Real estate and stocks are among the most common investments in the United States. According to Gallup, 63% of Americans own real estate, while 54% of Americans own stock. These numbers are not particularly shocking- but what is surprising is the Forbes study that showed upwards of 90% of millionaires in the United States created some or all of their wealth through real estate investments. Besides the obvious, you might be asking yourself- what is the difference between investing in real estate vs. stocks?
We are going to compare these two asset categories to help you understand which option might fit best in your investment portfolio.
Asset Risk
Historically, when it comes to risk, real estate has typically been the safer bet. The stock market can be incredibly volatile, and many financial advisors recognize equities, or stocks, as high-risk, high-reward investment vehicles. When you invest in a stock, you are buying an ownership share of a company. If that company has poor leadership, or cannot compete with other companies in its industry, it is possible that your investment can lose all or most of its value. With real estate, as long as you are not over-leveraged, it is unlikely the value of your investment will ever be worth nothing - after all you still own the building or the land.
Liquidity
Stocks are considered to have a liquidity advantage over real estate, in that they can be sold quickly on one of the exchanges. However, liquidity is a double-edged sword. If investors panic-sell their equities, they can realize big losses, all based on an emotional response to market events.
Compare that to the real estate market, where you can reduce risk due to the increased control you have over your real estate assets. You cannot control the decisions of companies that issue common stock, but you can control the rental income of an apartment building - as long as rents are competitive. You're in charge of finding the property, selecting a company to manage it, picking your tenants, and setting the rental rates. If your units are not producing, you can take steps to fix the problem by replacing tenants, upgrading properties, or increasing rental rates.
Diversification
Regardless of the type of investment, diversification is your best strategy for reducing risk.
Stocks have a few advantages when you build portfolios of securities. It is easy to create a diversified equity portfolio of 30 stocks or you can invest in an ETF or mutual fund. With real estate, you need to purchase multiple properties of different types, like multi-family residences, an office building, etc. It is also recommended that you spread your investment properties across a wide geographic area, another way to diversify your portfolio of real estate holdings. You don't put all of your money in one stock. You should not put all of your money in one real estate investment. It is more prudent to invest in several properties in different cities or states. This diversification protects against a market decline in a particular location.
There are ways to diversify your real estate portfolio without buying entire properties, for example you can invest in a REIT (Real Estate Investment Trust). Crowdfunding-based real estate investments are also making a big splash by making it easier for accredited investors to purchase interests in a diversified portfolio of properties. The rise of REITs and other fractional real estate investments are making diversification simpler and less expensive.
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Real Estate vs. Stock Stability
When it comes to stability, real estate is the clear winner. Attributes that are seen as positives, like the ease of sale and the ability to react to the market in real-time are the same things that make stocks more volatile than real estate investments. Market fluctuations are a trap that creates a lot of angst among investors. The reality is most people would be better off implementing long-term investment strategies.
A lot of the trading is emotional. They sell when they are afraid, and they buy when they are comfortable. A rational investor might do just the opposite depending on what produces the fear and complacency.
You can blame this on the stock market, which makes it easy to monitor prices minute-by-minute. Imagine if there was a market that told you the value of your real estate holdings minute-by-minute and you could make buy/sell decisions based on this information. There would be chaos on a day-to-day basis.
Tax Benefits
Very few asset classes can match the tax-advantages of real estate investments. As a property owner, you are entitled to an annual depreciation deduction, even though the property is increasing in value. Real estate investors can also take advantage of the powerful 1031 Exchange program, which you can use to delay paying capital gains taxes. There are also a plethora of local, state, and federal programs to promote development in distressed areas, like the newly created Opportunity Zone program.
The OZ program offers investors access to low-interest capital and tax-advantaged status if they choose to deploy capital in "Opportunity Zones," which are areas that have been traditionally underserved in terms of development and investment capital. Most of the tax advantages in the equities markets benefit issuers and investment bankers, while the real estate world's tax benefits are accessible to a much broader range of investors.
ROI
You're in the markets to see a return on your investment. While government agencies and private concerns track data relating to the overall ROI for both stocks and real estate, it is hard to find a definitive answer about which asset class has a better ROI.
There are so many variables that can influence the success of an asset, like when you buy, when you sell, market volatility, government actions, and a host of other issues that can change whether or not an investment is successful - this applies to stocks and real estate. When it comes to which asset class provides a better return on investment, I would say that it is a wash- both stocks and real estate offer significant ROI- as long as you make the right decisions at the right time.
Conclusions
Real estate and stocks both have a place in a diversified portfolio of investments. Each have their unique benefits. They have a similar return on investment over time, and while equities have advantages when it comes to diversification and liquidity, real estate is a better choice if you are focused on income, reduced risk, and more stable returns.