for savvy investors is to invest on a regular basis and for the long-term in a well diversified portfolio that includes both stocks and real estate. You must avoid the temptation of chasing performance so that you are not buying and selling these assets at the worst possible time like many people have done in the last few years.
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Comment by Dancel on 2007-06-25:
I think real estate is still the best investment option when it comes to long term investment schemes. It is secured and likely to appreciate in few years under normal economic situation while you could lose everything you invested in few days in stock investments. On the other hand stocks are great in overnight gains and short term investments like you pointed out.
Comment by Gina on 2007-06-26:
I agree with Dancel. Real estate investments are safe compared to stocks. However, it takes a long time for results to be sufficient in real estate while it’s fast in stocks.
Comment by Helen on 2007-06-27:
What’s important is to do your homework. With all the possibilities out there, there could be a lot of deals that can make a difference..
Comment by Marty Van Diest on 2007-07-02:
Hi, just stopping by to read your post for Carnival of Real Estate.
I think your last paragraph says it all.
It is always difficult to compare stocks and real estate investing because you have to use averages and real estate investors are going in to real brick and mortar investments that can easily outdo the averages.
What is the percent of return on a new home purchased with a triple 0 down VA loan that is sold 5 years later for a $50K profit?
Total investment is 0 dollars but profit is $50K.
Of course, with the same scenario you can lose $50K as well.
Comment by Michael Krotchie on 2007-07-11:
Don’t forget a huge real estate investment source of income – rent! You mention the statistics for the appreciation of real estate vs. performance of stocks but you must also think about the passive income you will be receiving at the same time (if you do choose to rent out). This can in turn be reinvested continually. I think that will change the numbers a bit!
Comment by Lord on 2007-07-14:
Averages never make for good comparisons unless you are investing in averages. How much easier is it to select better than average real estate versus better than average stock? I suggest not investing in average real estate.
Comment by Costa Rica Real Estate Guy on 2007-11-30:
As others have stated, real estate is a safer more certain investment method, you really can’t pick a bad piece of property, they all go up over time (certainly over a 20 year span). You just can’t say the same thing about stocks. Sure if you pick the right one you will be doing great, but if you pick the wrong one(s), you can loose your money in a hurry. Nothing retains it’s value like real estate, even in an down market.
Comment by Anti Real Estate Schemes on 2008-03-20:
Where do I even begin? First, I’ll address Michael: Sure you can get rent if you don’t live in the real estate but, let’s tell everybody the FULL story: Annual Insurance (>1%), Property Taxes (in NJ 3-5% annually), and the Fed Government says depreciation will run about 3% (BTW this is not just a rightoff but actual landlord costs or it’s defered maintenance and that will affect your appraisal). Since lately real estate speculators have been buying at 7% Cap rates or less then your rents are more than wiped out! Finally has anyone ever heard about Stock dividends (well, in real estate speak it’s stock rent you don’t pay insurance, property taxes, and they don’t depreciate. Furthermore they are subject to special tax rates. BTW, they can be automatically reinvested while I sleep, rent can’t be!
Now, for Gina. Women like safety and stocks can fluctuate less than Real Estate yet be less SAFE! What do I mean? Sounds crazy? If my stock drops 10% and my home drops 10% in 2007 I can still sell my stock in 10 seconds for $7 transaction fee. My neighbors have had to wait 6 months while they’ve been moved elsewhere. If they can’t cover the mortgage they may default. Sounds very risky to me and the Real estate agent still wants their 6% which is a lot more than my $7 trade fee!
Marty, don’t make me roll in on you now! That term means I’m in the military and know a little about VA loans. Let’s look at your $50,000 profit on say a $300,000 home. The real up side is $50,000 – $9,000 (3% Va funding Fee is total loss) – $18,000 (6% realtor charge) = $23,000 profit (I didn’t even consider seller paying part of closing costs!) vs. your example $50,000 loss – $9000 (VA fee) – $15,000 (Realtor, you pay less when you sell for less) = $74,000. Real estate doesn’t sound so great when your LEVERAGED upside is 3X you LEVERAGE downside. Leverage is bear in a down market, especially in real estate. BTW, I had to own that leverage 6 – 18 months longer than I needed to!
Comment by Investing & Passive Income on 2008-03-21:
everything moves in cycles.
the tirck is to predict which cycle is next.
Comment by Properties Costa Rica Guy on 2009-09-04:
I don’t agree with Costa Rica Real Estate Guy. Real Estate is very often a good investment, but if you don’t do your homework you certainly can pick also a bad piece or a bad deal.
Comment by larnarca on 2010-01-22:
i agree with INVESTING & PASSIVE INCOME..weird name though..the real trick is to predict which comes next..
Comment by cyprus on 2010-01-24:
me too..predicting sometimes does the trick here..