Asking the question: Which is a better investment – stock market or real estate? It’s like asking whether Cristiano Ronaldo is better than Romelu Lukaku or if chocolate or vanilla is superior.
The answer to the question depends on your preference, personality, and style. It also comes down to unique investment features.
In the year 1970, in California, very few stocks would have beat buying a beachfront property using a lot of debt, and crashing in 15years later.
No real estate could be better off investing in the shares of Berkshire Hathaway, Microsoft, Dell, or Southwest Airlines, Walmart, especially by reinvesting their dividend. However, the answer doesn’t sound simple.
The simple answer
First, keep in mind that stocks tend to increase in value faster than real estate.
The S&P 500 Index Fund has historically achieved total returns ranging from 9-10% over long periods. House prices, meanwhile, usually drive inflation, but not much.
Since 1940, the median home value in America has increased by 5.5% annually. But that’s a fallacy.
Today, homes are much larger than they were then. The average home in the year 1940 was 1,246 square feet, about half the 2010 average of 2,430.
The home size later adjusted, and the annual increased per-square-foot basis drops to 4.6%. After considering inflation, the average home value increased by only 1.5% per year.
Compare that to stock returns. After taking into account inflation, the stock generated about 7% a year in the long run. In other words, the stock market yielded returns more than four times the real estate value.
Real estate has a much stronger potential
Real estate values tend to outpaces inflation. Nevertheless, there are reasons why investing in real estate is better than that of stock.
One of the reasons is leverage. Unlike stocks, where it is irrational to invest with borrowed money, it is possible to use a significant amount of financing to invest in real estate without adding tons of risks.
With a down payment of 20-25% of the sales of any property, a lender can finance investment properties. The down payment requirement would be significantly lower when buying a primary home.
The effect of the leverage is that the small return can tremendously be amplified. For example, you buy an asset for $400 000 in cash, and its value increased by 3%, then you’ll earn a 3% ($3,000) return on your investment.
In real estate investment, when you buy a property, you have to pay an origination fee to a lender, and also various closing costs. These costs eat into your returns.
Also, it is possible to borrow money to buy a property but needs to make a monthly mortgage payment while you own it. With this, leverage can significantly amplify real estate returns, which is the reason why real estate investors choose to use it.
Another way to produce massive returns in real estate investment is by renting out investment properties to generate passive income. In real estate investment, renting out investment properties is one of the best ways to earn passive income.
Finally, stock investors did not enjoy a tax advantage while real estate investors do.
For instance, you have to write off purchase price over a certain number of years when you buy an investment property- a tax reduction known as depreciation. It would be awesome if you can write off your stock investment in the same manner, but it is not possible.
REITs (Real Estate Investment Trusts) also get an extra tax benefit- they avoid corporate taxes by paying out part of their income as dividends. It is easy for investors to buy in a tax-advantaged retirement account- they can prevent dividend and capital gains altogether.
How has real estate investment compared with investing in stock over time?
It isn’t straightforward to find reliable data on total returns from individual investment properties. There are several variables, and there’s no proven way to gather full profits realized by different real estate investors.
Take a look at this for comparison of the total returns of the Vanguard Real estate mutual fund and S&P stock index.
Property values tend to correlate with fluctuations in short-term interest rates, which is the main reason for reliable results below the three-year line. Raising interest rates is bad for REITs, and the Federal Reserve has raised interest rates eight times in the last three years.
However, over time, the effects of interest rate fluctuations usually offset, and we can better see how the results of these two asset classes are accumulating.
If you look at the most extended period, you’ll find that the results are comparable, but with a significant advantage to the real estate sector.
It will be an incomplete conclusion because there are other ways to invest in real estate aside REIT, and they have different investment dynamics. However, this shows the long-term potential for return on real estate investments.
Real estate Vs. Stock: Which is better?
It isn’t straightforward to make a comparison between the two. Although real estate and stock present both risks and rewards, it is fair to say real estate investments have high returns potential than stock investments.
When you combine the inherent tax benefits, price appreciation, and rental income potential of real estate investing, there’s potential for adequate long-term returns.
However, recent findings by statista.com on stock and real estate returns show that most people in the United States prefer real estate investment over stock investment.
With this, if you’re considering stock and real estate, the best bet for you would be real estate if high returns are your priority.