Real estate investing has long been a popular path to financial freedom, serving as a legitimate alternative to a strictly stock market based investment strategy. Both investment paths have pros and cons. Amon and I actually invested in real estate and in the stock market to grow our wealth. But, if you want to stick to only one form of investing, here are ten things you should consider before deciding on whether to invest in real estate or stocks.
I’ll be the first to admit that the act of investing in real estate and investing in stocks can be incredibly broad. When someone mentioned investing in real estate, they could be talking about anything from single family homes to strip malls. The same is true for investing in stocks - there’s large cap individual stocks, mid cap individual stocks, IPOs, index funds . . . the list goes on.
So, to narrow the discussion of whether you should focus on “real estate investing versus stock investing,” I’m going to have to first make a couple of assumptions: (1) you’re interested in investing in residential real estate, not commercial, and (2) you’re interested in investing in index funds, not individual stocks.
With that said, let’s go over some quick numbers: Over the past 100 years, the stock market has returned an average of about 10%, with most of the gains coming in the form of stock appreciation and dividends.
With real estate, there is certainly potential for capital gains in the form of property appreciation. But, most of your returns in real estate generally come in the form of rental income. Historically, since 1963 home prices have increased by an average of 5% annually. But, since 1963 the average American home size has also gotten a lot bigger - so it makes sense that you would be paying more for a house now.
With that being said, I have a third assumption: that the average appreciation of the home you’re considering as an investment is around 3%, which is the average appreciation of a home in the United States. Of course, depending on where you live, home appreciation may be significantly higher. In other places, it could be a lot lower. But, because the average appreciation of a home is around 3%, I’ll assume you’re considering investing in real estate with this 3% appreciation rate. Now let’s talk rental income: A reasonable rental income on a home would be around 6-7%. When you combine appreciation (3%) and rental income (6-7%) annually, you can expect around a 9-10% rate of return, which is more or less the same as what you could make through the stock market.
That said, it's important to note that real estate markets can vary SIGNIFICANTLY. A key variable for real estate is property location. A home in the San Francisco Bay Area, for instance, will not only appreciate at a higher rate than one in, say, a smaller midwestern city, but will also allow for much higher rents. Considering these variables, you’ll find that returns from investing in real estate in certain areas can sometimes far outweigh returns from the stock market.
But, for the purposes of this post, let's make one last assumption: your real estate and stock market investments would be the same amount, and both would produce the same annual return.
So, based on my four assumptions, I have ten different factors that you should be looking at when determining whether to invest in stocks or real estate.
1. Liquidity: Stocks Are More Liquid
Selling your stocks is MUCH easier, simpler and faster than selling your house. With the stock market, selling your stocks is often as simple as pressing the sell button. With real estate, on the other hand, the process of selling can be much more time-consuming and stressful. You’d have to put your house on the market, oftentimes by employing a real estate agent, and then wait for it to sell before you see any money. This could take a month or a year- there’s no way to guarantee you'll make a fast profit.
2. Control: Real Estate Allows For More Control
Once you invest in the stock market, you have very little control over that investment. Your returns are tied to how the stock performs. But with real estate, you have much more control. It is up to you to decide on your tenants, how much rent to charge, and how to add value to property (renovations, add-ons, etc.).
3. Amount of Work: Stocks Are Much Less Work
Investing in index funds requires virtually no work. It is a truly passive form of investing. All you have to do is set up automatic deposits to the fund and then just let the fund do what it does and follow the market. With real estate, however, there is significantly more work involved. From scouting and purchasing the property and fixing it up, to finding tenants and managing the property as a landlord, real estate investments require a level of oversight that index funds simply don’t. Of course, there is always the option to hire a property manager at an additional cost, but even then you will likely end up managing the manager to ensure everything is happening to your satisfaction.
4. Initial Costs: Stocks Require Much Less Starting Capital
You can get started with index funds with as little as $1. Conversely, real estate comes with a much heftier price tag. In the U.S., real estate typically requires a minimum of 3.5% down payment with an FHA loan. This percentage can get as high as 20-30%! It requires a LOT of cash upfront in order to purchase a home. Add to the down payment other costs like ESCROW fees, inspection fees, renovation costs, taxes, etc., and many people are completely priced out of the market. Another money eater to consider with real estate is the vacancy rate, or the amount of time your property is sitting without a tenant when you’re still responsible for mortgage payments.
5. Convenience: Stock Market Investing is Much More Convenient
As mentioned, even just getting started with real estate requires a huge investment of time, resources and effort. You need to find an agent, find a property, do inspections, make offers . . . the list goes on. And all of this can take a LOT of time. In contrast, you can set up an investment account and start purchasing index funds in as little as a few hours, from the comfort of your own home.
6. Volatility: The Real Estate Market is Less Volatile
The stock market can be incredibly volatile. With the stock market, your investments can fluctuate and drastically decline over a very short period of time. Within one week you can see your investments soar in value and then suddenly crash, or vice versa. With real estate, however, swings in the markets happen much more gradually and the housing market in general is simply much stabler.
7. Diversification: Stocks Allow For More Diversification
With real estate, all of your money can be tied up in one really big purchase and you’re really banking on that property doing well. If, for whatever reason, you’re unable to find tenants to rent at your target price or the property value doesn’t appreciate as much as expected, there is nothing else to balance those losses. With index funds, on the other hand, diversity is automatically built in by virtue of the fund itself investing in a number of different stocks.
8. Length of Investment: Real Estate Requires Less Time To See Profit
When deciding whether to invest in real estate or stocks, you need to consider how long you are willing to invest your money. Investing in stocks is really a long term play, and you will likely need to keep your money in the stock market for a long period of time in order to see a good profit. But real estate is a different story entirely. There are many cases, especially if you’ve purchased the property in an in-demand, developing area, where you can see a significant profit almost immediately (can anyone say “house flipping?”).
9. Tangible Investments: Real Estate Is Tangible
Many people prefer real estate because it is a real, tangible asset that you can see, touch, live in and see change over time. In fact, this is one reason we personally were drawn to real estate.
Because you can’t physically see or interact with stocks, for some people, there may be less of an emotional connection or satisfaction with a stock market investment.
10. Passion: Let Passion Drive Your Investments
At the end of the day, your best bet for success is to invest in whatever you are passionate about! That passion is what will keep you consistent on this path towards financial independence. You will likely get distracted or frustrated at some point on this journey, but if you are passionate about your investment, that will help you weather the hard times and motivate you to reach your financial independence goals.
Because isn’t that what it’s all about? You want to reach your financial independence goal. And the best way to do that is to stay motivated on your financial independence journey. So think about the ten factors that I shared. Which ones resonate with you? Do you want tangible property that you can see and feel and renovate; or do you want a passive investment that required little work?
At the end of the day, the choice is yours. So, make a choice . . . and start building your wealth on your financial independence journey!
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