What’s a better investment, stocks or real estate? And, what’s a safer investment? Unfortunately, there is a lot of misinformation out there on the web when comparing real estate vs stock market.
There are a lot of respectable people on both sides of the argument, but we need to dig down a little deeper first and sort out the good from the bad information. But opinions are never as useful as facts.
A team of economists from the University of California, Davis, the University of Bonn, and the German central bank, set out to answer these questions by analyzing a stunning amount of data. Does information for 145 years of economic data, summarized over the
next five minutes work for you?
The lead authors of the study reported the findings of their massive study in a paper entitled The Rate of Return on Everything, 1870-2015. In it, researchers looked at 16 advanced economies over the past 145 years. They compared returns on equities, real estate, short-term treasury bills, and longer-term treasury bonds. With each asset type, they adjusted for inflation and included all returns, not just appreciation. Dividend income was included for equities, and rental income was included for real estate. Their findings, in short: Real estate had the best returns, averaging over 7 percent per annum. Equities weren’t far behind, at just under 7 percent. Then came bonds and bills, with far lower returns.
Other studies of the average United States S&P returns since l972 show that during this time you would more than 25x your money with an average yearly return of 7.195% with stocks. When assessing real estate returns though it gets a little bit more nuanced. Unlike the stock market, which has been widely standardized and studied, real estate is extremely difficult to categorize and standardize because of the unique nature of every single property and the privacy surrounding most deals.
The key to real estate investment is its ability to produce cash flow (i.e. dividend). Single-family homes do not create cash-flow for investors so they are not considered investments in these studies. One key is to look at what actual investment property returns to its investors, and this is calculated using capitalization rates. The Capitalization Rates is the ratio of income from a property, net all operating costs, to the price.
Capitalization rates give us a very easy way to compare the stock market to real estate. If you want to beat the stock market, simply look for a property with a 7.2% cap rate or higher and you win. Also, you can have a lower cap rate if you use leverage to exceed that (low-cost and long-term leverage is one of the advantages of real estate). In all of real estate, except residential (1-4 unit), Cap Rates are used to calculate overall returns of an asset. Basically, it is the total return of a deal if it was bought in all cash (no debt). Because mortgage payments can vary drastically depending on the individual borrower, this is a standardized way to compare properties.
So, if a property has a 7% capitalization rate, also called a “7 cap” property, it would have a total return of 7%. So, if you bought it for $100,000, you could expect a total return of $7,000 per year. This, of course, does not take into account any potential appreciation. This is a simple example of determining a 7 cap property. You can click buy or sell and get all the shares you want for just a few bucks. But, real estate has a lot of transaction costs and inefficiencies that can cost anywhere from 5-8% of the total purchase/sale price. You need to increase the value of your property by 8% just to cover the costs to sell it! Buy right in the first place because of the extremely high transaction costs.
Stocks are considered “liquid” assets; that is they can be sold quickly to realize a profit. Real estate is considered “illiquid” assets; that is it may take time to sale a property, and the large profits from sales are not immediately available.
So, when considering the question “stock market vs real estate,” you need to think about how tangible the asset is. Businesses come and go but real estate is there forever. Though they can be difficult to quantify, these are real benefits that only real estate can provide.
In brief, a balanced portfolio of investments may be the best way for an individual to profit. This way the asset balance can provide revenue from various sources.
In short, don’t put all your eggs into one basket.
If you want more information on investing in multifamily and commercial real estate assets please feel free to fill out our contact submission form. Marjeanne will be in touch to help answer any and all questions you may have.