Real Estate vs. Stocks: Why Choose One Over the Other?

To maintain a portfolio of investments that will weather the market's ups and downs, ideally, you'll want to be diversified and own both stocks and real estate. But sometimes that's not possible.

If you have to pick, which should it be? Stocks or real estate?

Let's take a look at how these investments stack up against each other.

Choosing Real Estate over Investing in Stocks

When done the right way, real estate investing can provide great returns through rental income, tax advantages and the capital appreciation gained from buying below the market value.

However, investing in real estate is not for everyone. It takes time to learn to competently and confidently invest. It takes perseverance and effort to find awesome deals. And it takes financial discipline to save up enough money to get started. Let’s face it: Investing in the stock market is much easier!

Still, I have found that real estate is a much better way to invest my money than the stock market. I am making a much higher return on my real estate holdings than on my traditional stock portfolio. And real estate offers some unique qualities that make it attractive.

Here are key reasons real estate investing beats the stock market:

1. Stability: Real estate investments provide cash flow and can be a hedge against inflation.

The ease of stock trading is the downfall of many investors. While up-and-down market cycles are inherent, it's hard to stay invested when the market drops, even though research shows that trading in and out of stocks during volatile times leads to losses.

Since real estate is a less liquid asset that takes more effort and time to sell, you're likely to hold on to it through market cycles.

What’s nice about rental income is that your cash flow keeps pace with inflation. The market price for rental properties automatically rises as the cost of living increases.

You can also line up a big cash payday by buying a “distressed” or foreclosed property below the market value. Then you can fix it up and sell it a few months later for more than what you've paid — the purchase price and rehab and transaction costs.

You can choose to “fix and flip” to collect a windfall or hold and rent for monthly cash flow. Either way, investment properties can provide cash and a hedge against inflation.

2. Return on Investment (ROI): Real estate is a market where you can buy low and sell high.

We all know money is made in the stock market by buying low and selling high. But it is nearly impossible for most investors to do so consistently. You can’t possibly know enough about an individual company, its sector, management, competitors, etc. And institutional buyers will always have more leverage and know more than you as an individual investor.

Contrast that with residential real estate where you are dealing with individual properties and each one is different in location, size, features and other criteria. There is no set market for the exact property you are considering.

In the stock market, anomalies are quickly adjusted for by other investors. In the real estate market, there are thousands of little markets. You can always find deals and “buy low.”

There are strategies where you can buy low and sell for a high price once you have rehabbed a house. And there are geographical pockets in just about any real estate market where you can “sell high” if you know the type of housing that is in high demand.

3. Degree of Risk: Actively managed real estate provides better returns and lower risk than stock market investing.

Stock market values go up and down. Independent research firm Dalbar has been measuring the effects of investor activities over both short- and long-term time frames since 1994. They show that average investors are not very good at capturing the market return of a simple balanced portfolio. Never mind outperforming it.

Individual investors tend to buy and sell at precisely the wrong times. That wipes out possible gains in an already efficient market where bargains are sparse.

On the other hand, real estate is nearly immune to emotional buying and selling. As a less liquid investment, panic selling is impossible. You have more facts to make a better investment choice initially when you buy properties.

And the long-term nature of real estate assets ensures that you hold on through ups and downs. All the while, rents, and property prices rise due to inflation.

In general, your risk of loss goes down the longer you hold real estate investments. Your equity builds and home prices rise over time. That is unlike the stock market, where the risk typically stays the same.

4. Tax Advantages: Real estate investing provides unique tax advantages.

While there are others, depreciation is the tax advantage that most investors have heard about. For dwellings, the IRS allows you to deduct the cost of the property over 27.5 years.

What real estate investors love is that you are depreciating an asset that does not often lose value. In fact, property values tend to go up over time. That means you get a tax credit on the cost of an asset that may be going up in value, not down.

What is more, depreciation is a tax credit that is on top of property upkeep and other costs that you can take away from the rental income you get. When you take it, it provides a tax deduction that lowers your tax liability. That means more money that you can use to buy more properties. Or pay off the loan if you took one. Or pay for upkeep or anything else you want to spend it on.

5. Leverage: Real estate investors can use leverage to build wealth.

Leverage is a tool that many real estate investors use to build their portfolio of income-producing properties. Getting a mortgage to buy a rental property gives you leverage that you can use to invest in more properties (and different types of properties to spread your risk) with less money down.

Say you put 30% down on a $100,000 property. You are controlling an income-producing asset worth more than three times your cash investment. You are earning rent from a $100,000 property when all you invested was $30,000.

Well-selected rental properties will be cash-flow positive. That means that your annual rental income will pay all the costs (mortgage, taxes, insurance, maintenance, management fees, etc.). It will also give additional cash for your bank account.

Of course, you need to critically evaluate your strategy, the specific deal, and the terms of your loan. You can get easily in over your head with leverage. Being overleveraged greatly increases your risk. Leverage is a tool that needs to be managed and monitored. Any specific property or an entire portfolio can be made risky with high leverage.

6. Inflation Hedge

Inflation averages 3% annually, but it's skyrocketed in 2022. Home prices typically adjust up with inflation. This is because housing is essentially a consumer good, and inflation causes the price of consumer goods to rise.

Stocks don't have a built-in inflation adjustment. And stock prices can and often do swing widely, diluting the value of your shares instantly. A significant drop in the market such as what we've seen in the past can reduce your principle so much that it could take you years to recoup your initial investment.

7. Control of Investment

With stocks, trying to time the market is a loser's game that even the experts avoid. With real estate, timing the market is possible and can lead to huge gains. The housing market is more stable and predictable than the stock market — a tweet from the president doesn't cause a dip in the price of homes, but it could cause a selloff in stocks. The forces that move housing prices happen gradually, giving investors time to make informed and smarter adjustments in their holdings.

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Choosing Investing in Stocks Over Real Estate

1. Diversification

Stocks allow instant diversification with even small investment amounts. You simply choose a few diversified mutual funds or an index fund.

It takes a lot more money to properly diversify your real estate holdings because you need to buy various types of properties (condo, single-family, multi-family, townhouse, etc.) in multiple locations to spread your risk. And each individual property requires a sizeable outlay of cash.

Of course, you can diversify in real estate through real estate investment trusts (REITs), which are more like buying shares of stocks than buying real estate directly. (Fundrise‘s e-REITs are a great way to do this.)

2. Transaction Costs

Hands down, stock trading has much lower transaction costs than real estate. You can trade stocks and ETFs commission-free on a host of online stock brokers today. No tangible asset is being exchanged, so the transaction is quick and inexpensive.

On the other hand, real estate is a longer-term investment, in part because transferring real property from one person to another is expensive. You have title fees, attorney fees, agent commissions, transfer taxes, inspections, appraisals, and other inherent costs.

3. Liquidity

Stocks are by far much more liquid than real estate. With a few clicks on your computer, you can trade-in and out of just about any stock investment nearly instantly.

Real estate is a tangible, fixed asset that requires an involved transaction between real buyers and sellers. It takes time and a tremendous amount of effort. And if the local market takes a dive, you can't just pick up a house and move it to a better location.

4. Easier (Less work)

Stocks can be put into a passive mode. You can “set and forget” a well-chosen portfolio of mutual funds. Dividend stocks pay out dividends with no effort on your part. And you can automate your account to have dividends reinvested or a check sent to you. Here's our beginner's guide to investing.

Real estate requires more time and effort and can't really be put on auto-pilot.

5. Less Complicated

Both real estate and stock investing demand a lot of research. With stocks, you're investing in a company and you'll want to know as much as you can about its financials, management, and future earnings projections before you invest. With real estate, you'll need to do research into the location, past and projected property financials and property conditions.

Compared to stocks, real estate requires a lot of hands-on work in addition to research. Even if you hire a property manager to oversee tenant management and maintenance, you still need to provide a fair amount of ongoing oversight.

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Summary & Personal Thoughts

I have found that real estate provides many advantages over the stock market. You can make returns of more than 10% on the cash you invest from rental income. Your investment provides monthly cash flow, and residential properties typically go up in value, providing capital appreciation.

With real estate, you have much more control over the underlying asset. That means there are many opportunities to buy low and sell high. When you buy below market value, you can build $20,000 or more of instant equity.

The tax advantages of rentals can save you thousands of dollars each year, thanks to depreciation. When you get a mortgage on investment property, the rental income pays down the loan every month, building your equity in the property.

I do want to stress that you can’t just go out and buy any property. As a real estate investor, it’s crucial that you buy below market value. That means you need to put in the time and effort to find deals and do careful and complete research.

I pass on many more deals than I invest in. Many offers I make are turned down by the seller. It is common for sellers to believe their property is worth more than the market will bear. They do not know what repairs are needed or what rehab construction costs. They often do not see the issues that make the property unsalable in its current condition.

So asking prices can be high, and offers below the asking price are often turned down. That is just a reality of real estate investing. I have purchased less than 2% of the properties I have looked at in the last 12 months. But the deals I have moved forward with have performed much better than any stock investment I have ever made.