The research conducted by American and German universities discovered that investing in real estate brings better results like lower risks and larger income than value investing.
If you take the statistics, the return of stocks is estimated at about 6.89% per year over 145 years, in the U.S. it was even higher – about 8.4%. From the period of 1980 to these days the average income from stock investing was about 10.7% annually.
If to compare this income from stocks it is usually about 7.05% which is higher than the profit from stocks. Besides, real estate is a less risky and more stable investment. The ratio of income over risk is about 0.7% for real estate and about 0.27% for stocks.
Let us consider the main concepts comparing the stocks and real estate and five major differences if you want to finance either stocks or houses and apartments.
Firstly, let us review each type of investment.
- Investing in real estate. This type of investing requires purchasing a physical property. The owner needs to invest money not only in the purchase itself but also in extra costs like repairing, maintenance of the property, taxes, etc. In this case, there is an opportunity to receive monthly income from the tenants.
- Investing in stocks. When somebody invests in the stocks, he purchases a part of the company. Then he receives the part of the profit from every share he owns. If there are 1 million shares of the company, and the person owns 10,000, then he has 1% of the company.
5 Core Concepts
1. Annual return
Annual income in stocks represents the dividend earnings that fund or stock pays as the percent of the stock price. For instance, a 100$ stock with a monthly income of 2% pays $2 yearly. Although the yearly return doesn’t coincide with potential value.
When comes to rental properties, it is easy to predict money flow depending on the rental price and costs to calculate the yearly income.
For example, there is a property which cost is $100,000 and the rental price is about $1,200. So if the expenses are equal to 50% of the rent, the annual return will be 7.2%.
The evaluation will differ from income after buying the property. The real estate can grow at 5% or decrease in value like a stock.
2. Expenses for the investment
When purchasing the mutual or exchange-traded fund, you’ll observe the indicator of the exchange ratio. That is the amount that the investors pay for the fund for administration.
This ratio for index funds is usually from 0.1% to 0.2%. For the funds which are actively managed, this ratio is about 2% or higher. This number is the yearly per cent that you are charged by the fund.
For instance, if you buy $1,000 through a fund where the exchange ratio equates 1%, then you will be charged 10$ per year for administrative purposes.
In reality, this number will depend on the amount of the holdings. If your investments grow from 1,100$ to 1,100$, then next year you will be charged $11.
The costs of rental properties are even higher. You can calculate them according to the above-mentioned rule that consists of 50% of the rent per month. The costs are repair, vacancy, taxes, etc.
3. Managing stock and estate portfolios
The portfolios for stocks and property should be rebalanced from time to time to maintain the allocation of assets. You also need to buy and sell stocks periodically for achieving your investing purposes.
These tasks can be passed to the financial advisor. It requires a special fee, about 1%. For instance, if your portfolio is about $500,000, the management fees will cost you about $5,000 yearly.
The management of rentals is quite complicated in comparison to the stocks. This type of management task costs about 7-10% and includes making phone calls to tenants, controlling maintenance and repairing, etc.
Let us consider two major differences:
- Financial advisors usually provide you with consultation concerning purchasing and selling, investing approach and marketing issues. Property managers don’t provide help with such transactions.
- The second difference between financial advisors and property managers is the fees. They generally rely on the income rather than the value of the portfolio. For example, the $500,000 portfolio may produce the $50,000 rents yearly. If the property fees are about 10%, then the property management fees will be about $5,000. Investors earn the profit buying the stocks at a low price and purchasing at a high price.
It is not necessary to pass the management tasks to a financial advisor. You can manage your stock portfolio by yourself.
4. Price-earnings ratio
To find out the income of companies and rental properties, investors can compare the earnings with the prices. In this respect, investors can use the P/E or price/earnings proportion.
Let us take a look at the following example. For instance, a stock trading at $100 per share and revenue of $7 per share would have a price-earnings ratio of about 14.29.
For real estate this formula is different. Investors need to compare the expected rental earnings to the price for the purchase. This can be calculated with the help of capitalization rates. The cap rate formula is yearly net earnings divided on the purchase price. For example, a $100,000 property with yearly net revenue would have a capitalization rate of 7.2%.
It is essential to remember that though the capitalization rate and yearly income are similar to some extent, these concepts are not the same. Annual income calculation depends on your investments and the example above did not include leverage.
To buy more stocks or real estate investors can use other’s people funds if their assets do not allow this. There is a concept of hard money loans when one person puts down 20% and the lender provides the other part.
The money can be borrowed from the brokers. This is buying on margin. If the owner possesses $50,000 and wants to purchase a stock for $100,000, he can borrow the money from the broker to purchase on a margin.
The differences are in details. The first difference is the loan-to-value ratio.
The stocks are more unstable in comparison to real estate. The brokers lend up to about 50% to purchase stocks. That is a great difference from 80% that is expected from lenders by the investors.
Also, brokers can request a larger sum of money from investors if they purchase on margin if the value of the stock decreases. This situation is called the margin call, and it happens when the value of the stock reduces to some extent.
Purchasing on margin is mostly suitable for short-term investing. If the owner pays a mortgage for 30 years, then most of his money goes to debt repayment while his property grows in value.
The difficulty in liquidating a real estate is one of the drawbacks of investing in the property.
It takes time to sell the property at a good value, and it also includes the fees and other expenses. The value of the property is abstract and is based on the theoretical price on the paper that the buyer of the real estate can offer.
The situation with the stocks is quite different because they can be sold immediately. If the value of the stock is about $200 and the cost was about $120 then the owner can sell the stock right now and will get a profit of $80.
It is more difficult to operate rental properties than a stock portfolio. There are a lot of issues that you need to take into account while managing a rental property. It includes but is never limited to the repairs, maintenance costs, etc.
The index funds, in contrast, do not require so much time and effort.
4. Earnings Stability
For rental properties, it is quite easy to predict the returns more accurately. It is easier to calculate the profit based on the cost and rent, rather than on appreciation.
In the case of the stocks, the dividends are not the main point. Most of the returns from the stocks are predicated on the growth. For that reason, it is difficult to measure the profit in the long-term perspective. It is difficult to predict the income of the stocks.
If there are some troubles in the industry, then the company can also be affected. The stock value will fall, and this will also affect your investment. So it depends. Sometimes investing in the stock market is profitable, sometimes not.
5. Monitoring of Returns
One more benefit of the rental properties is the ability to control the profit. On the contrary, there is no ability to control the returns from the stocks. There are only two possible options here: buying or selling.
As for the rental property, there is more control over the potential and positive income.
The investors view real estate as a better option for investments than stocks because it is a more intuition-based approach. That is where their mistake is.
It takes some time (usually about a month) to learn how to invest in real estate directly. You can invest in REIT or crowdfunding platform indirectly, but there are some vital benefits of buying the rental property.
Comparing to stocks, there are lower risks and higher income although it requires some time, effort and work. So, investing in stocks or real estate is a matter of personal choice.
According to statistics, more and more people invest in stocks because they do not need a large amount of money to buy a stock. Though investing in stocks needs some special knowledge if you are not making it through the fund.
This is a little bit complicated for ordinary investors. To buy a piece of real estate, the owner needs to save up some money. Before investing in real estate it is necessary to gather all the information, pros and cons and the ways to avoid some common mistakes.