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Buying one’s own home is the traditional investment most people are expected to make. But investing in stocks can also build wealth for the savvy investor. Which one is better to choose? Should you even make that choice?
To answer this question, both real estate and stock markets need to be understood comprehensively. These markets offer some of the best opportunities in the world of investing, so read on and grab the opportunity!
Just the Nuggets
- Real estate gets you direct property ownership, while a stock gets you partial ownership in a company.
- Both options can provide a profit. Usually, real estate values vary less than stocks year-on-year but they have approximately the same average rates over long periods.
- Stocks can be bought with less money than real estate, but the latter can be used as loan collateral much easier.
- Both real estate and stock markets are great spots for investment. It’s just a question of investor ability, goals, and timing in choosing which one to enter.
Whether alone or in partnership with another, real estate investors hold claims over parcels of land or buildings. They can usually estimate the size of their real estate claims with relative ease.
For example, you’re starting off as a real estate investor and you’re considering a purchase of a 100-square-meter (1076-square-foot) apartment that can be easily repurposed for a living space or a small office. The price is $500,000 for the whole apartment. If you buy it alone, then you’d own all of it. But if you decide to partner up 50/50 with someone, then they’d own half the apartment or 50 square meters (538 sq. ft.) in exact measure. In either case, you have a clear idea of how much real estate you own.
With real estate, the discussion tends to focus on homeownership. But when looking at the whole market, investors need to be mindful of its pros and cons.
- Direct ownership. Investors hold a direct claim on the property bought.
- Value appreciation. Landlords receive an increase in wealth when the value of their property goes up.
- Flexibility. A real estate property can be a living space or business space. This way, landlords can both save and make money.
- Rental capability. Most properties can be rented out. This provides another cash flow, which can be used as disposable income or capital financing for more real estate purchases.
- Collateral use. Property can be used as loan collateral. This allows investors to make purchases with a part of the money needed.
- Fragmentation. There can be hot locations even when most of the market is a downfall.
- Maintenance. Property needs to be maintained. Aside from doing so for comfort, good locations usually have stringent maintenance standards.
- Value depreciation. Properties, except land, depreciate in value. Like with any market, real estate markets do experience their downturns.
- Tax liability. Property taxes exist in almost any location, and the hottest spots usually have relatively higher taxes.
- Insurance. Even if not required by law, insuring a piece of property you’ve put a large sum of money into is common sense.
- Low turnover rate. In a market downturn, properties can remain unsold for long periods. Look at the listings in New York City at this moment.
Investing in stocks is the act of buying a piece of ownership in a company. Though stockholders are partial owners of the company, they have no direct claim on its assets. Rather, stockholders have a residual claim on the company’s equity.
A residual claim means that stockholders can claim ownership over the remaining assets after the company has paid off all of its liabilities. This would only happen in the event of the company being liquidated. Otherwise, stockholders have no direct control over the assets.
For example, you’re considering buying 10,000 shares for $50 per share in a company that has 1,000,000 issued shares in total. If you decide to make the purchase, you’d pay $500,000 for 1% ownership in the company. This means you’d have a residual claim to 1% of the company’s equity, while the rest own the other 99%.
There are many powerful reasons to invest in stocks. But understanding the stock market before making any decision is a crucial step to wealth building. Investors should, therefore, be mindful of the stock market’s pros and cons.
- Straightforwardness. The act of buying stocks takes minutes and settles in a few days.
- Rising prices. The stock market has created the greatest fortunes in history and will likely continue to do so.
- Dividend yield. Stockholders can receive a part of the company’s profit if they own stocks in a company that pays dividends.
- Stability. Stockholders are owners of powerful and stable companies. Some of the listed companies have been market-dominant in decades.
- Inflation control. They counter inflation. Stock portfolios reflect monetary policy changes within days.
- Required effort. Stock markets take some time to understand and require some knowledge to make informed decisions.
- Declining prices. Aside from creating wealth, stocks can also result in loss of fortunes when invested the wrong way.
- High integration. Rarely does a stock beat the market in the long run—if the market goes down, most stocks are affected.
- Residual claim. Owners of stocks have the last claim during bankruptcy. So if a company goes bust, stockholders could be left with pennies on the dollar.
Comparison of Historical Returns
Both real estate and stocks provide two types of return on investment.
1. Capital Appreciation
Over time, the real estate prices will vary on the open market, and the prices can be tracked in end-of-period reports of real estate transactions. On the other hand, the prices of stocks come from the stock market, which is more rigorously organized and can be tracked in real-time. Traditionally, it is assumed that real estate prices vary less than stock prices.
2. Rent or Dividends
This amounts to cash (in the case of dividends—cash, shares, or property) you would receive as a landlord or stockholder. Rent is paid by the tenant to the landlord. A dividend is paid by the company to the stockholder.
Both capital appreciation and rents/dividends (if applicable) play a part in determining what the return on investment adds up to. To get a summary of both parts across large markets, let’s look at these investment funds:
- Vanguard Real Estate Index Fund ETF (one of the largest real-estate-focused investment funds in the world)
- SPDR S&P 500 ETF (an investment fund replicating the returns of the entire S&P 500)
As the chart shows, real estate can provide better returns in some years (see year 2014). But even though real estate and stocks have a difference in numbers year-on-year:
- real estate returns can plummet much like stock returns (see year 2008)
- over a long period, the average returns can only slightly differ (see averages)
Which Investment is Better for You?
How much can you invest?
Real estate can be quite expensive. Even at the height of the COVID-19 pandemic, the median home value in the US was close to $250,000. In contrast to stocks where you can begin with a few thousand (or even hundreds) of dollars, real estate requires much more funds and planning.
However, unlike stocks, real estate can be mortgaged to borrow large sums of money. As long as you have a reasonable down payment, getting a loan to purchase real estate makes sense. Meanwhile, borrowing to purchase stocks is generally thought of as bad practice.
Immediate and strategic goals
If possible, investors should own both real estate and stocks as a strategic long-term goal. If not, investors need to be smart in making a choice.
An investor who spends too much on rent ought to consider purchasing real estate, even if their portfolio is not very large. An investor who has affordable rent should consider building a stock portfolio, even if it means paying a rent expense for a little longer.
Real estate and stocks can be complementary to each other. A stock portfolio can build wealth that can be used to buy real estate. Real estate can be used to generate rent income to build a stock portfolio. A prudent investor would be wise to consider their funding capability and both the markets. Only then can they decide when to invest in each market.
Investments should be made to the best of an investor’s knowledge, both in real estate and in stocks. When deciding which market to enter, investors should be objective about how much they understand. What they shouldn’t do is enter either of the markets with insufficient knowledge, information, and understanding. Only once they’re able to make an informed decision should they make a purchase.
The securities exchanges provide an instrument to enter almost any market. Real Estate Investment Trusts (REITs) are a great option for investing in real estate via securities. REITs are investment funds traded on exchanges much like stocks, and purchasing them is as straightforward. REITs are ideal for investors who wish to capitalize on the real estate market without committing large sums of money and work associated with it.
Real Estate Today
Safe as houses may not sound right when looking at the exodus of people from places like New York City and the San Francisco Bay Area after the COVID-19 lockdown. But where are all those people going to live? What’s the new hot real estate area?
In the real estate market, overall homeownership rates have stagnated since the 60s and have been tapering off since. But homes outside major cities are used to be bought more often than today.
With the major shift to working from home making it possible to move almost anywhere, homeownership may be more accessible than ever. If you can move your work or business with you, the freedom to move to more affordable or better-valued areas increases. So it is very likely that the hot real estate areas today are outside major cities.
Ideally, all people should be able to own their own home and business premises, or even hold a large profitable stock portfolio. Both real estate and stocks can help build a fortune. But if they need to choose between the two, they should make an informed decision based on their goals, ability, and timing.
To sum up, these are the biggest differences between the two investment options.
- Investing in real estate is buying a property. Investing in stocks is buying equity in a company.
- Real estate gives you a direct claim on assets while stocks only give you a residual claim.
- To be the sole owner of real estate is not that difficult or uncommon. But sole ownership over a listed company requires the acquisition of all its shares, which is very difficult and uncommon.
Our References and Further Readings