Today, investors have many options. Real estate and stocks are two investment classes that offer investors opportunities to grow their money. With high-tech brokerages, retail investors have greater access to and control over their stock market trades. But a well-diversified portfolio should include a variety of asset types.
In this blog, we will consider these factors to answer the question of where to put your money: real estate or stocks?
Benefits of Investing in Real Estate
Real estate syndications, real estate investment trusts (REITs), and real estate exchange-traded funds (ETFs) give investors avenues into the world of real estate without having to purchase and assume responsibility for managing a property. Start-up costs range from just a few dollars for REITs and ETFs to $50,000+ for real estate syndications.
In the past, the high cost of entry excluded many investors from reaping the advantages that property investing offers over stocks. That is no longer the case, but the perks of real estate do vary based on the specific mode of investment. Here are just some of the benefits of investing in real estate vs stocks:
Truly Passive Income
Passive income tops the list of reasons to invest in real estate over stocks. Real estate investment is one of the rare ways to get a second stream of income without committing to another job. Passive investors earn preferred returns, profits from the sale of the property, and income generated by rent if the property is rented out to tenants.
That passive income usually comes from the property’s rental revenue. Investors in real estate syndications can enjoy passive income without the effort of owning and managing an income property themselves.
In real estate syndication, income sources are varied. Some cash-generating properties such as apartment buildings, rental houses, storage sheds, or strip malls can provide steady, reliable cash flow on a month-to-month basis. For those who do decide to purchase a property, the income is likely to feel anything but passive even if it is characterized as such.
As far as investments go, profits from stock investments come when you sell. However, investors can be paid while still owning stock through dividends which they can reinvest to buy more shares. Over time, with reinvestments, they should own more shares and earn more cash dividends. However, it would take a significant investment in a high-yielding dividend stock to generate reliable income.
Hedging Against Inflation
Savvy investors know that a dollar under the mattress today will be worth less in the future. Ideally, investment helps grow wealth, but it also plays an important part in simply maintaining it. Inflation is to be expected but can be planned for by investing in assets that tend to outperform the market during inflationary periods. Real estate is one such asset.
Real estate investments have traditionally been used as inflation hedges, since home values and rents typically increase with inflation, and protect against loss in the purchasing power of the dollar. During most periods, and especially during inflationary periods, the value of real estate continues to rise. But properties under a fixed-rate mortgage or with no debt encumbrance stay at the same monthly cost. Ideally, investors see substantial gains during scattered periods of significant appreciation, and those gains keep them at or above the rate of inflation.
Real estate opportunities across the spectrum, including syndications, REITs, ETFs, and the outright ownership of property all reflect this benefit.
Multiple Tax Advantages
Investing in real estate yields tax advantages not available to stocks. Real estate syndication comes with five major tax benefits that make a positive financial impact: depreciation, depreciation recapture, bonus depreciation, cost segregation, and capital gains. There are great deductions possible, like mortgage interests and points, but the best of all is depreciation. Depreciation allows the owner to write off a portion of the purchase price over time.
On top of the benefit of depreciation, if you own and sell commercial property, you may avoid capital gains tax pretty much indefinitely through a 1031 exchange by reinvesting proceeds in a similar type of property. Completing a 1031 exchange — selling one investment property and purchasing another like property with the funds – is another way investors can avoid paying capital gains upon the sale of a property.
For this tax break, the term “like property” is somewhat flexible. This means that investors can sell a property at a profit and then purchase a better, more valuable property without paying taxes on the first transaction. This cycle repeats, and the owner can continue to increase the value of the property owned, all without paying taxes on the profit realized each time.
In stock investments, capital gains tax is paid when you sell your shares. You may qualify for lower tax rates if you’ve held the stock for more than a year. However, you also have to pay taxes for stock dividends earned from your portfolio during the year.
Investing with Debt Creates Less Risk
Real estate has traditionally been an alternative investment that offers lower risk, yields better returns, provides greater diversification, and allows investors to build wealth over time. An income-producing property requires a higher buy-in than stocks. But, the initial investment for real estate is much less than the property’s actual value, and most owners usually finance the bulk of the purchase price.
Given that real estate usually appreciates in value, there is an assumption that the down payment amount can be recouped. In real estate, price fluctuations happen over months or years. Even if prices go down, most investors can sell their investment before they lose money.
Stock values are subject to market fluctuations that can make them move up and down much faster than real estate prices. These extreme changes can be caused by events happening in the economy as well as monetary policy, regulations, tax revisions, or changes in the interest rates.
Significant amounts of financing or borrowed money can be used when investing in real estate without adding much risk, which enables investors to buy more valuable investment assets. On the other hand, investing in stocks with debt, known as margin trading, is extremely risky and should only be undertaken by experienced investors.
Yield Greater Returns
In the event that property values do not outstrip the rate of inflation, real estate investment provides another vehicle to help investors get ahead: the leveraging of debt.
Leverage is all about maximizing the ratio of returns to the money invested. By purchasing a property with debt, the investor stands to see greater returns in proportion to the amount tied up in the property.
For example, the rental income from a $500,000 property should be more than that of a $100,000 property. Or, if each property appreciates 3%, the more expensive property will yield a greater return upon selling it. Those bigger returns can, in turn, be used to place down payments on more properties to produce income and appreciation. Ideally, leverage creates a chain reaction of increased revenue and value.
However, a real estate investment is not as easy to liquidate as a stock investment. Taking your money out of a real estate investment through resale takes more time and is not as easy as buying and selling stocks.
Always Research Prior to Investing
Real estate offers many undeniable perks to investors, but not all investments are created equal. While real estate is a key component in portfolios to hedge against inflation, it is not without risks or downsides.
Real estate can seem like a sure bet, especially with constant headlines about soaring property values. Unfortunately, there is no guarantee to earn a profit, and real estate projects can tie up capital for a long time.
Remember that investors do not have to choose only real estate or stocks. Plan your investment portfolio to include both asset types for maximum diversification! For more information from investing professionals, listen to our podcast with Alex Kholodenko on whether you should invest in real estate or stocks today. Life Bridge Capital is a leading real estate syndication company. We offer our investment partners the opportunity to leverage shares of multifamily rental properties into a passive monthly income. Learn more about our mission.