Real Estate vs. Stocks: An Investing Primer

Real estate and stock investing are two common ways to grow your wealth over time — both present opportunities and challenges, with unique sets of potential rewards and risks. But, of course, the two investments are not mutually exclusive, and there are benefits to pursuing both avenues.

Indeed, people invest because they hear about other people making a lot of money. However, this is not a good enough reason. However, as with any investment, it is helpful to understand each before diving in.

Real Estate

We have discussed New York City real estate investing. Many like real estate’s physical quality. It is something physical, and people feel more connected to it.

Your cash flow benefits from the tax advantages you gain from deducting depreciation. But, of course, depreciation is more than an accounting entry. As a good rule of thumb, you should plan to spend that much annually on maintenance expenses. Nonetheless, the deduction shields part of your income.

There are different ways for investors to make money. One approach is to buy-and-hold. You collect rents, and your yield or cap rate is your net cash flow divided by your purchase price. Therefore, you must watch how much you pay for the property and manage your monthly income and expenses. Historically, the city’s cap rate has been 3%-4%, but many people make their money through capital appreciation. This is a significant component of building wealth through real estate.

You can also buy a property intending to sell it quickly. Called flippers, these people generally seek a home that needs renovations. Then, after doing the needed repairs, they hope to turn a tidy, quick profit. The faster the turnaround, the better off you are since carrying costs outweigh the investor’s return. It is a high-risk/high-reward way to invest in real estate.

Advantages of real estate investing.

There are several advantages to investing in real estate. In New York City, it has appreciated rapidly. Of course, it is no guarantee it will do so in the future. But, with the city a financial and cultural hub, along with low crime rates, it is hard to bet against it. You can also leverage your purchase since lenders only require a down payment fraction of the purchase price.

We also mentioned the tax advantage and the potential to push out any capital gains tax through a 1031 exchange.

Real estate investing provides some diversification benefits from the stock market. Although, in New York City, there historically has been a higher degree of correlation than in other parts of the country since the financial services industry comprises a fair amount of the city’s economy. It makes up about 10% of the employees and 30% of the worker’s earnings, with banking and securities companies accounting for this.

Disadvantages of real estate investing.

Investing in real estate is not for everyone, though. The main problem is the lack of liquidity. This is particularly true during a downturn when buyers are scarce. As a result, your property may sit on the market for a long time before you receive an offer.

Additionally, there are costs to consider. These include closing costs when you purchase and sell the property. Additionally, there are ongoing expenses to run and maintain your investment.

You can become actively involved in the day-to-day decision-making. Otherwise, you must hire a management company/individual to take on the task. In either case, it is more work than merely investing in stocks.

Stocks

There are several ways to invest in the stock market. Generally, the easiest and cheapest is investing in an index or exchange-traded fund (ETF), such as one based on the S&P 500. Although the market is known for its volatility, this gets smoothed out if you are a long-term investor.

For instance, assume you invested in the S&P 500 in 1996, in the middle of a strong bull market. Then, you sold your position in 2016. This would have generated an annual total return of 8.2%. This return was achieved as the late-1990s speculative bubble built and subsequently burst. Then, a recession ensued in the early part of the century. After this, another bull market ended with a severe recession and a bear market. So, finally, we are in an upward movement.

Why stocks?

As mentioned previously, stocks have a solid long-term track record. Generally, equities are very liquid, making them easy to buy and sell. You can easily and inexpensively build a diversified portfolio, mainly through a mutual fund or ETF.

The disadvantages

There are various ways to invest in the market, including individual stocks, mutual funds, and exchange-traded funds (ETFs). In addition, many different strategies allow you to profit under various scenarios, such as bull and bear markets. However, these are likely complex and risky. Most people investing in a company, industry sector, or overall market expect to make money from the price moving up. Hence, you rely on many factors, including the overall economy.

Investing in equities, particularly an individual company, is inherently risky. This is particularly true in the short run. Those without the tolerance for short-term pain may sell at an inopportune time.

There are also costs to trading stocks, although many brokerages cut fees.

A compromise

For those that want to invest in real estate and own stock, you can purchase shares in a real estate investment trust (REIT). There are two broad REIT types: an equity REIT and a mortgage REIT. The former typically invests in a specific property category. These include residential apartment buildings, commercial properties, student housing, and shopping malls, among other types of properties. A diversified REIT is when the company invests in more than one category. For example, a mortgage REIT invests in mortgages and mortgage-backed securities.

Investors’ money gets pooled by choosing an equity REIT to invest in real estate property. That way, there are greater resources to purchase the assets. This is ideal for someone who is either not inclined or faces time constraints to manage a property actively. It also allows for a diverse portfolio of holdings.

There are various rules a company must adhere to qualify as a REIT. One item includes generating at least 75% of the company’s income from real estate. Additionally, the company must payout at least 90% of its taxable income in dividends. By doing so, the entity is exempt from taxation.