Buying Stocks vs Real Estate Investing — Which is Better?
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Buying Stocks vs Real Estate Investing — Which is Better?


Deidre Woollard: Stocks vs. real estate. It’s a long-standing question and
one that isn’t easily answered. This is Deidre Woollard, editor at Millionacres,
the real estate investing website from The Motley Fool. Today, we are asking the question,
should you invest in real estate or stocks? We all know that putting some of our assets
in real estate is good for diversification. But what about returns? Which asset class has produced better returns
over long periods of time — real estate or stocks? This is a tough question to answer partly
because there’s no reliable way to gauge individual investment property returns on a wide scale. Every property investment in each market is
different, so there’s no real way to make a comparison on a one-to-one basis. Having said that, though, there is some broad-stroke
data that can help us compare how the two asset classes stack up
as long-term investments. First, it’s important to note that stocks
tend to increase in value quicker than real estate. Over long periods of time, an S&P 500 index
fund has historically produced total returns in the 9% to 10% range. Meanwhile, real estate
prices tend to outpace inflation, but not by much. Since 1940, the median home price value in
the United States has increased at an annualized rate of 5.5%. However, this is
misleading for several reasons. Consider this: homes are significantly larger
today on average than they were back then. The average home in 1940 was 1,246 square feet
— roughly half of the 2,430 average of 2010. So, if you just for home size, the annualized
increase on a per-square-foot basis drops to 4.6%. And, after accounting for inflation, the average
home value has risen by just 1.5% per year. Now, let’s compare this to stock returns. Stocks have generated roughly 7% per year
over the long run after accounting for inflation. In other words, the stock market has generated returns
at more than 4X the rate of real estate appreciation. If you’ve ever heard someone tell you that
your home isn’t an investment, this is probably why. But wait. There’s more
to consider in this question. This is important: real estate as an investment
has much stronger return potential. Real estate values tend to barely outpace
inflation; however, there are a few reasons why real estate
investments tend to do better. First is leverage, also known
as investing with someone else’s money. Unlike stocks, where it’s irresponsible to
invest with borrowed money, you can use significant amounts of financing for real estate
investments without adding a ton of risk. When you buy stocks or mutual funds,
most people buy with cash they already have. In real estate, you’re generally only putting
down a down payment and financing the rest. This means that you are making your investment
using your money as well as the bank’s money. Although real estate does experience price
swings over time, they tend to be far less dramatic than stock market swings. If you look at the most dire periods of the
real estate market — AKA the Great Recession — the simple truth is that investors got
into trouble with debt during the financial crisis for two reasons. One, they stopped caring about their properties’
cash flow and focused on price appreciation. People were essentially betting that home
prices would go up because they go up, without focusing on fundamentals. Two, there were tons of creative mortgage
products given to borrowers who were clearly not creditworthy. It’s unfortunate that those
people got roped into complicated products. Fortunately, many of
them aren’t available anymore. If you use debt responsibly, it’s a healthy
part of a real estate investing strategy. Just don’t forget about the core metric of
any property: its ability to generate cash flow, when you’re thinking
about real estate investments. Lenders typically finance investment properties with
down payments of just 20% to 25% of the sales price. When buying a primary home, the down
payment requirements can be significantly lower. You may have to pay mortgage insurance with
less than 20% down, but you may be able to put down as little as 3% to 5% — or, in some
cases, such as VA loans, no down payment at all. The effect of this leverage is that
small returns can be greatly amplified. Here’s an example. Let’s say that you buy an asset for $100,000
in cash, and its value increases by 3%. You earned a $3,000, 3%,
return on your investment. On the other hand, let’s say that you buy
a $500,000 asset by investing $100,000 of your own money,
and borrowing the other $400,000. If the value of this asset increases by 3%,
you’ll have a return of $15,000, or 15%, of your initial $100,000 investment.
This isn’t a perfect example. When it comes to real estate, you’ll typically
have to pay an origination fee to a lender, as well as various closing costs when you
buy property. These costs eat into your return. Plus, if you borrow money to buy a property,
you’ll need to make mortgage payments each month while you own it. That said, leverage can still dramatically
amplify your return on investment, which is why most investors choose to use it
rather than paying cash for properties. The second reason why investment real
estate can produce strong returns is that investment properties can be
rented out to generate income. You can also rent out part of a house and
live in the rest — a move called house hacking. Real estate investors enjoy
tax advantages that stock investors don’t. For example, when you buy an investment property,
you get to write off the purchase price over a certain number of years —
a tax deduction known as depreciation. It would be awesome if you could write off
your stock investments in a similar manner. That isn’t the case. Even if you don’t own a property, real estate
can offer tax advantages that the average equity investment can’t. Real estate investment trusts, or REITs,
get an extra tax benefit in that they avoid corporate taxes by paying out most
of their income as dividends. REITs are easy for investors to buy in an
IRA or other tax-advantaged retirement account, meaning they can avoid dividend and
capital gains taxes altogether in the short term. Together, the combination of rental income,
leverage, and tax benefits can combine to produce attractive long-term gains. How has investment real estate
compared with stocks over time? It’s difficult to find reliable historical data on
total returns from individual investment properties. There are too many variables, and there’s
no reliable way to track total returns achieved by individual investors. However, one good way to visualize the power
of real estate investments is to examine how real estate investment trusts
have performed over time. Let’s compare the total returns of the S&P
500 stock index and the Vanguard Real Estate mutual fund, a good
benchmark index of equity REITs. The difference isn’t too significant over
the first few years, but by 20 years out, the vanguard ETF crushed the S&P 500. Real estate stocks tend to be correlated with
interest rate fluctuations over short periods of time, which is the main reason for the
big underperformance over the three-year period. Rising interest rates are bad for REITs,
and the Federal Reserve raised interest rates eight times over the past three years. However, over longer periods of time,
the effect of interest rate fluctuations tend to balance out, and we can get a better look
at how the performance of these two asset classes stack up side by side. If you look at the longest time period,
you’ll notice that the performance is comparable, but with a significant
edge to real estate. This is an imperfect conclusion, as there
are other ways to invest in real estate besides REITs, and they have different investment
dynamics, but it does illustrate the long-term return potential of real estate investments.
Now, there are some downsides to real estate investing. Actually buying real estate
is a time-consuming investment. Hiring a property manager helps, but searching
for, evaluating, and buying properties consumes far more time than simply buying stocks.
Also, real estate is an illiquid investment. You can sell stocks with
a couple of clicks in no time at all. Conversely, it can take months to sell an
investment property unless you want to accept a highly discounted price. Of course, if you invest in real estate investment
trusts, you have the same flexibility that you would with stocks; however, to really
see the benefits of REIT investing, it generally makes sense to hold
these investments for the long term. It’s tough to make an apples to apples comparison
of the two, but it’s fair to say that real estate investments have just as much, if not
more, return potential as stock investments. When you combine the safe use of leverage,
price appreciation, income potential, and the inherent tax benefits of real estate investing,
there’s potential for impressive long-term returns. In the end, you don’t
really have to choose. Since stocks and real estate investments are
vastly different and each offers their own advantages, why choose? A diversified portfolio with stocks, bonds,
and real estate will put you in a position to better weather market hiccups, while also
seizing the relative advantages each asset has to offer. If you liked this video, please let us know
by giving us a thumbs up and subscribing. If you have a question we didn’t answer,
drop it in the comments section below. If you want more information on investing
in real estate, we have a free 40-page guide. Just head over to real.fool.com
to download your copy. Remember, we publish new content on real
estate investing daily on millionacres.com. Thank you for watching!

47 Comments

  • GenExDividendInvestor

    I think its kinda like saying "do you like cherry pie or apple pie"? They are both good, with their own pros and cons, and both are better than none 🙂 That being said, I've done residential and commercial real estate, and I've done stocks… and for me personally, I way prefer investing in quality dividend stocks.. Though if I were going to do more real estate, then I'd prefer to do NNN Commercial (over residential) due to its better passivity.

  • Cory Spencer

    When comparing these two forms of investing, if considering the rental income aspect of real estate, did your stock return evaluation include the dividend component in its calculation?

  • EquitiesTracker

    The problem with real estate is that the market is quite efficient.

    You're not going to know much more than the residence around there.

    Hence the lower opportunity for arbitrage.

    Not to mention the high upfront cost too.

  • Kaito Riku

    Real estate involves some legal certifications and also so much money, Buying stocks is most preferable to me as an investment starter it helped me make so much money. In stock a $15,000 can go a long way but in real estate $15,000 is nothing but a mere joke

  • the.Warlock

    The orange, purple, and green value-line transitions are REALLY annoying. Just transition to the next slide or graphic without these PLEASE.

    From the 5:40 mark to the end, I counted 18 of these flash transitions bridging the transition to the ACTUAL information; the video even ends on one!

  • Steven Lott

    I started investing in property in 1996 with 0 down. I can say if a person can’t comprehend all the profit centers in REI(rent, appreciation, amortization, tax breaks and reinvestment), they really shouldn’t invest in property. In fact, a better choice would be to invest in the stock market, pay taxes on the gain as they cash out and rent where they live.

  • ContrarianFire

    Even if you lived in a house that you bought as your primary residence, it saves you the market rental value of that house AND you don't get taxed on money saved.

  • Bo Fu

    That 15% return on real estate return at 4:25 is such a joke and misleading information. If your mortgage is 4%, the real return is even less than 3%.

  • My name is Steve Rogers

    She's not literally talking about buying houses versus buying stocks. She's talking about reit real estate vs stock. Didn't realize she had to be literal for you all to get IT. Since no one can afford real real estate in this kind of scenario

  • Istayfly Always

    A single family home is not a investment. It does not pay you . You pay to live their. The bank owns your house not you. Even if you pay off your house but don't pay your taxes you lose your house to the bank. How is that right.

  • Randy Ly

    As a starting invester, stocks are easier to get in to. Real estate is like a marriage that you really have to know, understand, and commit to.
    But to answer the question, having BOTH is the best option

  • Jackson

    Another thing positive thing about real estate is debt pay down for rentals. Your tenants are paying off your loan while you gain the net worth from it.

    Debt pay down combined with leveraging debt several times over with the BRRR method of real estate investing means exponential growth to your net worth. With, for example, 70k up front you could buy a house, fix it up, rent it out and refinance to purchase your next property. The cool part is that it doesn’t have to be your 70k and could come from a friend, family member or whoever.

  • Christopher Orick

    You can get into real estate with zero money down if you find a motivated seller. Take over their payments on their current mortgage or owner finance. Get a tenant in quick and you’re making money.

  • Andrew Jones

    The best financial decision we made was buying a multi unit as our first home. Your ability to save, grow a business, etc is enhanced when your housing is paid for by your neighbors (neighbors you get to pick as a bonus).

  • Juan carlos crovett

    I compared vanguard real state etf with s&p500, my results was different. The plot shows s&p was much more
    profitable. I used yahoo for the data, and VNQ, VGSLX, and VGSIX for mutual fund. Any ideas? And yes…. I do believe in investing in real state and stock market

  • HD93

    You missed the MOST important tax advantage: 1031 exchange. This is how RE beats stock in a very long run. You paid no taxes from rental income thanks to depreciation and no tax from selling thanks to 1031. May be you are not mentioning it for some reason?

  • AKEWSD

    She is from real estate….only fool trust her.

    1. Maintenance cost, building is just like a car. Foundation and roof might reach closer to its Lifespan.

    2. You can use leverage in stock. Leverage in real estate has a ceiling.

    The best thing to do right now. Be the private lender, when real estate investor bust, you can take over.

  • Magnum Opus

    The elite invest in child pedophilia and seems like they all agree investing in sex with little kids is most valuable to them

  • sbkpilot11

    this is an idiotic analysis… leverage has a cost of capital in the range of 4-5% so you're paying for the use of that capital. Leverage isn't free. If the ROI is 1.5% real and you're paying 4.5% for the cost of capital (interest) then you are losing money with this leveraged "investment", I think Motley Fool needs to understand Math better. In addition, Real estate has very high transactional costs, maintenance costs and other risks too involved to get into in this comment box. Ben Felix (PWL capital) computed that the unrecoverable cost of owning Real estate, very broadly turns out to be around 5% which is well over the typical rate of appreciation.

  • sbkpilot11

    Lies and misinformation in this video – Depreciation isn't free again, when you sell that asset you will be hit with massive capital gains taxes as it will be from the depreciated cost basis. The tax man will get his money at some point, you're just deferring it until you sell it. Quit misinforming the public. Also as in my previous comment, your example of 15% ROI is completely ridiculous and false. In that period you pay interest on that $500k at 5% annually so you are losing money not gaining 15%. MATH again, learn math. Also comparing REITs and personal real estate purchases or investing is ridiculous, REITs largely involve commercial Real estate which has much different characteristics than residential so again more ridiculous nonsense in this video.

  • John Moore

    Totally correct about real estate being highly localized, in my area property taxes are tax deductible were 2.5% put a big drag on cash flow and gains like stocks are subject to capital gains plus depreciation I enjoyed was recaptured in summary in my area property taxes made real estate investments difficult

  • Land Lord

    Stocks is like Bitcoin, until you hold them you can feel richer, but to really get profit you must sell portion of them (not dividend stocks). Rental profit is real value, you dont ever need to sell your golden goose.

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