Real Estate Investing vs. Stock Market Investing- Is there a Clear Winner?

by Cooksquared

Real Estate Investor

Author website

Real estate enthusiasts have been sounding their trumpet during the latest run in the real estate market. Many real estate focused investors truly believe real estate outperforms every other investment by a wide margin and even go as far as to wonder why investors would choose any other investment vehicle. Our own Jeff Brown even took quite a swing at the stock market in his post, My 4% will Beat Your 10 Any Day — Stocks vs. Real Estate. In the other corner stock market aficionados contend that in the long run stock market returns dominate. As an investor in both I am here to definitively say neither dominates.

Starting with the facts: Long run real estate investment returns average about 3%. This is simply a year over year long run appreciation average (cnn.com report data), while the average long run stock market return hovers around 10%. It is important to note that anyone can point to specific year, or even five year, period that one asset class has outperformed the other. This is not relevant because long term investing is the focus of this discussion.

Many stock market champions simply stop their analysis right there. That is wrong, plain and simple. Of course, as the analysis goes deeper, the water gets muddier and muddier. The starting point is leverage. Very few investors pay 100% of the purchase price when they buy an investment property. At most an investor will put the standard 20% down in a direct commercial real estate investment. This means that an investor could buy 5 times value of an investment. For example, if an investor has $100,000 to invest, they could buy $100,000 worth of stocks or $500,000 worth of real estate. Using some simple math, after 1 year the stocks would be worth $110,000, while the real estate investment would be worth $115,000 ($100,000 + $500,000 x .03).

Unfortunately many real estate investors stop their analysis here. This is also incorrect. Not only is it unfair to compare a leveraged real estate investment to an investment in the stock market that is not leveraged, but there are a host of additional cost to real estate that are not factored into this equation.

The common investor may be unfamiliar with leveraged stock investments. They can be achieved in several ways. Short selling and margin investing represent two ways to invest using leverage. Short selling is simply selling stock before it is purchased. Margin investing involves borrowing money to invest. These two techniques are virtually the same, the only difference being where the money comes from. Consider this example: Homebuilders have a very poor outlook for the next year. If an investor short sells homebuilders, he/she has additional money to invest in the broader market. Instead of $100,000, the short sell now provides the investor $150,000 assuming they short sold $50,000 worth of homebuilders. Assuming homebuilder stay flat or decline, the investor in the stock market has matched the return of real estate with far less leverage.

At this point the waters begin to muddy because real estate investors might argue that leveraging stock market investments increase the level of risk. This is completely true, but while real estate investments tend to have less risk, they have far more holding and opportunity costs. When an investor buys one share of Toll Brothers, they are done with the transaction. Furthermore, when that same investor wants to sell their share of Toll Brothers it can be done immediately.

On the other hand, as soon as an investor buys an investment property they become a landlord. Even if the property is large enough to support a management company, real estate represents a huge hands-on investment. To maximize the value of a property, the investor must make key and critical decisions that take time. Many hardcore investors have to give up their day jobs, eliminating a huge potential income stream. While the opportunity cost differs by the level of direct involvement, it is present in all forms of direct investment.

Transaction costs also must be factored in. An investor can buy and sell $50,000 worth of stock for $100 or less through many electronic brokerages. A real estate investor buying and selling the equivalent investment in property might pay $10,000 or more. Even if an investor does a 1031 Exchange it will costs much more than a typical stock transaction.

The list of considerations goes on and on. Taxes, ability to directly influence investments, holding cost, and liquidity are just a few more items that differentiate these investments. In the end it comes down to investor preference. Many real estate investors get personal satisfaction from owning and managing property, while other investors might be put off by having to constantly deal with investment issues. For this reason, real estate investments or stock investments might provide a level of personal satisfaction that outweighs the drawbacks listed.

Finally, investors should note that while neither investment dominates the other, a combined diversified strategy is better than simply owning one or the other. It has been proven that by adding a 10-20% REIT weighting to an all stock portfolio, an investor can increase their expected return and decrease the overall volatility of their portfolio. While this discussion was a bit academic, the major takeaway should be that real estate investments have the ability to compete with stock market returns. Whether an investor has a passion for real estate or for the stock market, understanding and investing time and money in both provides the highest possible return.