Investment Smackdown: Are Stocks or Real Estate a Better Investment?

Just after we finished discussing the pros and cons of real estate versus stocks, Money magazine came out with a feature article in its May issue (sorry, I can't find a link for it online) that compares the two. It's a full-out analysis of what makes real estate a great investment, what makes stocks a great investment, and how the numbers for each line up. They look at several factors including performance (return), leverage, costs, taxes, transparency (how easy it is to assign a value), effort, volatility, and diversification -- using cold, hard facts along the way to back up their findings.

So, what's their conclusion? Here's the summary:

Stocks win the bout four rounds to three, with one round a draw. But the fight is in truth considerably more lopsided. Stocks roll up large margins of victory in performance, costs, diversification and effort you need to expend as an investor. Real estate's only big win is leverage.

But don't get them wrong, they still think buying a house is a great financial move. They're just saying that for investment purposes, they think stocks out-perform real estate. Their two cents on the issue:

Using that leverage to buy a home you can afford makes sense. You're building equity and collecting other benefits as well. But jumping into the real estate ring thinking you'll use others' money to score an investing knockout is pretty risky. And the big prize, as you may have noticed if you've tried to flip a condo lately, is more elusive than it might have seemed.

Notice they said "a home you can afford?" It's a key point. Many people stretch too far to buy a house they really can't afford and end up in deep financial water.

The piece is a very interesting read and I suggest you either get the magazine or find it online (which I'm sure it will appear eventually -- probably sometime in May.)

By the way, this is the same conclusion Forbes came to in determining the winner between stocks and real estate. Their main thoughts:

But if you take a longer view--say 25 years--you'll find that the S&P 500 has actually stomped the real estate market, from Boston to Detroit to Dallas. From the start of 1980 to the end of 2004, home sale prices increased 247%. A pretty sweet deal, it would seem. Over the same period, however, the S&P 500 shot up more than 1,000%.

So from here, the only issue is how to make the most of your stock investing, right? You know how I'm going to answer that one. ;-)

Comments

[limeade]

Not all real estate investing is concerned with capital appreciation. It's not all about buy and flip. Buying and holding income producing real estate is a completely different ball game. When was the last time your stocks paid your mortgage payment for you? An income property can.

-limeade

[Edmund]

I still don't get it.

If you want to hold an investment for the short term, buying options is way better than buying a house to flip. The leverage is many times higher for options than for a small down payment for a house.

For long term investments, don't stocks pay you dividends? I guess that should go toward paying off your mortgage too. (Although it's probably best to reinvest that money back in the stock market)

The part that I really don't get is, why buy individual houses for long term investments? That's similar to buying individual stocks. Why expose yourself to risks that can be diversified away when you can expose yourself to the real estate market via REITs?

[Lord]

This is the reason why you should immediately sell all your bonds and buy only stocks. ;-) Seriously, diversification is good, but stocks alone don't do it.

[Ciji]

Why not do it all? There's no law saying you can only invest your money one way...

All I know is, if I buy a home for $100K then sell it for $120K, I've made $20,000 in a year. If I bought $100k of stock I doubt in a year it would yield $20K.

But beyond flipping, limeade is right, long term for homes makes more sense to me. My apartments always bring me $1000 a month. The building is worth much more now than when I bought it (and with gentrification, its value is likely increase more). I can borrow against it to buy other income investments, it helps me keep my credit looking good, and I have a property manager that charges a minimal fee to collect rent and maintain the building. And my insurance covers most repairs. Yeah, I had to evict a lady, but that's part of the management company's job. It really wasn't a big headache (or bill) for me.

Whereas the stock I bought the same year has only brought me $1000 over the past 5 years. In my book, $60K is greater than $1000. And that difference is worth the risk and effort.

[John]

Why is it that when people talk about investing in real estate, the conversation is only about A. flipping houses or B. renting single-family homes. There are thousands of ways to make a dime in real estate including: the two aforementioned methods, renting apartments/condos/office space/retail space/industrial space, holding land long-term, equity/debt in building or development projects (residential or commercial), hard money lending, mezzanine debt, brokering sales, referrals, public or private reits, real estate opportunity funds, stock in publicly traded builders/developers, etc...

Each one of the above methods has its own risk/reward profile, so to overgeneralize by saying real estate is riskier than the stock market or vice versa is ridiculous.

[InvestBlogger]

I agree with John on this. Each alternative has a different risk and different reward at the end of the day. You just need to determine your goal and then invest accordingly.

[Kishore]

I say real estate for sure. Here's why:

As a real life example, I bought my primary residence in 2003 for $265k. I borrowed/begged part of the down-payment. In 2007, the property was appraised for $435k.

Over the years, my disposable income increased slightly, therefore, I refinanced, paid off the rest of the borrowed down payment and took out 20% as a down payment on a $535k house which is now my primary residence. I am currently renting out my old house for $500 less than the total mortgage/taxes/insurance on that house.

If the house appreciates at 7%/yr and I sell the first house (rental) in 10 years, I could net (before Cap Gains tax) over $450k (net of the $500/month extra).

On the other hand, even if the return in stocks (mutual funds) stretched to an average 15%/yr, I would need to invest $2900/month to get the $450k gain from stocks. Both gains are tax deferred until cash out.

Furthermore, Cap Gains on the rental house can be eliminated (or reduced) by making it my primary residence for 2 years prior to sale. If I had an extra $2900/month to invest, $500 would go towards rental property and the remaining 2400/month invested elsewhere (another rental or vacation home, but I don’t).

[Robert DiNero]

Kishore: Would you sell your rental and pay off your new primary if you had the equity?