Real Estate vs Stocks
Real Estate vs. Stocks
The stock market is officially on fire now after taking a severe hit at the beginning of 2020 just 10 months ago or so. Many investors who pulled their money out are trying to decide what makes more sense: investing in real estate or getting back into the stock market.
The juicy returns that investors who invested in the stock market in April of 2020 are seeing now are always appealing to the outside investor hoping to capitalize as the market continues to shoot up again (fingers crossed). Investing in the stock market can be a good way to make your money work for you, but choosing the real estate route may actually bring you higher returns.
When deciding whether to invest in real estate vs. stocks in the new year, what should you consider? Liquidity, risk and return, and asset control are high on the list.
Liquidity…Is That All There Is?
When asking newer investors why they invest in the stock market rather than real estate, they’ll often say that they do not invest in illiquid assets because they want the option to pull their cash out quickly in case of an emergency.
Seasoned investors who have several decades under their belt will tell you a different story. You will consistently hear that they built their empire on real estate investments that have steadily grown their net worth while spitting out cash flow to snowball their investing along the way. They didn’t invest their entire net worth in liquid securities that could deplete to zero and wipe them out should things go sideways.
For those who are unclear on what liquidity is, it refers to the speed at which an asset can be converted to usable cash or cash equivalents. A liquid asset can quickly be converted to cash and cash equivalents.
Securities in the stock market are highly liquid because they can often be converted to cash within 48 hours, whereas real estate is a longer process. For example, when selling a rental property, it may take 45 to 70 days from the time you decide you want to sell it until you actually receive cash in your bank account.
In more extreme examples such as commercial real estate, the average length of time required to close on a deal can be as long as two years after deciding to list it for sale. This depends on what demand is like for the asset type in your particular market. For example, an industrial park will take longer to sell than a value-add multifamily property.
Although liquidity is important in certain cases, with enough planning and forethought, you can ensure that you will not need that amount of cash out of the blue.
Set aside reserves from real estate cash flows to accumulate and use should you find yourself in a dicey situation. Maintaining a balance of liquid cash on your balance sheet to cover emergencies should be a priority regardless of investment strategy.
Risk. Reward. Let’s Get Real.
Whether investing in real estate or the stock market, there is a certain level of risk involved. Coming from a perspective of institutional and corporate finance, the risk is directly correlated with an expected return rate on an investment.
Textbooks and experts tell us that the stock market provides an average expected return of roughly 10% in the long term, and real estate investments provide average expected returns of 12-15%. From this, we can infer that real estate also has a higher risk of losing capital and failing to provide a return whereas the stock market has a higher likelihood of delivering its expected return (even though lower) due to its lower level of associated risk.
In reality, this depends largely on the individual investor’s strategy as well as how they operate their real estate investment portfolio.
In the case of a highly experienced stock trader, returns will be significantly higher than 10%, with a lower likelihood of losing invested capital. An everyday trader who does not want to spend eight hours per day researching companies can expect average returns. This is why sophisticated investors are willing to pay high fees to invest in hedge funds where their money is managed by some of the brightest minds in the industry.
The same goes for experienced real estate investors. These investors are more likely to have annual returns that are significantly higher than 10%. However, they would make less informed investing decisions should they shift to investing in stocks at the same capital scale.
Is Your Investment Worth Anything in the Event of a Market Collapse?
Something to consider when accounting for the risk of real estate vs. stocks is what happens if things do go south. With investments in the stock market, your investments can (worst-case scenario) go from a value of $500,000 to $0 in the case of a total market collapse. If the real estate market crashes, the amount you can liquidate the property for will decrease but will not reach zero.
If you have a rental property that is worth $500,000 before a market crash, you may not be able to sell it for $500,000 after the crash, but you will get something for it. Even during the worst real estate market crash in history (which coincided with the stock market crash in 1929 that spurred the Great Depression), when real estate values dropped by as much as 67%, an investment still did not lose all its value.
This is a huge reason why many of the world’s wealthiest and most-seasoned investors pick real estate as their investment vehicle of choice. It has the ability to consistently provide steady returns and monthly cash flow as well as preserve wealth.
Control of the Asset
With real estate, an investor has control of the asset and the ability to increase its value and returns.
An investor might purchase a run-down house with the intent of converting it to a rental property. They repair it and add vinyl plank floors, granite countertops, stainless steel appliances, and a fresh coat of paint on the walls to increase the property value. Upon renting out the property, it can be refinanced for more than it was purchased for, plus the renovations’ cost.
This ability to force appreciation is what pulls so many investors to the real estate industry.
Let’s say you purchase a home for $80,000 and put $20,000 into it in repairs and updates before renting it out for $1,500 per month. Afterwards, you reach out to your local lender to refinance the property and pull your invested capital out.
The appraiser that the bank hires appraises the property at $150,000 given its current condition and that it is rented out for $1,500 per month. The lender allows you to pull out 80% of the property’s value.
This means you now have pulled out your initial $100,000 that you put into the property plus an additional $20,000 in capital that you can reinvest in more properties should you choose to do so. All of this occurs while you still own a cash-flowing investment that will continue to increase in value in the long term.
On the flip side, stocks are different in the sense that no matter how many iPhones you buy or packages you order on Amazon, you are not going to affect the share price of Apple or Amazon enough to influence your portfolio returns. This is a huge advantage of real estate that should not be discounted, especially when stock returns look more attractive than ever.
Real Estate Is the Smart Choice for Your Investment Future
The most important factors to consider when deciding between investing in real estate vs. stocks are liquidity, risk and return, and the control that the investor can have over the investment’s performance (hint: you can have an impact on the value of real estate investments).
When weighing each of these factors, it’s clear that real estate is the superior, more stable investment vehicle in the long term.