Trying to decide whether real estate investing or stocks is the right choice for you is, at times, a very emotional decision. It was for us at least.
One the one hand, the stock market is what “everybody” talks about and usually invest in. On the other hand, real estate investing conjures images of either wealthy people, or those who have lost it all in a real estate crash.
As for ourselves, we prefer real estate investing over stocks, but that choice is not necessarily the right one for everyone.
This article will lay out some of the pros and cons of each strategy and give you more information to help you make your own decision.
Investing In Stock Market vs Real Estate
To figure out the best investment for you, compare the pros and cons of real estate and the stock market, and then decide whether mutual funds, stocks, residential rental properties, or commercial real estate will help you achieve the lifestyle you want.
You’re not limited to one thing or the other. I would guess that most real estate investors also invest in the stock market. However, the opposite is not always true: most people who invest in the stock market are not always real estate investors (outside of owning their home). Real estate investing can appear to be less accessible than mutual funds and stocks because it has unique features. Although there are some risks associated with investing in real estate, there are also some potential rewards that are not available to those who only invest in stocks.
So, which is a better fit for you? Do you think you would be cut out for real estate holdings and being a stock investor? Maybe you’re more interested in investing in mutual funds or real estate syndication funds?
To learn more about each of these options and see what you are most interested in, let’s look at the advantages and disadvantages of each type of investment, as well as the different ways you can invest in real estate or stocks. We will also compare the tax implications and other benefits of investing in real estate versus stocks.
Investing in the Stock Market
When you invest in stocks, you own a small piece of a company. You receive a portion of a company’s profits if you own a fraction of that company. You can buy shares in publicly traded companies regulated by the SEC and make money in two ways:
- Sell stocks for more than you paid.
- Receive dividends as a shareholder.
In addition to buying individual stocks, you can buy shares in exchange-traded funds (ETFs). Exchange traded funds can be a great way to own shares in various stocks while avoiding high management fees. Mutual funds are attractive to people who want to invest in the stock market but lack the skills or time to choose individual stocks.
Real Estate Investment Trusts
REITs are similar to ETFs, but with REITs you are buying shares of a company whose primary business model is real estate investing and management. Many investors believe that an investment in a REIT is the same as investing in physical real estate assets, but this is not the case.
Although it may seem like REITs only own one type of property, they may actually own a variety of commercial properties that are bundled together. Although investing in traditional real estate through online brokerages is easier than it used to be, you are only investing in the company, not in the physical property they own or in their products.
By investing in REITs, you can have quick and easy access to your money, just like with regular stocks. An advantage of investing in REITs is that they provide the liquidity that investors sometimes need.
As an investor, you are always responsible for doing your research and making sure you understand what kind of company or investment you are putting your money into, and what risks and rewards you are willing to accept.
Benefits of Investing in Stocks
Here are a few reasons you might want to maintain an investment portfolio of stocks:
Attractive Historical Returns
Many people have put their money into stocks instead of other investments because stocks have done well in the past. This is not to say that every year has been successful for the stock market, or that all stocks always increase in value.
The average annual return for the S&P 500 Index, adjusted for inflation, is about 7% since its inception in 1926. If you invest in an index fund that tracks the S&P 500, you can expect to see approximately 7% return annually.
Getting started with stock market investing is incredibly easy. In order to invest, all you need is a self-directed brokerage account or a robo-advisor account. There is no need to use premium investing services or to make a large initial investment. You can buy stocks or ETF shares for a couple of dollars each and sell them just as easily.
Ease of Diversification
Different types of investments are known as asset classes. A well-diversified portfolio will spread your investments (or asset allocation) across different asset classes. Diversifying your portfolio is easy with index funds because you are investing in all the stocks that are in the index, which could be up to hundreds of different companies. An index fund is a type of investment where most investors can afford to buy just a few individual stocks, rather than many.
You can choose how active or passive you want to be when you invest in the stock market. Some people relish the thrill of day trading. Some people want to buy a index or mutual fund and only check on it every three months because they think of it as a long term investment.
If you’re looking for ideas for passive income, investing in the stock market can be a good option. To earn money from stocks, purchase shares in an index fund or individual stocks, then wait for the value of the stock to increase. Dividend-paying stocks provide a regular income that doesn’t require any additional effort from the investor after the initial purchase.
While stock trading isn’t always profitable, one advantage of the market is that you can buy and sell quickly. If you need to quickly cash out your investments or want to change your stock portfolio, this is a major advantage.
Drawbacks of Investing in the Stock Market
Although the stock market can be a good investment for many people, it also has some drawbacks, such as the fluctuations in value and the pressure that can come with investment. Although the market usually goes up in the long run, it can go down a lot in the short term.
Over the long run, however, they have consistently outperformed most other investments. The value of stocks can go up and down a lot in a short period of time, but they have usually done better than other investments over a long period of time. Although stocks are able to be sold quickly, they are not always ideal for investors who want to earn money in the short term.
Some investors get worried when their stock portfolio falls by a few points, even though it might not mean anything in the long run. They might become obsessed with their returns and live in a constant state of stress. Investors who sell low and lose a bunch of money are creating a self-fulfilling prophecy.
Although the real estate market may not be as strong as it once was due to high interest rates, investors are still interested in the market and are likely to invest again when interest rates go down. The results of a Bankrate survey from 2022 showed that Americans preferred investing in real estate over stocks.
There are many ways for consumers to invest in real estate, including options other than becoming a landlord. Although becoming a landlord is a time-tested option for those who want to manage a property themselves, it is not the only option. New business platforms have made it easier to invest in real estate without needing a lot of cash upfront.
Investing in Real Estate
The rising interest rates have hit the real estate market hard. As interest rates rise, homes become less affordable for buyers and owners may have to lower their asking prices in order to sell their property. This has been the case for much of 2022.
Early in 2022, interest rates remained relatively low. While mortgage rates were not as low as they had been earlier in the year, the Federal Reserve had not yet raised interest rates significantly. The central bank has made it clear that it is prepared to raise rates significantly in the months ahead. Buyers who are aware of the market trends looked to lock in lower mortgage rates on their purchases.
The amount of residential real estate available was quite low, with only 1.6 months of inventory, according to Trading Economics. The low supply of homes, combined with buyers taking advantage of still-low interest rates, caused home prices to increase quickly in the first few months of the year.
After this, the Federal Reserve Bank increased interest rates rapidly in an unprecedented way. The recent rate increases have made purchasing a home less affordable and as a result, many sellers have lowered their asking prices.
Investing in real estate is generally a long-term proposition, and those who are thinking of getting involved should keep that in mind when making their decisions. Even though interest rates are high, it may be a good idea to save up money for a down payment while waiting for rates to go down again.
Pros and Cons of Investing in Real Estate
There are advantages and disadvantages to every investment, including real estate.
- Long-term appreciation while you live in the property.
- Potential hedge against inflation.
- Leveraged returns on your investment.
- Passive income from rents or with REITs (Particularly through turnkey real estate)
- Tax advantages, including interest deductions, tax-free capital gains and depreciation write-offs.
- Fixed long-term financing available.
- Appreciation is not guaranteed, especially in economically depressed areas.
- Property prices may fall with higher interest rates.
- A leveraged investment means your down payment is at risk.
- May require substantial time and money to manage your own properties.
- Owe a set mortgage payment every month, even if your tenant doesn’t pay you.
- Lower liquidity for real property, and high commissions.
Although real estate provides several benefits, especially financial benefits related to taxes, there are significant disadvantages as well, such as high commissions when selling property.
Does investing in real estate make sense for you? What kind of investor are you willing to be? Both residential and commercial real estate offer opportunities to make a lot of money, so it depends on your financial situation and how much work you’re willing to do. The type of investment you choose should ideally suit your temperament and skills.
In particular, potential investors should ask themselves questions across three broad areas:
- Financial resources: Do you have the resources to invest in a given real estate investment? There are opportunities at every investment level. Do you have the resources to pay a mortgage if a tenant can’t? How much do you depend on your day job to keep the investment going?
- Willingness: Do you have the desire to act as a landlord? Are you willing to work with tenants and understand the rental laws in your area? Or would you prefer to analyze deals or investments such as REITs or those on an online platform? Do you want to meet the demands of running a house-flipping business?
- Knowledge and skills: While many investors can learn on the job, do you have special skills that make you better-suited to one type of investment than another? Can you analyze stocks and construct an attractive portfolio? Can you repair your rental property or fix a flipper and save a bundle on paying professionals?
Before you can figure out what sort of investment is best for you, you need to take a hard look at your own skills, abilities, and willingness. There is no need to invest in real estate to be successful. Many investors only invest in stocks in order to get the long-term return of 10% annually that the market offers. This is a form of passive investing.
Top Tax Benefits of Real Estate Investing
The amount of tax benefits you get from investing in real estate depends on how you invest, but it can be significant. Let’s run through them based on the investment type:
1. Your own residence.
- You may be able to deduct any interest expenses from your mortgage, depending on your specific financial situation.
- If you itemize your tax return, you can deduct up to $10,000 in property taxes.
- When you sell your residence, you can also receive $250,000 in capital gains (or $500,000 for married filing jointly) tax-free, if you’ve lived in the house for two years and two of the last five years.
2. Your rental property.
You can reduce your taxable gains from rental revenue by deducting property taxes.
Additionally, you can lower your taxable income by deducting your interest expense and depreciation; this will also allow you to continue collecting cash flow.
The taxes on the investment property will be lower when it is sold because it will have depreciated in value. If you sell a property and use the proceeds to buy a new property, you can defer the taxes on the gain.
If investors roll their proceeds into their next deal and follow the rules on 1031 exchanges, they can keep deferring any taxes on gains, as long as they can keep finding good property deals.
This is an attractive tax profile for REITs because you won’t have to pay any capital gains taxes until you sell the shares. you can hold the shares for many years without having to worry about paying taxes on them.
You can give the shares to your heirs and they won’t have to pay taxes on the money you gained from them.
REITs are tax-efficient because corporate taxes are not paid on the money paid out to investors, meaning the money has only been taxed once.
The most important thing is to know your investment goals and what you want for your future. Then take the necessary steps to reach your goals, whether that be through the stock market or the real estate market: these are the investment tools for your long-term investment in yourself, your happiness, and your bright financial future.
What about you, the reader. What asset class do you prefer? Let us know in the comments.
Kurt has gone from the financial lows of the ’08 financial crisis to personal financial success. He is a professional real estate investor, media buyer, faithful Red Sox Fan.
One of his passions is financial education and the pursuit of financial freedom.
You can learn more about Kurt here, or get a hold of him on Facebook or Twitter.