#1 Stocks vs Real Estate
Which investment is better for you?
The question of whether to invest in stocks or real estate is an age-old debate in the investing world. Talk to a seasoned real estate investor and they'll probably tell you that the stock market is a casino where fools go to lose money.
Ask a long-time stock market investor, and they'll tell you that real estate is hard work - full of fixing toilets and dealing with nightmare tenants.
While there's a lively debate about which is the better investment, the truth is that both can be great investments. It really comes down to which is right for you.
To help you decide, we're going to cover 3 areas where these investments are different:
Active vs. passive
Debt + Taxes
Real estate is a business
Buying an investment property is more similar to buying a small business than it is to buying shares of public companies. Real estate is a business - albeit the simplest business in the world:
Your customer is the tenant and your product is a home
You may need a local business license, LLC, insurance etc.
You are responsible for delivering a service and are legally liable in some cases
Real estate investing is not 100% passive, however you can make it more passive by hiring a property manager. It comes down to time vs money - how much work you want to do yourself, and how much you can afford to pay for other people to do that work, while still earning your desired return on investment from the property.
If you hire a property manager you will not need to spend time on your investment every day, or even every week. But there is always an element of 'managing the manager'. You may also need to approve repair requests, pay bills, do bookkeeping, and pay taxes.
Real estate is a simple business but at the end of the day you need to decide if you want to run a business or not. If you want zero headache and 100% passive investments, real estate is not for you.
On the other hand, investing in stocks can be as passive or active as you want - it depends on your style of investing. If you take the bogleheads approach and invest in 1-3 broad market index funds (ETFs), and you automate your regular investments, then you’re investing is 99% passive. Or you could use a robo-advisor such as
However, if you choose to invest in individual stocks you may spend hours researching companies, listening to earnings calls, and scouring their financial statements. While there are no toilets to fix, this constant research and decision making takes time and effort and can make this style of investing much less passive.
They make you wealthy in different ways
Both stocks and real estate provide equity in an underlying asset. You can also earn income through both investments, in the form of stock dividends or cash flow from rentals. But the big difference between them are in how they are financed and taxed.
Returns from real estate = appreciation + cashflow + loan paydown + tax benefits
Returns from stocks = appreciation + dividends (+tax benefits IF stocks are held in a tax advantaged account)
When you break it down, the primary advantages of real estate are how you can finance the investment (leverage), and how the government incentivizes real estate investing through taxes. The combination of debt + taxes is extremely powerful.
Debt is powerful in two ways: As you pay your monthly mortgage payment, your equity grows incrementally because the loan balance decreases over time. This is often called loan paydown. Essentially, your tenant is building your equity (wealth).
On top of that, as the property appreciates in value, you get 100% of that equity upside - not the bank. Let’s say you purchase a property for $500,000 with a $50,000 down payment. The bank loans you $450,000. 5 years later, the property is worth $750,000. You now have $300,000 in equity, not counting the load paydown over that 5 years! That’s a 6x return in 5 years. That is the power of leverage.
But wait, there’s more! Those interest payments you make are tax deductible, so they lower your taxable income from the property. The tax advantages for real estate investors allow you to earn cash flow on a property and with deductions and depreciation, pay low or no income tax on the property. And in some cases, pay no taxes at all. In addition, if you choose to sell the property, you can defer paying capital gains tax by using a 1031 exchange to roll the entire proceeds of the sale into bigger/better property - tax free.
They offer different levels of control
While real estate and stocks both grant you ownership (or equity) in an asset, the level of control you have over the outcome of your investment is very different between them.
Your control over stocks: When you buy, when you sell, and how much you own.
Your control over real estate: Increase rents, reduce expenses, force appreciation with improvements.
Again, rental properties are mini-businesses that you own and control. If you own a house and rent it out, you can improve your return on investment by improving it's financial performance, or by increasing the market value of the property. Are the current rents below market rate? You can increase them.
Now, unless you're Warren Buffett (and I hope you are), it's going to be difficult for you to influence the performance of Apple. I know, I know, you're doing your part by buying a new iPhone every three years!
The reality is that most public company investors like you and I have zero control over the businesses they're investing in. Your control over the outcome of your investment in public company stocks is based on your behavior. You can control what stock you buy, the timing of your purchase, how much you invest, and when (if ever) you decide to sell the stock. These decisions will determine the returns you achieve when investing in public companies or ETFs.
Real estate investing has geographical constraints and is inherently local.
When investing in real estate it's important to understand the area and neighborhood to ensure it's somewhere you want to own.
Real estate can constrain your physical location. It's possible to invest outside of the area you live in, but you'll need a property manager and a team to help you do it successfully. Many owners want to be close to their properties, and as a result their physical location (and freedom) is constrained.
Owning stocks generally does not constrain your physical location. If you have an internet connection and a brokerage account you’re set.
Their liquidity and trading frequency are very different.
Stocks are much more volatile than real estate because the market gets together every day to decide prices. Real estate prices are much slower moving. You can see your home value on Zillow but realistically it's a monthly measurement and is not volatile on a daily or weekly basis.
High liquidity and ability to trade often leads to bad decisions or bad behavior with stocks. Volatile prices lead to emotional decision making, which often leads to lower overall returns. You are your own wost enemy when investing in stocks.
Low volatility can make it mentally and emotionally easier to hold real estate forever than individual stocks. This may suit some personalities much better.
Lower volatility for real estate also allows you to use low interest rate loans to build wealth (safely). This is one of the unique advantages of real estate. You can borrow 80% of the price of a property at low rates. From there, every dollar of appreciation adds to your equity. Stock brokerages allow you to use margin (debt) to buy stocks, but this is much riskier due to the volatility of the markets.
So, which is better? Well, it depends on your personal situation and your strategy.
Some questions to ask yourself to help you determine what's right for you:
Do you have time to find, purchase, and manage a property? And if not can you hire a property manager and still make money (cashflow) each month?
Do you have a high income? Real estate can potentially help you reduce your taxable income.
Are you bankable and do you have good credit? Lenders have strict requirements.
Do you want to run a business?
In closing, here are some key benefits of each investment:
Real estate typically has higher potential for cash flow, meaning you can build passive income faster than with stocks
Real estate allows you to pay little to no taxes on that income, which boosts your after-tax returns even higher
Real estate allows you to safely boost your returns with low interest fixed-rate loans
Stocks and ETFs are highly liquid - easy to buy and sell with the click of a button
Stocks and ETFs can be 99% passive and historically have good returns