Real estate and stocks are two of the major classes of assets available to investors. They each offer returns on your investments, but for different reasons. Their risk factors are different as well. In the real estate vs. stocks debate, should you invest in one and not the other, or should you invest in both? We will take a look at the risks and rewards of investing in real estate vs. stocks. Consider working with a financial advisor regarding which asset classes make the most sense for you given your goals, risk profile and timeline.
Investing in Real Estate
Almost two-thirds of Americans already have an investment in real estate. According to U.S. Census Data, 65% of single-family homes in the U.S. are owner-occupied. Americans’ biggest investment is their home.
Most people, when they invest in real estate beyond their investment in their home, go for commercial real estate. They invest in buildings where people live or work. They also invest in land on which to build those buildings. There are benefits to investing in real estate as opposed to stocks. Because real estate is a physical asset, it has intrinsic value. It’s not just a piece of paper like a stock certificate. Real estate is probably always going to be worth something, even in the worst financial collapse.
Some real estate investments, like vacant land, may not generate any cash for you unless you sell it to a land developer. Other types of real estate investments generate cash flow. You may buy an apartment building or an office building, both of which will generate rent payments as income. There are also costs associated with real estate. You have to pay property taxes on it even if it is a vacant parcel of land. If you buy a building and rent out apartments or offices, you not only have to pay property taxes but also the costs of maintenance. Unless you hire a property manager, which is another cost, you will have to field all the complaints of your tenants.
Another issue concerning real estate investing is income taxes, but real estate is usually an investment that is favorable to your tax position. You can deduct mortgage interest up to $750,000 in mortgage debt if you are a qualified homeowner. If you are a commercial real estate investor, you can avoid capital gains tax if you sell your real estate as long as you buy similar real estate or use MACRS depreciation. There are, however, many fees associated with real estate transactions costs like real estate agent fees, which may be as much as 10% of your selling price, and closing costs which could be another 10%. Keep in mind that it’s difficult to diversify investing in only real estate assets.
There are alternatives to investing in traditional real estate. To increase the liquidity of your portfolio, you can invest in REITs that trade like stocks on the market. They tend to have a high dividend yield. There are crowdsourcing real estate platforms and the opportunity to invest in companies that are off-shoots of real estate investing, like real estate renovations. You can even invest in real estate portfolios that are already diversified for you.
The bottom line is that you can generate a good, passive cash flow with real estate investments, but you do incur costs and your money is tied up long term. Real estate is not a liquid asset. But, if you want a hedge against inflation and market volatility, an investment in real estate will serve that purpose. When you look at real estate vs. stocks, you see that real estate usually rises in value as inflation increases.
Investing in Stocks
When you invest in a stock, you actually buy a little piece of a company. The value of a stock can go to zero and that is not likely to happen to real estate. It’s much easier to diversify a stock portfolio than a real estate portfolio. You can buy pieces of many companies without approaching the dollar investment it would take to diversify a real estate portfolio.
Stock investing does not require the high transactions costs of real estate investing. There are no closing costs and there does not have to even be brokerage fees. You can invest on your own, even buy fractional shares, if you use one of the many free stock trading apps that have been developed. If you don’t use a broker, what you will spend is your time. Since you are not relying on the advice of a broker, you have to do your own research. That’s only possible if you have above-average knowledge of finance and the stock market.
It’s far easier to diversify a stock portfolio than a real estate portfolio. Finance theory tells us that it only takes, on average, nine to 13 well-chosen stocks to diversify a portfolio although many seasoned investors may not agree. That assumes, however, that you are a knowledgeable investor who can choose those stocks unless you use a full-service broker. Discount brokers don’t give advice and the multitude of stock trading apps that exist use robo-advisors at most. It also assumes that you are stoic and will not panic-sell in the event of a market pullback. In reality, and according to Warren Buffett, you need a portfolio of carefully chosen stocks, across market sectors and industries, that are bound to do well in the long run.
Stocks are liquid assets. You can usually buy and sell at a moment’s notice, so you have easy and quick access to your money. If you look at real estate vs stock, you see that it could take weeks, months, or years to sell a real estate investment.
You can increase your wealth through stock investing within a tax-advantaged portfolio. Investing through an IRA or 401(k) allows your investments to grow tax-deferred until retirement at which time you may be in a more favorable tax bracket. If you own stock outside a tax-advantaged portfolio, then you will take an income tax hit if you sell your stock. If you sell within a year after you buy it, you will pay the higher short-term capital gains tax on any gains you make. If you sell after a year, you will be subject to the lower capital gains tax rate.
Many stocks generate current income in the form of dividends that are similar to real estate investments that generates current income in the form of rent payments. You can offset income taxes on rent payments with expenses, but since the expenses are not as high if you own stock, it is difficult to offset dividend income.
The Bottom Line
To evaluate whether you should invest in real estate or stock or both, you should consider the factors of market volatility, cash flow, diversification, management and transactions costs, liquidity, tax effects and your own time and effort. There are pros and cons for each of these factors for stock and real estate investing. It ultimately comes down to your own preference for risk, your time horizon and your investment goals.
Tips for Investing
Would you like to try building a “test” diversified portfolio before you build your real portfolio? Try SmartAsset’s asset allocation tool that allows you to experiment with different assets and different scenarios.
Putting together a portfolio for retirement or any other reason is complex if you want to take the least risk possible but earn maximum rewards. You may want to consult with a financial advisor before making any investment. Finding a financial advisor doesn’t have to be hard. Start with SmartAsset’s financial advisor matching tool to find an advisor you are comfortable with. All it takes is a few clicks of your mouse. Get started now.
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