Retail investors often flock to two very different asset classes to reach their retirement goals. Two common investments seem to be real estate and publicly-traded stocks. Let’s look at these two different asset classes to compare their pros and cons.
Investing in Real Estate
Real estate has a few advantages that makes it attractive for individual investors:
- Leverage – Real estate is an investment that performs best when leveraged. As an individual investor, real estate can be levered 5:1 with a traditional loan with 20% down. Enterprising investors who can make use of FHA lending programs can borrow with only 3.5% down to purchase a live-in four-plex, offering far more leverage to the investor.
- Cash flow – Real estate is all about cash flow. Unlike dividend stocks, which might yield 3-4% at the most, real estate brings impressive cash-on-cash returns to the investor. Depreciation tax benefits are most beneficial to investors in a high tax bracket, seeing as property is depreciated over 27.5 years, which creates a tax shield for high-income individuals.
- Control – Real estate investors have much more control over their investment than an investor in a public company. Whereas you have full control to set rental prices, make new investments, and select tenants, minority owners of public companies have very little control over the day to day decisions to be made in publicly-traded companies.
Real estate also has disadvantages:
- Time – You can’t passively invest in real estate like you might stocks. Real estate investing requires time and energy to find good properties and tenants. Investing in real estate is much more like running a business than investing in stocks.
- Operating leverage – The effects of real estate spill directly into your personal finances. Each dollar you borrow to buy real estate is a dollar of debt for which you, as an individual, are 100% responsible to repay. Furthermore, if rental units go without tenants, you have to cover the cost of debt service and maintenance out of your own pocket.
Investing in the Stock Market
The stock market has its own upsides, as well:
- Less active – It is significantly easier to be a passive stock investor as the day to day operations of the businesses you invest in are handled by someone else.
- More liquid – It’s much easier to sell $100,000 in stock than it is to sell a $100,000 home. The stock market is far more liquid of a market, making it a better investment for people who will need to make principle withdrawals in the future to cover living costs or immediate cash needs.
- No credit needed – There are plenty of companies on the stock market that are just as leveraged as your average real estate investor. However, these companies borrow on their own balance sheets, meaning that the investor isn’t required to carry debt themselves. When you buy into a public company you are not liable for losses should it go bankrupt. The same can’t be said of an individual investment in real estate.
Of course, the stock market isn’t perfect, either:
- It’s all correlated – In the short-term, stocks move up and down with each other. The real estate market moves very differently, and home prices do not follow the ups and downs of the stock market on a day-to-day basis.
- You have no control – Unless you own 51% of a public company, or can persuade 51% of stockholders to agree with you, you have little to no impact on how a company performs or what it does going forward. This is very different from real estate, where the cash goes directly to the individual for reinvestment or deployment elsewhere. Shareholders are at the mercy of executives to make decisions that favor shareholder interests. No one stands in the way of a real estate investor who owns his or her own properties.
Real Estate vs. Stocks: The Biggest Factor
All in all, the biggest difference between real estate and stocks isn’t in the returns, the leverage, or even the correlation. I think the biggest difference is the amount of time you’ll need to invest in either one.
As a real estate investor, you are a business owner who has to set prices, deal with customers, and hire employees (contractors when necessary) to take care of your inventory (homes.) As an investor in the public stock markets, your only requirement is capital – you won’t have to listen to customers, hire workers, or manage your own business. You’re just a partner in a much bigger entity when you own stock in a company.
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