All investments carry some level of risk. Commonly, people are told to invest in mutual funds, bonds, stocks, and/or real estate. Financial advisors tell people to “diversify their portfolio.” But to do that, you should know how stocks compare to real estate with regard to performance and suitability.
Investing in real estate commonly requires one to purchase a building, home, or apartment, potentially renovating it, and finding tenants to live or work there. According to sources like CBSNews and The Washington Post, the number of renters has increased by nearly 2 million in the last decade. Why? It’s flexible for millennials who are entering the work force and baby boomers who want to retire, downsize, or get out of the suburban areas (TheWashingtonPost). This provides added security to the owner, providing a larger pool of tenants to choose from, thereby reducing the vacancy rate and increasing the security of the investment. It also means that rentals are in demand causing renters to drive up the price to rent over time.
Investing in stocks used to be the choice of the many because one could invest a little bit at a time. However, stocks can be less appealing because you have less control over your investment. To quickly explain buying stocks, “if a company has 1,000,000 shares outstanding and you own 10,000 shares, you own 1 percent of the company”(TheBalance). Once you buy your desired stocks, you may have to sit and wait to gain a return. Additionally, the stock market is constantly changing. Stock prices can be affected by a wide variety of variables such as world or national politics, and scandals, in addition to new products. Historically, the changes in the stock market can be much more volatile than in real estate.
What’s the verdict?
Luckily, some intelligent researchers looked at 16 economies of the past 145 years and compared returns on equities, residential real estate, short-term and long-term treasury bills and longer-term treasury bonds. They found that residential real estate had the best returns, averaging over 7 percent per annum with equities just under 7 percent. You can read their massive study in a paper titled The Rate of Return on Everything, 1870-2015.
Below are a few important factors to consider, courtesy of InvestorJunkie:
Investing in real estate is typically a lower risk investment because the investment is tangible; your rental will not just disappear one day. The key factor in mitigating risk is to make sure that the expenses are low and property damage is kept to a minimum.
The Sharpe Ratio is a helpful tool used to measure risk vs. return in an investment. It is basically “return divided by risk”(BiggerPockets). Equities have a .27 ratio. While they have good return, their high risk drags down the ratio. Real estate has a .7 ratio because it has lower risk and higher return opportunity.
This used to be a deciding factor because real estate is expensive. However, in the past ten years crowdfunding has allowed people to invest as little as $100 a month, like stocks (BiggerPockets). The cost of the “buy-in” is now the same for both real estate and stocks.
Stock investments are generally considered more liquid, meaning that, when you want to cash out, you can do that immediately. In real estate, you have to find a buyer whether it be in a crowdfunding scenario or in real life. Depending on market conditions it can take a long time to sell real estate.
If you like to feel in control, real estate may be more your style. Once you buy stocks, you don’t have control over the decisions that the company makes. If your stocks are down, you can sell at a loss or wait until the value goes up. With a real estate investment, the market tends to fluctuate less rapidly allowing for more time to develop a plan of action.
In the end, there’s no simple answer to which is “better,” so you must decide what fits your lifestyle, and your goals. Higher risks can yield higher returns. When you are ready to invest, do your research or hire a professional to help you.