Real Estate vs Stock Market - Which is a Better Investment?
There is a lot of misinformation out there on the web when comparing real estate vs stock market.
Some say that stocks beat real estate every time. Too bad they only look at appreciation and forget about rents.
Others say real estate wins every time, but usually they have overly optimistic forecasts about rent growth and expenses.
So who's right?
I'm going to dig down and weed out the good from the bad in order to help to you answer the question once and for all.
Real Estate vs Stocks
There are billionaire real estate investors and billionaire stock market investors. The internet is full of sites showing you how to make money in the stock market, and in real estate (like the one you're reading). So clearly you can make money in both, but what is the best way for average people?
Stock Market Vs Real Estate Returns
The first thing people want to know, is what the returns are. The average returns of the s&p 500 are well studied. It is widely known that stock market returns are around 10% per year, or around 7% once adjusted for inflation.
This would translate into a commercial investment property with a 7% capitalization rate (assuming another 3% or so for appreciation).
In 2016, many major metro areas are selling real estate around the 6% cap rate, with secondary markets selling around 7-8% cap rates. So, clearly real estate can match the average returns of the stock market.
Well, not exactly. Other people will cite the returns of single family homes and show a 4-5% return for the average investor, though some people in a few markets hitting near double digit returns.
And other people will cite the real estate sector of the S&P 500 and show real estate is better than stocks and beats the market by about 2% per year on average.
Though I've listed a few examples and real estate clearly holds it's own against stocks, the story is more complicated.
SHOULD I INVEST IN REAL ESTATE INSTEAD OF STOCKS?
So let's take a deeper look at the benefits of real estate that are forgotten about:
Real Estate is the Only thing that is "Real"
There is a reason why it's called real property and everything else is called personal property.
With real property, it's harder to be the victim of fraud - you can physically inspect the property and verify everything.
It is also one of the 3 basic necessities - food, water, and shelter. It's a tangible asset that cannot disappear suddenly, it never falls out of favor, and nobody can take it away (unless you don't pay your taxes).
These are real benefits that only real estate can provide. Though it is hard to quantify some of these benefits, they nevertheless exist and should be considered
Real Estate Returns Can Be Leveraged
This is the biggest advantage of real estate vs the stock market. Real estate can safely, and cheaply, be leverage to really bump your returns.
Let's consider the 7% cap rate rental property, with 3% appreciation.
That means you will earn $7,000 each year on a $100,000 property along with $3,000 in appreciation for a total of $10,000 or a 10% return.
If you mortgage 75% of the value ($75,000) at 5% interest, you will have a cash return of $2,164 per year with $3,000 in appreciation and $1,100 in principal paydown in the first year. That's a total return of $6,264 on a $25,000 investment, or about 25% return. You could purchase 4 properties and earn $25,056 on the same $100,000 investment.
So you can see that a real estate investment with the same rate of return actually actually earns 3.5x as much.
THE STOCK MARKET HAS BEEN "DUMBED DOWN"
It's super easy to invest in the stock market now. Various funds have made it so you just auto-deduct money each money and invest it in the market. Of course, the market is still as advanced as you want it to be for the experts.
Real estate investing has not been "dumbed down" sufficiently that anybody can just drop a couple hundred dollars a month directly into property.
The drawback is it will require substantial time and effort to educate yourself and learn about real estate to make great investments.
Real Estate is Less Liquid Than Stocks
It goes without saying, but you can't sell your house on a whim. You can cash out of the S&P 500 tomorrow, but you can't sell your house tomorrow, or even next week.
It may be a couple months before you can get the cash from your property, and you will be lighter 6-8% of it's value in selling costs.
If you need your money back soon, stocks are better than real estate.
The Types Of Real Estate Investing
In order to be able to answer the question "stock market vs real estate", we first need to determine what type of real estate we are talking about. When people talk about "real estate" they are essentially talking about one of three types of real estate investments.
Most Americans look at their homes as an investment. I personally would consider a home like an expensive bank account (which is why I prefer a duplex or triplex instead). Unfortunately, most people will spend more money maintaining your home than it will ever return to you in appreciation.
You need to set aside 1 to 4 percent of the home value every year for maintenance. Guess what the average home appreciation is - 3.5%. Another point to consider is the average US inflation rate has been...guess it... just over 3%. So if your home appreciates at nearly the same rate as inflation, you are really losing 1-4% per year because of maintenance.
This is why your home isn't really an investment. Home prices shouldn't be used to compare against the stock market.
Exchange Traded Real Estate Funds And REITs
Real estate ETF's and REITs are very commonly invested in because they have a low cost to get involved, and they are still priced mostly based on their underlying real estate holdings. There are many pros and cons to these:
- Compared to actually buying real estate, people can buy into an exchange traded fund or REIT for as much or as little as they want.
- Very liquid - you can sell them very quickly.
- They are still stocks
- They are correlated with the broader market
- They incur significant regulations and overhead expenses to be listed on the stock market
Since REITs and ETF's are still stocks, they can be compared to the stock market quite easily. This is why most information on the web uses real estate stocks to judge real estate investments as a whole.
Comparing the real estate sector against the stock market is no different than comparing the energy sector or financials sector to the broader stock market. It is just comparing one part of the stock market to another part of the stock market.
I'm not against REITs entirely, I actually have money invested in one REIT.
I don't think it captures the whole picture.
Direct Investment In Real Estate
If you want to invest in mining, you can buy property and build a mine or buy stocks in a company that does mining. Similarly in real estate, you can buy the real estate, or buy into a company that invests in real estate.
Clearly though, owning some stocks in a mining company doesn't make you a miner just like buying shares of a REIT doesn't make you a real estate investor.
To truly answer the question and determine if you should invest in real estate or the stock market, I think you need to compare directly investing in rental property against the stock market.
Investing in real estate could mean buying property and renting it out yourself, investing passively through a syndication, or being a sponsor for real estate deals (such as a syndication). There are other ways to invest as well - private lending and tax liens are other examples, but are not what I'm calling "direct investment" in real estate.
Should I Invest in Real Estate or Stocks
I can't give you an exact answer, as everyone has a different situation. I can simplify it a little for you:
- Invest in Real Estate - If you have money that you don't need immediately, have time to learn about real estate, and enjoy earning very high returns.
- Invest in the Stock Market - If you don't have a lot of money or need your money back sooner. Also, invest in stocks if you are satisfied with smaller returns.
Though real estate clearly earns more, it may not be the better investment for you, depending on your situation.