Real estate and stocks are two of the most popular investment vehicles. It is always important to have a balanced portfolio, which will usually include both. However, if you have to pick one, it is my experience that real estate earns stronger and more consistent returns. In this article, I will explore some of the reasons why real estate can better serve your investment goals. Let’s get down to it:
1.) Real Estate is a Tangible Asset.
Real Estate is a physical investment that you can see and touch. Shares in a company are nothing more than a piece of paper giving you an interest in a company. While these shares have value, real estate is essential! People must have homes to live in and businesses must have places to operate from. You can live in a house or an apartment, but you cannot live in a share of stock from Google.
This tangibility leads to the most important benefit of real estate – it’s not as volatile as the stock market. Stocks can plummet for any reason at any time, leaving investors at the mercy of things beyond their control. Global events, such as natural disasters, corporate bankruptcy, and high-profile white-collar crimes, can all negatively affect the value of stocks. Any of these events could wipe out your portfolio, but a piece of property… and its value… will still be standing.
2.) Real Estate allows for Leverage.
Now leverage can be a double-edged sword, and over-leveraging a property can cause your asset to become a “money pit” faster than you can say “Bubble”. The over-leveraging of properties (coupled with greed) is the primary reason for the 2008 real estate market crash. However, responsible leveraging can allow an investor to put up 20-30% of the purchase price of a property and borrow the remaining amount. It is this leverage that allows the investor to realize higher gains than the stock market.
Not convinced? Let’s look at an example: Say you have $100,000 dollars to invest in real estate, you can generally leverage that into a $500,000 property. So your $100,000 will serve as a 20% down payment on a $500,000 property and you will get a mortgage for the remaining $400,000. If the property appreciates at 5% ($25,000) over the course of a year, that is an unrealized gain of 25% on your invested capital of $100,000. In addition, if the property was generating a positive income, then your returns would be even greater.
Now just to be straight forward, this is the broad view of the investment. It doesn’t take into account closing costs, loan costs, illiquidity of the investment, etc. So there are more costs that would be associated with this investment that would take away from that 25% return. Additionally, you would have to sell or refinance the property to realize that 25% return. However, over the course of a few years with responsible leverage, real estate returns far outpace the stock market.
Stocks can generally only be leverage at a 50% – 100% ratio if you are trading on margin. So if you have $100,000 to invest, you can generally purchase $150,000 – $200,000 worth of stock. Assuming you purchased $200,000 worth of stock and it appreciated 5% ($10,000) over the course of a year, that is an unrealized gain of only 10% on your invested capital of $100,000. And just with the real estate investment you still have additional fees that will take away from this gain, including brokerage fees and interest on the borrowed capital.
3.) Real Estate allows for more Control.
When you invest in real estate, you have more control in how that investment will perform. You can implement strategies to maximize your returns. With stocks, you really don’t have any control over how the company operates. At best you can submit suggestions to the board of directors, and maybe they will implement some of your suggestions… MAYBE!
Real Estate also provides other advantages for the risk-averse, and in terms of how gains are realized and in terms of the overall volatility and manipulation of the markets, which we will delve into with greater detail in another post, but we can always carry the conversation over into the comments below so please let me know your thoughts and comment below.
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