Real Estate Versus Stock Invesment Which Is The Better Strategy
Chairman Investment University
Real estate gurus such as Donald Trump and Robert Kiyosaki think real estate is the best way to become rich. Warren Buffett and Peter Lynch see stocks (or businesses) as the better way to go.
There are, of course, lots of ways to climb to the top of a mountain, but which is better: real estate investments or stock investments?
Having invested in both, here’s my take. Let’s start off with real estate
Real Estate Is a Good Inflation Hedge, But…
Trump and Kiyosaki like investing in rental properties because they’re tangible assets you can see, feel and visit. You can leverage real estate investments with a mortgage or two, allowing you to control a valuable asset with very little money. That’s why “cash poor” investors are attracted to it.
If the property goes up in value, you can multiply your wealth. And real estate is usually a good inflation hedge. Residential prices have risen steadily year after year and spectacularly in some hot markets.
Investing in real estate also has tax advantages. You can:
• Depreciate the property.
• Deduct taxes and mortgage interest, and
• Pay only 15% capital gains tax when you sell.
Sometimes you can avoid taxes entirely with a like-kind exchange (Tax Code 1031). Or if it’s your home, you and your spouse can avoid tax on the first $500,000 profit, and 15% thereafter.
Not surprisingly, real estate has made lots of millionaires and even some billionaires. Eight percent 32 billionaires have made the Forbes 400 Richest Americans List this way, including Trump.
The Dark Side of Investments in Real Estate
Closing costs commissions, fees, points, and taxes can add up to thousands of dollars at the time you buy or sell the property. You have to be a good negotiator. Renting the property can be a nightmare if you have the wrong tenants. (I’ve had my share of sleepless nights from tenants who don’t pay and don’t leave.)
Negative cash flow is common if you have borrowed too much. Leverage is a two-edged sword. Real estate prices don’t automatically go up every year; sharp declines can occur. And selling can be a major difficulty if the real estate market is in a slump or slowdown. (Don’t buy into the myth that land can only go up in value because “they aren’t making any more of it.”) Your property can sit on the market for months. Not everyone is comfortable taking on massive debts.
Donald Trump complains about friends who invested in a stock and lost everything. But he fails to mention that, while a billionaire today, he has gone bankrupt three times through investments in commercial real estate.
Stock Investments vs. Real Estate: Liquid, Tax-Friendly And Positive Cash Flow
Investing in stocks and mutual funds has some clear advantages over real estate. With few exceptions, stocks and funds are extremely liquid and can be bought and sold in seconds. If you find yourself in a losing stock, you can get out fast. “Closing costs” (commissions and bid-ask spreads) for most stocks are almost non-existent in today’s competitive brokerage business.
Stocks once lacked tax advantages, but not anymore. If you hold a stock for a year, you can qualify for the 15% long-term capital gain. Granted, profits on short-term trades (less than a year) are fully taxable as regular income, but they can be offset by short-term losses, or can be postponed indefinitely inside a tax-deferred retirement account (IRA, 401(k), etc.). And dividends are now subject to a 15% rate, just like real estate.
Finally, investments in stocks offer leverage without borrowing huge amounts of money. It’s not uncommon to find publicly traded growth companies that increase 30%, 40%, even 100% or more during a bull market. You can leverage further if you wish, with margin accounts or options, which are far less risky than a busted real estate deal.
Stocks even offer positive cash flow and potential capital gains, with real estate investment trusts (REITs), oil & gas trusts, business development companies and bond funds. You still have to worry about the possibility that the company will cut its dividend, but the risk is certainly lower than the risk of a tenant failing to pay his rent.
Keep in mind, though, that liquidity in the stock market is a two-edged sword. Stocks are far more volatile than real estate. Some tank and even go to zero if the company files chapter 7. That’s highly unlikely with land or rental properties. You have to do your homework in picking good stocks, or you could get burned.
The Golden Mean
In sum, when stacking up stocks versus real estate, I suspect many of you think like me. You may own stocks and mutual funds, and perhaps you own or you’re looking into some real estate either in the form of rental properties or your own home.
It pays to diversify. Treat real estate as a long-term inflation hedge, and your stock portfolio as a way to profit from free enterprise and, if you wish, as a short-term investment strategy.
When the stock market crisis began in 2008, one of the reasons operators sited then was investors shift of focus to the real estate sector. The explanation then was that many investors who made money during the stock market boom divested from the stock market and were investing in real estate.
Apart from individuals, most corporate organizations joined the race to invest in properties and sell later. However, the property sector suffered weak demands too as the global economic crises worsened.
Like the stock market, many investors both corporate and individuals had their fingers burnt and suffered huge losses. But the negative experiences in both markets - stock and real estate- will not stop people from investing. Already the stock market is showing signs of recovery due to increased investor confidence. Despite this, many investors who are liquid are still contemplating on where to invest - stock or properties.
In the opinion of leading investment experts, both markets are good but the investment objectives and ones sources of income will determine ones choice. Another investment consultant concurred, saying that the choice of any form of investment will depend on many factors.
Real Estate Versus Investment, Which Way To Go? has been a raging question for long. First will be the motive or intention of the investor. Is it for a short term or long term> Is the investor interested in capital returns or in streaks of returns in form of regular income? Is it an investment to be left for ones children in death? The answers to these questions among many others will set the tone for the rest of the investment decisions that will follow.
If one is only interested in short term investment of funds that are not needed immediately but may be required in a short while - say in two to five years, buying stock may be more preferable than real estate. This is because it is easier to convert stocks to cash than buildings. However, beyond this simple reason, is necessary to examine the principles of investment and apply the different tests to both stocks and land properties before concluding on which one is more suitable in any particular case.
SECURITY OF CAPITAL
Whatever your intention, the first thing to consider is the safety of the capital to be invested. Any investment that does not guarantee the recovery of the capital invested is not worth considering at all. When you relate this to stocks and investing in buying buildings, to a large extent capital investment in land and buildings are more secured than stocks. Except in the case of war or natural disasters, an investor can guarantee the safety of his or her investment in properties by taking out an insurance policy. Hence in the invent of fire or other agents of destruction, you can always recoup your loses from the insurer. But investments in stocks can vanish in one day if for instance the stock market crashes or the company fails.
The second point to consider is the issue of capital appreciation. It is known that except in rare cases of war or natural disasters, land and building values are always on the increase, even if marginal.
SECURITY AND REGULARITY OF INCOME
In most cases, the major reason for investment is the expectation of income from the investment. In this regard, dividends are expected from investments in stocks and rents from investments in land and buildings. However, while it is certain that rent will be paid on your property [barring a bad defaulting tenant] you can never be sure that dividends will be paid on your stocks. Many companies has not paid dividends to their share holders for many years. More over, you can never know how much that can acrue to you as dividends from stock investment until they are paid. One year it may be $0.20, the next it may $0.10. It is difficult to plan on such irregular source of income. Regarding income from real estate, except the unusual happens, you will know your rent at the beginning of the year or term of the lease. In some cases, the rent is even paid in advance.
We have made a fair attempt at answering the question, Real Estate versus Stock Investment Investment, Which Way To Go? I hope you found it useful enough as a guide to profitable investment decisions.