Between stocks and real estate, most investors tend to stick to one type of investment or the other, depending on what they are comfortable with. But the only issues that should matter when considering an investment is what kind of “true” return on investment can I get verses what is my risk to earn that return. Hands down, real estate is far superior to stocks in terms of both high ROI and security.
Before we begin this discussion, it is important that I point out the major mistake made by just about every other writer who has ever written on this subject; in every comparison of stocks to real estate, either the Dow or S&P values are used as the basis of measuring stocks’ performance, however it is rarely mentioned that the Dow is a select sample group of only 30 stocks and that the original companies of the Dow are not the same as the present companies that make up the Dow Jones. Recently General Motors (GM), along with government bailed out Citigroup, were dropped from the Dow because they both fell below $5/share, and they were replaced by Cisco Systems ($20/share) and Travelers ($40/share). The real estate equivalent of this would be to choose a portfolio of properties in the beginning and then removing a poorly-performing shack from the collection and replacing it’s valuation with a stronger performing Trump Tower. Such a practice makes it impossible to truly measure the performance of the stock market, however it is clear that whatever gains can be measured are “slightly” inflated, if not completely overstated.
Now that we understand the shortcomings of prior comparative analyses, we will choose to use the S&P 500, despite the previous discussion, with the understanding that this provides a slight advantage to stocks, for we will show that real estate is still superior, even in a comparison favoring stocks. There is an abundance of circumstantial evidence all around us for this fact. The most significant and lucrative investment most people make is their primary residence. 85 to 90% of the wealthiest individuals in the world built and hold their wealth in real estate.
What specific ways does investing in apartments and rental properties help us multiply our money faster? There are 4 major ways:
- Appreciation. This the gross increase in valuation of the asset. When the stock price increases to a higher value or likewise, when a house increases in value, appreciation is the profit from this change in valuation. Of course, a decrease in value is also possible in both types of assets, and the result of this is negative appreciation. This is the aspect that is most often focused on by previous comparisons. However, despite being the most important income with investing in stocks, appreciation is the least important of the ways of making money in real estate. Individuals who focus on appreciation in real estate are not investors, but speculators, many of whom were the hardest hit because of the burst of the housing bubble.
- Depreciation. This refers to an estimation of the “loss” of valuation of investment real estate as a result of deterioration or obsolescence. The wear and tear is not tabulated from a list of specific damages, but rather takes the cost of the asset and spreads this cost over the legally estimated useful “lifetime” of the asset, 27.5 years in the case of residential property. When running your real estate investing as a business, this tax deduction can be huge, along with tax-deductable expenses, in offsetting income and legally decreasing your tax liability. There is no equivalent to this in offsetting capital gains from stock income.
- Amortization. This refers to the building of equity in a property as the mortgage on it is paid off over time. This is another way of expressing the advantage of leverage in investing in real estate-the ability to buy an asset with only 3 to 25% of the purchase price and pay the rest off over time, preferably using the asset’s own income, is unheard of in the world of stocks.
- Cash Flow. This has to be the sweetest money from your real estate investment; after all expenses, this is what is left over to go straight into your hip pocket. This is analogous to stock dividends, however the company in which you hold stock has the ultimate decision as to whether they will offer you a dividend, and they can change this decision without consulting minor stockholders. A properly structured real estate investment will provide positive cash flow FOREVER. And, again, if you run your investment as a business, this passive income will not be subject to self-employment tax.
About the only clear advantage that stocks have demonstrated over real estate is the relatively greater liquidity that is provided by having a ready market of buyers. However, the knowledgeable and experienced real estate investor understands this, and the investor builds a list of buyers and recruits real estate agents and brokers onto his or her team for this very reason. Even in a tough market, as exists today, investors are able to move property and maintain liquidity.
In addition, the clear and widely acknowledged advantage that real estate investments have over stocks-the ability to leverage your money and credit to buy the asset and the tax advantages and other streams of income benefiting owners of rental properties-are often greatly underestimated and understated. The accumulated tax savings and other hidden income streams when added up is a more than significant amount of money; all the annual tax write-offs translates into more money to leverage and reinvest into more income-producing real estate, and this cycle of reinvesting is the process that will multiply your investment money at a rate that the best stock can never hope to keep up with.