For any individual, an investment that generates ‘sufficient’ returns is a good investment idea. Investing in real estate means buying, holding or selling a piece of land or property with the expectation to earn some return on it. Investing in stocks means buying, holding and selling a piece of a company to earn profit and dividends. Before deciding which one is better among real estate and stocks, consider the following differences-
- PHYSICAL PRESENCE: Real estate investments are tangible. You physically own a piece of land or property. Stocks are not tangible.
- LEVERAGE: Use of leverage in real estate is very much structured and safe as compared to stock markets. Even a fixed rate for 30 years is possible for real estate but for stocks the rate is variable.
- INACTIVE PERIOD/HOLDING COST: When the property is vacant and stops producing returns, expenses like maintenance, utilities, taxes etc. never stop. Around 3% to 5% of the total asset value goes to the insurance; maintenance etc. On the other hand, the tax cost ratio for most of the ETFs is close to 0.5%.
- COMPOUNDING OF RETURNS: Suppose an investor buys a piece of land costing $500,000. He pays $100,000 and the rest is leveraged by a bank. If the inflation rate for the year is 3.5%, the property is worth $517,500. The investor has invested $100,000 so his return on investment is 17.5%, adjusting for inflation the return is 14%. Compounding of this return over the years will give a significant profit to the investor. Considering cash inflows from rent are equal to cash outflows to the bank for mortgage payments. There is no such advantage in holding stocks.
- OWNERSHIP RIGHTS: By investing as little as $1 in stocks, you partially own the company. This is not the case with real estate.
- DIVERSIFICATION: Diversification in stocks is easy and cheap as compared to real estate. An investor can buy a fully diversified portfolio with a variety of ETFs, shares, equities with different levels of risk for $10,000. The same amount will hardly buy anything in real estate.
- LIQUIDITY: Stocks are more liquid than real estate. An investor can get his stocks sold in just a few seconds, some times over the phone or just by sending texts. For a real estate investor, it may take weeks, even months to sell his property. When the market is low, it may even take years to find a buyer for the property. Properties are not sold and bought very frequently.
- MARGIN BORROWING: Margin trading or borrowing against stocks is easy and needs little paperwork. Borrowing against the real stock is not easy, it takes a lot more time, effort and documentation. Margin loans are called off when the stock fall below a certain level. Real estate margins are called off when the investor stops making the payment which happens very rare.
- PRICE FLUCTUATIONS: Stock price fluctuates very frequently. Real estate prices usually move slowly but steadily in the long run.
- INCOME TAX ADVANTAGE: Real estate owner can show the depreciated cost for tax purposes and deduct mortgage interest. In stocks, there is no hiding place from taxes.
- IMPACT OF INFLATION: If the rate of mortgage is fixed, an increase in inflation will raise rents you get on your property but the mortgage payment will remain the same. Stock markets move every day with factors like inflation, interest rate etc.
- TRANSACTION COSTS: Transaction cost for real estate is much higher. Broker’s commission, taxes, inspection fees etc. can sometimes cost 8%-10% of the property’s cost. For index ETFs, transaction costs are minimal.
- MANAGEMENT COST: Cost of managing index funds and ETFs is around 0.02% to 0.05%. Cost of managing real estate is much higher than this. Even if you personally manage it, the time and effort that goes into it can be used for something more rewarding than this.
- BELOW MARKET PRICE: Sometimes it is possible to buy real estate at a price lower than the market when the seller is in a hurry or does not have a clear understanding of the market demand. This is not possible in the stock market, to buy the stock at a price lower than the market (undervalued stocks cannot be termed as below market priced stocks).
- TIME & EFFORT CONSUMPTION: Holding and managing real estate involves a lot of work even after hiring a property manager to look after the property.
Investments in stocks and real estate are not mutually exclusive, an investor can invest in both or either. Investment in stocks is a good idea for short term as well as long term but investment in property is a long term commitment. It takes a lot of patience and time. Your money is bound for a longer period than in stocks. But every individual has different objectives and circumstances for investments. The advantages of stocks are far greater when compared with real estate. But the final decision of an investor to choose from these two investment options mostly depends on investment goals, tenor, risk appetite and personal opinion and experience of the investor.