Real estate vs stocks, what you need to know

Miniature House on A Blue Financial Graph- real-estate-vs.-stocks

There are many considerations to be made when determining your personal investment strategy. Whether you are thinking about your family’s future, saving up for retirement or simply looking for ways to set up some kind of passive income stream, there are many investment options available to you depending on your needs, budget, and time management skills. 

Here we take a look at the difference between investing in real estate versus investing in stocks—two of the most commonly considered investment options. Like all investments, both real estate and stocks have their own set of benefits and risks. 

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Investing in real estate versus stocks: a closer look at real estate

There are many ways to start investing in real estate. You can directly purchase property if you have the finances to do so, you also have the option to invest in a property with the goal to buy it eventually and you can invest in the real estate market without buying property at all. 

Here are some of the ways to invest in real estate by purchasing property

1. Become a homeowner. Purchasing your primary residence and getting involved in its upkeep has historically been a good investment over the long term. This way it can be treated as a long-term investment with tax benefits, opposed to a shorter-term fix and flip which we’ll explain below. 

2. Buy a fixer-upper, put in the work required to increase its value and then sell it for a profit. This is also known as fix and flip. This option requires you to do the research needed to ensure you are buying property in an area with strong market fundamentals, have the capital needed to get involved in such a project, and the patience to see it through to a point where you make a profit from all your efforts. This means that you either need to have the knowledge to do the work or bring in a team that would be able to take the project on. 

3. Getting involved in a rent-to-own contract can be a great alternative for those who either are not eligible to take out a mortgage or do not have the capital for a down payment. A rent-to-own contract has two parts to it: a standard lease agreement and an option to buy at the end of the contract. It is more complicated than a regular leasing agreement, but it can work as long as you do your homework and the terms suit your needs.  

4. Purchase a property that you then rent out for income. This includes options like the obvious, which is to rent your property to a tenant based on a lease, purchasing a vacation home that you then rent out to tenants for short-term stays or using apps like Airbnb to create supplemental income for short periods of time.

5. Investing in commercial property is a great idea if you have the kind of funds needed. There is a lot more research required in this scenario as there are high risks and high rewards involved in commercial real estate investing.

Here are some ways to invest in real estate without directly purchasing property:

1. Invest in REITs, or real estate investment trusts. Essentially, REITs are corporations that own and manage a portfolio of real estate properties and mortgages. REITs are either publicly or privately traded. Anyone can buy shares in a publicly traded REIT. They offer the benefits of real estate ownership without the headaches or expense of being a landlord. Remember, REITs must distribute at least 90% of taxable income to shareholders each year in the form of dividends. 

2. Real estate mutual funds typically invest in REIT stocks, real estate related stocks, or a combination of both. When choosing this option, you can go with a fund that is either income-oriented or growth-oriented. While they tend to be less risky due to diversification, they are still open to the risks that are inherent in all investing. Depending on their investment strategy, real estate mutual funds can be a more diversified investment vehicle than are REITs. This can cut down on transaction costs for those looking for greater diversification concentrated in one or a few funds. They also have the benefit of professional portfolio management and research.

3. Invest in companies that service real estate. This could be through companies that sell real estate via real estate agents, management, or construction companies. This is a way to invest in the real estate market without actually purchasing any property.

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What are the potential benefits of investing in real estate vs stocks? 

Real estate is a tangible asset

Real estate, by definition, is real. It draws its value from the income it can generate or potentially generate in the case of vacant land.  Additionally, real estate is one of the few asset classes that has historically appreciated in value over time. 

A strong source of passive income

Income that is generated by renting out real estate can be lucrative. People will always have a need for residential, commercial or industrial real estate, making it a great investment to vary your portfolio. 

Attractive tax breaks 

Investing in real estate makes you eligible to deduct some expenses when you file your taxes. These include depreciation on buildings, building repairs or improvements, mortgage interest and business expenses. If you decide to buy and sell a property, you could even file for a like-kind or 1031 exchange, which lets you delay paying taxes on the property.

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What are the potential drawbacks of investing in real estate vs stocks?

Illiquid Asset

Real estate is an asset that cannot be converted to cash quickly, making it illiquid. Even a highly motivated property owner with real estate in a desirable location might find it difficult to sell it quickly and it may be even harder to sell property in less sought-after areas. 

Management, upkeep and expenses

If you choose to invest in real estate by purchasing it, there can be a lot of time and expenses involved in maintaining it. Whether you plan to live there yourself or rent it out, as the owner, you are responsible for managing the property and maintaining its upkeep. 

It takes a while to get started

Conducting research about what areas to buy properties in, figuring out how you can finance them, and thinking through the best strategy to manage them is time consuming. As purchasing real estate is a big decision for most people, it can take a lot of time to decide the best way to go about it. 

Bad tenants

Once you have purchased property to rent out, there is always the possibility of coming across a bad tenant. While you can take measures to ensure you have enough funds to cover damages done by a tenant by requiring a security deposit, it can still turn into a time-consuming chore if you have a bad tenant. 

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Investing in stocks vs real estate

Stocks can sometimes be referred to as equities or shares. They are a paper asset that signifies your proportional ownership in a corporation. Corporations sell stocks to raise the funds they need in order to run their business.

Public stocks are typically traded on stock exchanges while private stocks are less accessible to regular investors. The buying and selling of stocks is highly regulated by the government to prevent investors from engaging in fraudulent transactions. 

Publicly traded companies are considered to be their own legal entity, which means they must pay taxes, can buy property, can borrow and even be sued. When you are buying a stock, you become an owner in that corporation and can participate in the income the business generates via dividends or stock value appreciation.  Faster growing businesses tend to reinvest in their operations rather than pay a dividend. 

To explain this simply, if a company is selling 1000 shares of stock on the stock exchange and you purchased 100 shares, you would own 10% of the company with the voting rights that go along with that ownership stake.

What are the potential benefits of investing in stocks vs real estate? 

Earning through economic growth

Stocks are more strongly correlated to economic cycles compared to real estate.  This is a double-edged sword because the market is cyclical. During an expansion, share prices go up because businesses are doing well. This creates jobs, leading to higher incomes and increased consumer demand, leading back to more business. It is important to realize that after an expansion and peak, a contraction and trough often occur.

Easy to start investing

As stocks are the most common form of investment, there are many ways to go about investing in them:

  1. Investing through a 401k plan that is sponsored by your employer
  2. Investing through an IRA. 
  3. Investing through a brokerage account, which is where an investor deposits money with a licensed brokerage firm that invests it in stocks on their behalf. 
  4. Investing directly through a stock purchase plan (DSPP), which lets investors purchase stock directly from the corporation without the involvement of a broker, or a dividend reinvestment plan (DRIP) which lets investors use the cash they earned from dividends to automatically reinvest in the corporation. 
  5. Investing through discount brokerages and do-it-yourself models make it possible for anyone with access to the internet and a bank account to get started with investing in the stock market. 

Stocks are a liquid investment 

Stocks can be bought and sold easily.  Some stocks are extremely liquid, almost cash-like, and others are very illiquid with limited shares trading on a daily basis.  

No direct involvement required

Once you purchase stock, you can sit back and relax as the market dynamics take their course. You do not have to be directly involved in the day-to-day management of the corporation in any way. This makes stocks a good investment if you have limited time. 

Tax on capital gains is lower for qualified dividends

There is an incentive to hold stocks for periods longer than a year so that you may benefit from the long-term capital gains tax rate which is lower than the short-term capital gains tax rate.  It can be beneficial to hold stocks for a longer time to benefit from tax breaks, but it is viewed by many as not the best reason to drive investment decisions.  

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What are the potential drawbacks of investing in stocks versus real estate?

Risk

By investing in the stock market, you are exposed to the broader market moves that occur day in and day out with clear pricing transparency.  In addition, if the corporation you are invested in starts to do badly, other investors might sell their shares leading the stock value to go down. If you were to also sell at this point when the stock is devalued, you may experience a loss. 

Stocks are a paper or intangible asset

Stocks are a kind of financial asset. This means that they carry a representative value to the entity that holds them. This is in contrast to real assets that are tangible and have an intrinsic value. 

You have no control over the value of stocks

Investing in stock does not give you any kind of control over a corporation. While you may have voting rights as a common stockholder, you don’t have managerial control over how the business is run day to day and could lose your investment if those who are managing the corporation are not successful. 

Stockholders are the last to get paid

In the event that a corporation that you have shares in goes under, as a common stockholder, you will be the last to get paid. Creditors and preferred stockholders get paid before common stockholders. One way to help protect the downside of this prospect is to diversify your portfolio. 

The stock market is emotional 

Investing in the stock market makes you vulnerable to not only your own emotions, but of the whole market’s emotions. Individual investors tend to buy and sell based on their sentiments. If things are going well, demand for a stock is high and people buy more of it. If a stock begins to fall, individual investors panic and sell

Whether you invest in real estate vs stocks is a personal decision. They are different kinds of assets and provide different value to your portfolio. Understanding the difference between these two kinds of investments can be the key to gaining a deeper knowledge of what kind of investor you are. Once you understand your own investment preferences, you can go about building a diversified portfolio that suits your goals. 

This communication and the information contained in this article are provided for general informational purposes only and should neither be construed nor intended to be a recommendation to purchase, sell or hold any security or otherwise to be investment, tax, financial, accounting, legal, regulatory or compliance advice. Any link to a third-party website (or article contained therein) is not an endorsement, authorization or representation of our affiliation with that third party (or article). We do not exercise control over third-party websites, and we are not responsible or liable for the accuracy, legality, appropriateness or any other aspect of such website (or article contained therein).
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