Which Is Best for Investors in 2023?
No two people have the same investment strategy. For some, investing in real estate makes sense and excites them, while others prefer the more laid-back approach of investing in the stock market. How do you decide which is the better investment?
Check out our real estate versus stocks guide to see which investment opportunity is right for you.
Real Estate Investing Pros
Real estate investments can take place in different ways, including buy-and-hold strategies involving renting residential or commercial properties, such as shopping malls or office buildings, to tenants.
Another approach is fix-and-flip, where you acquire undervalued properties, renovate them, and sell them for profit.
Real estate investors realize different benefits from each of these investing methods. Here are some of the most common benefits.
Opportunity for leverage
If you qualify for mortgage financing, you can purchase a property worth more than you have available. For example, suppose you have $100,000 for a real estate investment but find a rental property selling for $200,000. In that case, you may be able to borrow the additional $100,000, allowing you to own a higher-priced investment property faster and earn larger capital gains.
However, if you invested the same $100,000 in stocks, you’d only be able to get as many shares as your $100,000 would buy.
Own a tangible asset
Real estate is a tangible asset. This means you see what you own and can control it, unlike stocks, which don’t provide anything to show for your investment except possibly a stock certificate.
Also, you can control real estate, fixing it up, maintaining it, and deciding how much to charge for rent or list the home when ready to sell.
While no one can 100% control the real estate market, you have more control over how your investment performs and can increase your chances of positive returns.
Can offer a steady income stream
If you own rental properties, you may generate income from the rent charged to tenants. Monthly rental income can be steady when you have regular tenants.
The possibility of owning a property that generates income increases when you do your market research and purchase rental properties in areas with high rental demand.
Real estate appreciates
Per the Federal Reserve, real estate prices have grown substantially over 20 years. From Q1 2003 to Q2 2023, prices climbed from $186,000 to $416,100, resulting in a remarkable difference of $230,100.
Of course, there’s no guarantee real estate values will increase, but if you invest in real estate long-term, your chances of earning a profit are high.
Option for a 1031 exchange
If you want to sell real estate but aren’t ready to pay capital gains taxes, you can use the 1031 exchange. This real estate transaction allows you to defer taxes on your profits by using the proceeds from the sale to invest in another property.
There are strict rules regarding the timeline for selling the initial property and buying another. Still, if you follow the rules closely, you can defer taxes on the property until you sell it and take the cash.
Tax advantages as a real estate investor
Investing in real estate offers several tax advantages, including deducting depreciation. According to the IRS, residential property is depreciated over 27.5 years, and commercial property over 39 years.
In addition, if you qualify as actively participating in real estate investments, you may be able to deduct expenses, such as property management, property taxes, mortgage debt interest, and travel expenses.
Real Estate Investing Cons
Like any investment, there are downsides to investing in real estate. Comparing the pros and cons can help determine if investing in real estate properties is right for you.
Keeps capital tied up long-term
You could tie up your capital for many years, depending on your real estate investment. This is most common with buy-and-hold real estate investments. You purchase and hold on to a property, renting it to tenants and collecting income.
You won’t get a return on your capital until you sell the property. This time frame can vary from a few months for fix-and-flip projects to several years with rental properties.
An alternative is refinancing the property and accessing earned equity before selling.
Large up-front initial investment required
Even with the ability to leverage your real estate investments with mortgage loans, you’ll likely need a significant up-front investment to qualify for financing.
Because a mortgage is riskier on an investment property than on a primary residence, lenders have stricter requirements, including a larger down payment. Many lenders require a 20% down payment or higher to reduce the risk investment properties create.
Requires a lot of work
Real estate investments require extensive knowledge and work unless you hire a property manager. To succeed, with or without a property manager, real estate investors need a solid grasp of the real estate industry. This includes evaluating fair market value and rent, comprehending landlord-tenant laws, tenant management, and property maintenance and renovations.
Managing a real estate portfolio is very hands-on and labor-intensive for the property owner.
High closing costs
Investing in real estate requires you to attend a real estate closing. Even if you pay cash for the property, there are closing costs you’ll incur to transfer the property and handle all legalities.
When you finance an investment property, you could pay 3% to 6% in closing costs or more, decreasing your profits.
Stock Market Investing Pros
When comparing real estate versus stocks, it’s essential to consider the pros and cons of investing in stocks.
Stock investors can select various types of stocks, such as dividends or common stocks. Some brokers also offer the opportunity to buy fractional shares, enabling you to distribute your capital more extensively across different stocks.
Consider the following benefits of stock market investing.
Stock market investments are liquid
Unlike real estate investments, stock investments are highly liquid. You can buy and sell stocks during regular trading hours, virtually cashing out your investment in minutes.
Most expert investors suggest keeping stock investments long-term, as the average return on the S&P 500 is 10% to 15% over 10-year periods.
Low transaction fees
Unlike real estate transactions with high transaction costs, stock purchases have very few fees. You may even find discount brokers that offer free stock trades.
If you invest in exchange-traded funds (ETFs) or mutual funds, there may be more transaction fees, so always read the fine print. Actively managed asset classes usually have higher fees than passively managed investments.
Diversification is simple
A diversified portfolio is the key to reaching your financial goals. When comparing real estate vs. stocks, it’s much easier to diversify with stocks because they cost less, and you can purchase across many industries or asset classes.
Real estate is much more expensive, so it’s difficult to diversify your portfolio as much as it’s possible with stock market investing.
You may realize tax benefits by buying stocks in your tax-advantaged retirement accounts, such as a 401(k) or IRA. Buying stocks in your tax-advantaged accounts allows your portfolio to grow tax-deferred.
You only pay taxes when you withdraw the funds, which, if you do during retirement, you may be in a lower tax bracket, saving more money.
Anyone can invest in stocks
You don’t have to know much about the stock market to invest in stocks.
While it helps when you know which assets to invest in or when to buy and sell stocks, you can get help from robo-advisors or human, financial advisors to help you reach your goals.
Investing in stocks offers passive income. You don’t have to actively manage properties or the companies of the stocks you purchase.
As a stockholder, you own a small percentage of the company and get rewarded when the company performs well, and possibly lose money when they don’t do so well.
Long-term capital gains tax
Holding stocks for at least 12 months may qualify for the long-term capital gains tax.
This tax rate is lower than most standard tax rates, saving you money. Most investors fall under the 0% or 15% long-term capital gains tax rate, and a few are in the 20% bracket.
Stock Marketing Investing Cons
Stock investing has downsides, which you should understand when comparing real estate and stock investing. Here’s what to consider.
Stock prices are volatile
Stock prices often change, sometimes multiple times a day. Most people, even experts, can’t predict how a company’s stock will perform, so from one day to the next, it can be quite the roller coaster thanks to market volatility.
Rash decisions are easy
Stock market investing can be highly emotional. If the stock market performs poorly, it’s natural to want to bail out fast and get to selling stocks. This isn’t an option with real estate investing, since selling a house takes months or longer, depending on the real estate market.
But selling stocks on a whim isn’t the best idea and can lead to unnecessary losses for your stock portfolio, especially if the dip in stock price is temporary.
To purchase stocks, you must have enough cash flow to buy the number of shares you want.
Some investors may be able to “buy on margin,” which means borrowing money to invest, but it’s nowhere near the amount you can borrow for real estate investment properties.
Requires a high risk tolerance
Investing in stocks isn’t for the faint of heart. You need a high risk tolerance and a long-term investment strategy. Those without a high risk tolerance may find stock investing isn’t for them.
Holding on to stocks long term usually offers a better return on your investment than if you invested for the short term, hoping for a big win.
Other Investment Strategies
When comparing real estate vs. stocks, it’s important to consider other investment strategies you may implement to reach your financial goals. A well-diversified portfolio may help you reach your goals and lower your risks.
REITs, or real estate investment trusts, offer a passive way to invest in real estate. When you buy shares of an REIT, you become part owner of the commercial real estate the REIT owns. Each REIT operates differently and has a different portfolio.
Your only requirement is to invest the funds; the REIT managers do the rest, including choosing the properties and managing and selling them.
REITs must pay shareholders at least 90% of their profits, so investors can earn monthly rental income plus capital gains when a property is sold.
Real estate crowdfunding
Real estate crowdfunding is another indirect way to invest in real estate and is a great investment strategy for investors who don’t have a lot of capital. Instead of putting all your capital in a single property, diversify your funds across as many real estate properties as you see fit.
Some real estate crowdfunding platforms allow investments as low as $25 per property, and others have higher minimum requirements.
Real estate crowdfunding typically operates on a set timeline, often around five years, during which your funds are committed. Ensure you’re comfortable with this timeline and can manage without the funds throughout the investment period.
Depending on whether you invest in equity or mortgage debt, you may receive monthly dividends from rental or interest income, plus a return of your capital with capital gains when they sell the properties.
Peer-to-peer lending is an investment in people who don’t qualify for bank financing. Some may have bad credit, so you need a high risk tolerance. Yet others have various reasons they don’t qualify with a traditional bank, such as being self-employed or having a recent bankruptcy.
Like real estate crowdfunding, you choose the investments you want to put your money in that fit your investment strategy. You receive income payments monthly and a return of your principal by the end of the term.
With peer-to-peer lending, you can select the level of risk for the loans you invest in. Remember that a higher risk tolerance translates to higher interest rates earned.
Real Estate vs. Stocks: Which Should You Choose?
When comparing real estate vs. stocks, you might wonder, which is the better investment? The answer isn’t a one-size-fits-all approach unless you diversify your portfolio and invest in both.
In a perfect world, investors have money in real estate, stocks, bonds, ETFs, and alternative asset classes.
However, if your funds are limited and you’re deciding on one investment, weigh the pros and cons of each option. Assess whether you should join the ranks of real estate investors or take a more passive approach by investing in stocks.
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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.