Reasons to invest in real estate versus shares in the Stock Market
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Should you invest in real estate or stocks, or both?
Many investors have traditionally turned to the stock market as a place to invest their savings. While stocks are a well-known investment option, not everyone knows that buying real estate is also considered an investment. Under the right circumstances, real estate can be an alternative to stocks because it offers lower risk, generates better returns, and provides greater diversification.
Whether it's planning for retirement, saving for a college fund, or earning residual income, people need an investment strategy that fits their budget and needs. Comparing an investment in real estate to buying stock is a good starting point.
- The decision to invest in real estate or stocks is a personal choice that depends on your financial situation, risk tolerance, goals and investment style.
- Real estate and stocks have different risks and opportunities.
- Real estate is not as liquid as stocks and tends to require more money and time. But it does provide a passive income stream and the potential for substantial appreciation.
- Stocks are subject to market, economic and inflationary risks, but do not require a large cash infusion and can generally be easily bought and sold.
Overview: Real Estate vs Stocks
Investing in real estate or stocks is a personal choice that depends on your financial situation, risk tolerance, goals, and investment style. It's safe to assume that more people are investing in the stock market, perhaps because it doesn't take as much time or money to buy stocks. If you are buying real estate, you will need to save and put down a substantial amount of money.
When you buy shares, you buy a small part of that company. In general, you can make money in two ways with stocks: appreciation in value as the company's stock rises, and dividends.
When you buy real estate, you purchase land or physical property. Most real estate investors make money by collecting rents (which can provide a steady stream of income) and through appreciation, as the value of the property increases. Also, since real estate can be leveraged, it's possible to expand your properties even if you can't pay cash outright.
For many potential investors, real estate is attractive because it is a tangible asset that can be controlled, with the added benefit of diversification. Real estate investors who purchase property own something concrete for which they may be liable. Keep in mind that real estate investment trusts (REITs) are a way of investing in real estate and are bought and sold like stocks.
There are a number of considerations for investors when choosing between investing in stocks or buying real estate as an investment.
Profitability: Real Estate vs. Stocks
Investing in the stock market makes more sense when combined with benefits that increase your returns, such as company matching in a 401(k). But those benefits aren't always available, and there's a limit to how much you can benefit from them. Investing in the stock market independently can be unpredictable and the return on investment (ROI) is often lower than expected.
Comparing real estate and stock market returns is an apples-to-oranges comparison: the factors that affect prices, values, and returns are very different.
Risks: Real Estate vs. Stocks
The real estate bubble and banking crisis of 2008 brought about a fall in value for investors in the real estate and stock market, and the COVID-19 crisis is repeating it, although for different reasons. Still, it's important to remember that stocks and real estate have very different risks overall.
Risk in Real Estate
Here are some things to consider when it comes to real estate and the risks associated with it. The biggest risk that people overlook is that real estate requires a lot of research. It is not something you can casually walk into and expect immediate results and returns. Real estate is not an asset that is easily liquidated and cannot be cashed in quickly. This means you can't cash it out when you're in a bind.
For homebuyers or those who own rental properties, there are risks that come with handling repairs or managing rentals. Some of the main issues you will run into are costs, not to mention the time and headache of dealing with tenants. And you may not be able to postpone them if there is an emergency.
As an investor, you may want and should consider hiring a contractor to handle your home repairs and renovations, or a property manager to oversee your rental maintenance. This may affect your bottom line, but it reduces the time you spend monitoring your investment.
Risk in Stocks
The stock market is subject to several different types of risk: market, economic and inflation risks. First, stock values can be extremely volatile and their prices are subject to fluctuations in the market. Volatility can be due to geopolitical and company-specific events. Let's say, for example, that a company has operations in another country, this foreign division is subject to the laws and rules of that nation.
But if that country's economy is in trouble, or political problems arise, that company's stock may suffer. Stocks are also subject to the business cycle, as well as monetary policy, regulations, fiscal revisions, or even changes in interest rates set by a country's central bank.
Other risks may come from the investor himself. Investors who choose not to diversify their positions also expose themselves to increased risk.
Consider this: Dividend-paying stocks can provide reliable income, but it would take a sizable investment in high-yielding dividend stocks to generate enough income to support retirement without selling additional securities. Relying solely on high-yield dividends means an investor may miss out on higher-growth investment opportunities.
Pros and Cons: Real Estate
Real estate investors have the ability to leverage their capital and take advantage of significant tax benefits. 1 Although real estate is not as liquid as the stock market, long-term cash flow provides passive income and the promise of appreciation.
Despite this, it is important to consider the amount of money that goes into real estate investments. You must be able to secure a down payment and financing if you are not doing business in cash.
Since real estate is not that liquid, you can't rely on selling your properties right away when you need them. Other disadvantages include the costs associated with property management and the investment of time spent on repairs and maintenance.
- passive income
- Tax advantages
- hedge against inflation
- leverage capacity
- More work than buying stocks
- Expensive and illiquid
- High transaction costs
- Appreciation is not guaranteed
Pros and Cons: Actions
For most investors, it doesn't take a huge cash infusion to get started in the stock market, making it an attractive option. Unlike real estate, stocks are liquid and generally easily bought and sold, so you can rely on them in emergencies. With so many stocks and ETFs to choose from, it can be easy to build a well-diversified portfolio.
But, as noted above, stocks tend to be more volatile, leading to riskier investing, especially if you sell in a panic. Selling your shares may result in capital gains tax, which makes your tax burden that much heavier. And unless you have a lot of money in the market, your holdings may not be able to grow much.
- very liquid
- easy to diversify
- Low transaction fees
- Easy to add to tax-advantaged retirement accounts
- More volatile than real estate
- Selling shares can lead to big taxes
- Some stocks move sideways for years
- Investment potential driven by emotions
Additional Factors to Consider
Buying a property requires more initial capital than investing in stocks, mutual funds, or even REITs. However, by purchasing property, investors have more leverage over their money, allowing them to purchase a more valuable investment vehicle.
Putting $25,000 in stock buys $25,000 in stock, assuming you're not using margin. By contrast, the same investment in real estate could buy approximately $125,000 worth of property with a mortgage and tax-deductible interest.
The cash obtained from the rent is expected to cover the mortgage, insurance, property taxes and repairs. But a well-managed property also generates income for the owners. Additional benefits of real estate investment include depreciation and other tax write-offs.
Real estate that generates monthly rental income can increase with inflation even in a rent-controlled area, which offers an additional advantage. Another consideration is taxes after selling the investment. The sale of stock typically triggers capital gains taxes. Real estate capital gains can be deferred if another property is purchased after the sale, which is called a 1031 exchange in the tax code.
The bottom line
Both real estate and stocks have risks and rewards. Investing in the stock market gets a lot of attention as a retirement investment vehicle, particularly for people who regularly contribute to a tax-advantaged account, such as a 401(k) or individual retirement account (IRA). However, diversification is important, especially when saving for the long term.
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