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Hello! Welcome!
It’s the million-dollar question and one of the greatest debates in personal investing. I want my money to grow. Do I invest in real estate or stocks? I hope to answer this question today to help you all decide which is best for you.
So let’s get into it!
Clearly both, real estate and stocks, have their advantages and disadvantages and if you compare the asset classes as a whole over a long period of time the returns are somewhat similar. That is sadly not a fairest way to compare them in my opinion. Hence the reason for my video/post today!
So let’s start with the stock market.
What are the advantages
First, very easy to buy and sell. All you need is a brokerage account and you can instantly buy and sell. That’s very quick and easy.
Second, minimal transaction costs. It’s ridiculously cheap nowadays with low-cost online brokers. You can initiate an investment for as little as $1 and some brokers like Robinhood even offer zero-cost commission.
Third, you can get consistent income from dividends and pending your tax jurisdiction, dividends are often treated more tax effectively than regular or rental income.
Fourth, easy to gain diversification. You can simply buy a ETF with hundreds of stocks or even a single stock that is a global company and you get exposure to global diversified income.
Fifth, stocks require very little ongoing effort or upkeep to maintain the value of the asset. The management of the company take care of the asset. You just have to hope they are doing a good job.
Sixth, a key point but slightly complicated, which I will expand on, but for now I will just say there is typically little to no leverage which means you can’t lose more than you invested.
Disadvantages for stocks
First, a very challenging point or most, stocks can be really emotionally difficult to own, as you instantly see the price fluctuate every day. So many people can’t handle even a 5% down move without panicking! Therefore, I always suggest people start as early as possible with small amounts of money to get more comfortable with this feeling, as it takes a lot of time to get comfortable with this uncomfortable feeling and for most it’s impossible to not look each day!
Second, the entire market can go down and therefore even if you have bought a great stock at a great price your investment can go down for a period of time, even an extended period of time, and it’s not at all your fault and nothing you can do about it but wait for it to return higher value.
Third, a key point, typically little or no leverage and while I said that means you can’t lose more than you invested, it also means there is no benefit of higher leverage during periods of high growth. And the reality is leverage is as much your friend as it can be your enemy. So this is by far one the greatest differences to consider and I will expand on it later.
So now for real estate
And for today’s conversation I will keep it simple and focus on residential real estate, so homes and apartments, but the theory applies to most real estate.
Advantages
First, it’s an actual physical asset that you can get actual utility from if need be. Meaning you can live in it.
Second, you have some control over adding value to it by renovating, painting, replacing carpets, building a carport, etc.
Third, lack of correlation to other asset classes. Meaning an indirect event which shakes the global stock market, like the big move in the Japanese stock market a couple of weeks ago which affected all stock markets, just doesn’t have the same impact on residential home prices in some random city in the world.
Fourth, a great hedge against inflation, which has been thoroughly demonstrated over the past few years since covid in most countries, as house prices have skyrocketed.
Fifth, and by far the strongest positive, is you can far more easily borrow money and leverage your returns. This is the key point for today’s video/post. It is not uncommon to put down 10 or 20% and borrow the remaining so you get 5-10x leverage on your initial investment. You can even put 5% or less down in some cases getting 20x leverage. So during times of low interest rates and high inflation, like we had recently, you can really increase your returns.
Sixth, many jurisdictions have favourable tax treatment for residential real estate. In the US for example, you can use interest from your mortgage on your own home as a tax deduction (up to a $750k mortgage) and in Australia you can do the same for investment properties (not your own home), what they call negative gearing.
Disadvantages for real estate
First, buying and selling takes a considerable amount of time and effort and cost. Therefore if something changes you are unable to easily change your mind after investing so you can get stuck with the asset or a huge loss.
Second, due to the size of the commitment to buy real estate your money is highly concentrated in a single asset and is therefore not diversified if something goes wrong with your piece of real estate.
Third, while I highlighted leverage is a great when interest rates are low and inflation/growth is high, sadly when interest rates start to go up you can very quickly get squeezed, potentially even forced to sell, as rents rarely increase at the same speed.
Fourth, the leverage can magnify your losses. The Global Financial Crisis is the worst example of this in recent history where many real estate owners found themselves with negative equity. Meaning the value of the real estate was less than their mortgage so if they sold they would continue to have a mortgage after selling. This is a horrible situation to be in.
Fifth, very high transaction costs, government charges, bank loan fees, agent fees, these often add up to be very significant when buying and again when selling. So real estate is not typically something you can buy short term. Plus, you also have ongoing costs for managing tenants and maintenance. It can typically eat into your rent by 20-30% on an ongoing basis.
In summary, it really depends on your personal circumstances and stage of life but my personal opinion is for people starting out is to focus more on residential property because you’re getting far more leverage. So $50,000 can give you access to an asset of $500,000 and therefore a 10% gain in one year means you double your initial investment (less borrowing costs which can be offset by rent of course). Which is far more likely than a 100% gain in the stock market. So you are more likely growing your capital faster. Plus, you can also add value to it by renovating after you buy it and further increase your chances of growth and/or even live in it.
That said, there are no black and white right answers. There are risks to each decision and there are pros and cons. You could argue the stock market is a great place to leave some capital for liquidity reasons, so $100k for living expenses if needed because it’s easy to draw on and you get 10% return on average over a year. But, you could just as easily argue having that $100k sitting in a loan offset account which reduces your interest on your mortgage means you save 5-6% of interest over the year which is about the same return factoring in taxes. So it really depends on your circumstances and risk tolerance.
Another way to look at it is if you had $100k cash total but you know you need $200k to buy your next property and you think it will be a year or two before you save up to 200k, you could consider putting $50-100k in the stock market. Knowing though the same applies, you need to make 10% pretax in the stock market to breakeven because offsetting your mortgage at 5-6% is effectively 10% pretax. Stock market return is far from guaranteed but saving mortgage interest is. That said, the stock market has returned over 20% for 4 out of the past 5 years so you would be ahead in those years and compounding your returns.
My final word, is what Einstein is often quoted as saying. Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.” In other words, compounding your returns is the magic so stay invested and compound your returns! And if you have the risk tolerance, then compounding with much higher leverage in real estate is definitely worth considering but don’t forget to keep a little liquidity at your disposal, at least 3-6 months living expenses in case of a rainy day!
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