A new Bankrate survey reveals that more Americans think they should put their investment money into real estate rather than the stock market, with 29 percent preferring that option to the 26 percent in favor of stocks. With homes hitting record prices last year during a red-hot market, it's not a surprise that many people see real estate as the best investment option. An exploration of the classic battle of the titans: real estate vs stock market!
The Floor: Getting a Home Loan
In the debate between stocks and real estate, there are some parameters. First, it's only a debate once you are either able to get your own home loan or can join as a partner on someone else's home loan. If you don't have the financials (income, credit score, debt-to-income ratio) to secure a home loan, you cannot invest in real estate outside of REITs, which are similar to the stock market. Of course, you can always invest in REITs as a hedge against inflation and downturns in the stock market, but REITs are typically not what people refer to when they say "invest in real estate."
Assuming you can get a mortgage for an investment property, usually a smaller house to rent to others for middle class and upper middle class investors, now it's worth it to debate whether you should pay this monthly mortgage - using the rental income - or put that amount of money each month into the stock market.
$500 Per Month: Mortgage or Stock Market?
Assuming you've got $500 per month that could be used for investing, you have some key decisions to make. If you invest in real estate, you'll immediately receive income via rental income. If you invest in the stock market, even if you take the quarterly dividends, you won't bring in nearly the same amount of income as renting out a house will generate. Therefore, if you're looking for immediate income, at least in any realistic proportion to the amount you're investing per month, real estate is the only way to go.
Real Estate Requires Careful Budgeting
But the immediate generation of rental income will take a lot more legwork, especially if you're looking for good profit. You may be able to rent a house for twice your mortgage payment, thus bringing in $500 net income (profit) per month, but there will be greater risk. If damages or unexpected issues arise with the rental house, you the owner are on the hook to fix the problem. Failure to fix it promptly could result in legal action from tenants. There will also be routine expectations of maintenance and upkeep, meaning your profit will also be less than initially expected. As a result, you will need to budget carefully to ensure you have a reserve of cash for unexpected expenses.
Real Estate Pays Sweat Equity
If you've got energy and/or discipline, you can increase your profit from real estate investing...if you're willing to put in your own labor! A smaller rental house can be updated and renovated with "sweat equity" from the owner, saving thousands of dollars versus hiring a contractor. However, this requires hands-on effort, potentially limiting who can benefit from this sweat equity. Individuals who work demanding jobs or cannot do renovation work due to health issues will have little choice but to pay market price for all the tasks required to run a rental property: lawn care, painting, property repairs, etc.
Real Estate is More Volatile
On the Risk-Return Relationship, real estate is higher up on the chart than stocks. A red-hot housing market can generate returns many times greater than the stock market...but there are also housing market crashes. If there is a severe housing market slump, or other economic calamity, and you cannot find renters for your property, you will have to make tough decisions regarding your rental property. You will be expected to continue paying the monthly mortgage even if you don't have rental income, meaning a substantial loss. To avoid a net loss every month, you would have to sell the property, potentially at a loss as well.
When investing in stocks, you can never lose more than the lump sum amount of your investment.
Both Can Increase in Value
When investing in stocks, you can increase the value of your portfolio over time by simply selecting to automatically reinvest the dividends. This will lead to slow, but steady, increases in the shares of stock you own. Similarly, the value of your rental property will also typically increase in value from year to year. However, the increase in value is more volatile when it comes to real estate. While a housing market crash can decrease the value of the rental house, a stock market slump will not decrease the number of shares of stock one owns. Many corporations will continue to pay dividends even during recessions, meaning the number of shares one owns increases even during a recession.
Although real estate returns can be higher than stock market returns when the housing market it hot, it's tougher to get out of a bad situation in real estate due to less liquidity. In a financial crisis, stocks can be sold quickly. A rental home, however, may take months to sell, even at a loss, during a recession. This liquidity risk means that investors should be cautious when determining how much money they can spend per month on a rental property mortgage. With stocks, however, there is very low liquidity risk, meaning investors can spend their entire monthly investing budget on stocks without undue concern.