People develop an investment strategy to fit their budget and needs, from saving for a kids college fund or creating residual income while still working, to socking away money for retirement. The stock market is a popular go-to for investors. However, real estate also offers investment potential, and for many people can be a more effective vehicle to accomplish goals, often with lower risk and higher returns under the right circumstances.
Investing in the stock market has also taken a downturn in America since the Great Recession of the last decade. This sharp decline in economic activity is still fresh in many investors minds, as the stock market suffered the worst downturn since the Great Depression. The means by which investors invested their money was also called into question, and a third of Americans just stopped investing in stocks all together. Market participation dropped to just over 50% by 2016. Still, only about 15% of Americans invest in real estate outside their primary residence.
Making investments is a good way to maximize long-term returns. Although real estate is not without its own risks, many are including real estate in their long-term investment strategies.
The difference with real estate investing
Unless one intends to get in the business of flipping homes, real estate investing is more of a long game. There is a higher investment upfront and the investment cannot be sold as quickly as a stock. But in addition to increasing equity in the property over time, investment real estate also provides passive income along the way.
Real estate may be appealing for many investors, because it is a way to diversify investments- creating a wide variety of different types of investments within a portfolio in an attempt at limiting exposure to any single asset or risk. Real estate is also appealing because it is a physical asset with a finite value. Real estate is something investors can touch, see and be accountable for.
On average, stocks have averaged compounded returns of about 8% over the past two decades. However, investment experts say that is shifting, and anticipate significantly lower returns in the years ahead. An article from brokerage house Charles Schwab explains it this way: “The main factors behind the lower expectations for market returns are below-average inflation (despite a recent rise in expected inflation), historically low interest rates, and equity valuations.”
It’s not easy to compare stocks and real estate because they are totally different types of investments, but they can be compared on the basis of value. Since 2000, real estate has outperformed the stock market by about two to one. Annual average earning in that time period is 10.71% for real estate versus 5.43% for stocks. This high performing return on investment has many investors seeking to obtain rental property.
Even though real estate prices fluctuate over time, property appreciates at approximately 3% to 4% annually, according to Investopedia. Plus, a solid real estate investment will garner 8% to 12% per year in return from renting out the property.
Real Estate vs. Stock Risks
The Great Recession impacted both real estate and stock market investors, although their risks were distinctly different.
Real estate requires a lot of research, learning and developing knowledge about this type of investing. We have a series of articles in our blog for those just jumping in real estate as an investment. A new real estate investment is not something you can expect immediate results or returns from. Also, if your personal situation changes, real estate cannot be quickly liquidated. In fact, your real estate investing strategy should be set up to ride out changes in the market or your personal circumstances so you are not forced to sell at an inopportune time. It there is a downturn in the market, there will be a lot of people trying to sell all at once.
If you buy real estate with the intent to flip it, or sell it quickly for a profit, there are risks in finding unforseen problems when making repairs or updates.
Those who look to own rental properties must also take into account management issues, including the time and potential headaches interacting with tenants. Unless you are planning to manage your rentals as your job, tasks can seriously eat away at your free time. Tenant issues follow business hours, and you may not be able to delay a repair if it is an emergency. You may want to incorporate the cost of a rental manager into the cost of your investment so that you can spend your time elsewhere. Destination Maui Realty not only oversees all management and upkeep for a rental, we work with licensed contractors for all trades should your investment property have an emergency or need updating.
From fluctuations in the market or a wavering economy to rising inflation, the stock market is subject to several different kinds of risk.
Stock prices can vary widely depending on market conditions, and sometimes the market or geo-political conditions of other countries. For example, if a company has foreign holdings, that division is subject to that country’s rules, economic problems and political troubles. These circumstances affect stock values, as does our own country’s monetary policy, regulations, tax changes and interest rate adjustments.
Investors who do not have diversity in their stock holdings, or are too heavily reliant on specific types of stocks, also have higher risk.
Pros and Cons of Real Estate
Real Estate investors have the ability to gain more leverage on their capital and see some tax benefits. Although real estate is not as liquid as the stock market, the long-term cash flow provides passive income and the promise of appreciation.
When purchasing property, investors have more leverage over their money enabling them to buy a more valuable investment vehicle. Putting $25,000 into securities buys $25,000 in value. Conversely, the same investment in real estate could buy $125,000 in property with a mortgage and tax-deductible interest.
Cash garnered from rent is expected to cover the mortgage, insurance, property taxes, and repairs. But a well-managed property also generates income for the owners. Additional real estate investment benefits include depreciation and other tax write-offs.
Real estate generating monthly rental income can increase with inflation even in a rent-controlled area, which offers an additional advantage.
Another consideration is taxes after selling the investment. Selling stocks typically results in capital gains taxes. Real estate capital gains can be deferred if another property is purchased after the sale, called a 1031 exchange in the tax code.
On the flip side, investors need to have the ability to secure a down payment and financing if they aren’t making all-cash deals. Since real estate isn’t as liquid, investors can’t rely on selling their properties immediately when they may be in need. Other disadvantages include other costs associated with property management and the investment of time that goes into the building’s upkeep.
Pros and Cons of the Stock Market
For most investors, it does not take a huge cash infusion to get started in this market, making it an appealing option. Unlike real estate, stocks are liquid and are easily bought and sold, so you can rely on them in case of emergencies.
Stocks tend to be more volatile, leading to a more risky investment. Selling your stocks may result in a capital gains tax, making your tax burden much heavier. And unless you have a lot of money in the market, your holdings may not be very sizable.
The Bottom Line
Real estate and stocks both present risks and rewards. Investing in the stock market receives a lot of attention as a retirement investment vehicle, particularly for people who contribute regularly to a 401(k) or Roth IRA. However, diversification is important, especially when saving for the long term. Investors should opt for a variety of asset classes or sectors to reduce their risk. Investing in real estate is an ideal way to diversify your own investment portfolio while at the same time reducing risk and maximizing returns.