Stocks vs Real Estate
Many new investors start in the stock market. It is easy. You can sign up on many websites and deposit small amounts of money. You can then select a stock or mutual fund for your first investment. Many people praise the stock market as a great way to invest. While it is true that stock can bring wealth, let’s take a look at why we think real estate investing is actually a better investment.
Recession or Downturn
A recession is defined as 2 consecutive quarters of declining GDP. The average dip in the stock market during a recession is about 30%. Real estate prices typically do not drop that amount. Nationally, they may drop, but every market and sub-market is different. Good markets may only see a slight decline due to its diverse economy. Real estate provides something that stocks do not - SHELTER. Shelter is a basic human need. During a downturn, most people would take money OUT of the stock market to cover rent or mortgage payments, rather than move in with someone and continue investing in stocks. Real estate is very resilient during a market downturn.
We look for markets that have a diverse economy and population growth. This helps in a downturn or recession. Oftentimes during a recession, interest rates will rise causing prospective home buyers to continue to rent. This increases rental demand and rental prices.
Investing is always a risk. Some risks are bigger than others. You have often heard “diversify your portfolio”. This will help mitigate risks, but can also reduce the amount a portfolio can increase due to diversification.
A lot can happen in the world to increase or decrease risks. For example, gas prices, wars, the economy, etc. can all make the stock market move downward. Stimulus packages can help increase the stock market. All of those are EXTERNAL factors. An investor cannot change those risks.
In real estate, those risks are not as important. Interest rate increases or decreases have more of an impact on real estate than gas prices, wars, or the economy. Additionally, there are many INTERNAL factors that can increase or decrease real estate prices. For example, adding value (new countertops, new appliances, new paint, or reducing expenses) can increase the value of real estate) regardless of the external factors.
In a worst case scenario, a company can go bankrupt causing the stock to be worthless. While this is unlikely to happen, it does happen, and there isn’t anything an investor can do besides sell the stock. This happened with Enron in 2001.
Lenders realize that real estate has less risk inherently. Lenders require insurance on real estate. If a property burns down, you have insurance to cover it. If insurance does not cover it all or you canceled insurance, you at least have the land value you can sell.
Commissions and Fees
While the S&P may grow by about 7.5% on average since 1990, that is not what the investor gets. Investors may have to pay fees to buy and/or sell, pay fees to the financial institutions, pay fees for mutual funds, and it is all taxed.
In real estate, we provide the projected returns after taking into account all of the fees. While this is not legal or financial advice and we suggest you talk to a CPA or lawyer, taxes may be greatly reduced due to the expenses or depreciation of real estate.
When buying stocks, you are able to buy stocks on margin and leverage, however, you are paying interest on these stocks. If a stock increases, you will earn more. If a stock decreases, you will lose more of your leveraged money.
In real estate, by nature, lenders allow you to use leverage all of the time. When you buy a $100,000 house, you do not have to pay all $100,000 out of pocket. You are able to take a loan from any number of lenders. Depending on the lender, you may be able to pay 5%-35% down for the property, but you are able to get all of the gains when the property sells.
While stocks are typically much easier to get into due to the lower initial investment and plethora of websites to use, the risks are EXTERNAL. There is not much that can be done besides selling a stock. Real estate on the other hand, has some EXTERNAL but many INTERNAL risks that can be mitigated if the right investor knows what to look for.