Investing: Real Estate vs. Stock Market
Reminder: This week I am giving away a copy of The Maui Millionaires. There is still time left to enter the random drawing. It’s easy.
The gurus tout real estate, real estate, real estate as the way to get rich. It’s perpetuated in the media, penetrating a number of people I know who generally speak intelligently. Yet, unless you’re in a special situation, over the long run real estate barely keeps up with inflation. Yeah, that’s not an inspiring, motivational thought for getting out there and buying a piece of land (or a piece of a building while someone else still owns the land).
Ben Stein has the facts, as usual.
y wife and I bought our house in Malibu for $600,000 in 1990. It might have gone up by 150 percent since then, but in that span, the stock market has more than tripled on the Dow, counting dividends. Other indexes such as foreign stock indexes have gone up vastly more than that… ver very long periods homes barely keep pace with inflation. Stocks, over very long periods, beat inflation by a large margin…
Stein admits that real estate has its place:
ou won’t make as much in the long run as you would on stocks, but no one I know can live inside a stock, make love inside a stock, read a story to a child inside a stock, or lie in bed reading next to their dogs in a stock. So, yes, real estate rules. It’s a good, even great, investment — just not the perfect investment.
You can make more money in real estate than the stock market if you do more than buy a house, live in it, and sell it later. Any sort of activity that might create profit, like flipping properties for a quick gain or looking for tenants to manage, introduces risk. On the other side of the coin, you can earn nothing in the stock market by buying at the wrong time, trading frequently, or following hot trends. There are an infinite number of variables that get in the way of achieving the long-term averages calculated after the fact with the help provided by 20/20 hindsight.
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I am interested in getting a copy?
Why not do simulation with real market data over the past 30 years?
It is actually not too complicated with excel.
I have done mine that include electricity, water, gas, tax, food, travel and insurance. 30 years of past monthly mortgage rate (mortgage-x.com), stock market performance (dow jones from yahoo), real estate performance, as well as inflation rate (bls.gov) data are feed into simulation
My simulation is not ideal, but I would say it is pretty close to the real thing
Based on my simulation, I am pretty much convinced that stock market is better.
Anyone comes up with similar result, using real data?
Hi–I think that Tom’s comments are really thought-provoking. But I am not sure that I am understanding how the numbers are derived…
If we assume that 20% is an appropriate proxy.I agree with the simple (too many extras–taxes, tax benefits, monthly payments, rentals, convenience makes me nervous) calculation that the investment in the stock market created an additional $240k, but why isn’t the original investment excluded ($120k*3-$120k=$240k) similarly in the home appreciation?
Instead of $300k on his house–he really made $180k. (Or, looking at it another way.. his $120k*1.5=$180k for a $60k gain, (versus his $120k*3=$360k for a $240k gain) Isn’t the value of the GAIN of 150% versus 300% minus the initial investment–ALWAYS going to be a 4x not double? Because it’s the delta that is important…
Like, in this case if he put 100% down: $600k * 1.5 = $900k. Subtract the $600k and it’s a $300k gain. Versus $600k * 3 =$1.8m. Subtract the $600k and it’s a $1.2m gain: 4x the housing gain.
I think that because the gain percentage is double, it is misleading some people (including maybe myself!) but the rules of math here should be that the gain in DOLLARS will always be half of the original investment. So, in this example, the returns aren’t even close.
But is this is a fair example? Look at the Case-Shiller (only 10-20 cities, but again I’m a simple-minded chick) over the past 10 years. Tracked against the S&P, the CS has outperformed the S&P cumulatively.
But a closer look would reveal that the S&P/Citigroup REIT index trounces them all. And is a cleaner line. I’m with Global Investor–why not combine both loves into one? It’s a safer way to play housing and can give you the appreciation to buy a house with all of your “extra” money. 😉
A very good choice for the young investor would be to buy a duplex or 4plex to combine the necessity of a place to live along with the benefits of investment. Advantages of this type of property include: depreciation, interest and maintenance tax deductions, appreciation, rental income, and principal reduction. And you have the tremendous advantage of leverage! When you start losing your depreciation advantage, you can do a “Like kind” tax deferred exchange. You can live rent free and enjoy the above benefits. Tom
Investment real estate is far riskier than purchasing even individual stocks (never mind mutual funds).
The monthly service can be enormous – Tim gives us the example of $10,000+/month.
Not to mention big, but irregular expenses, like roof replacement (easily $5,000 for a SFR), which he hasn’t budgeted in his monthly expenses.
Tim only has 6 renters to service those costs. If a unit or 2 becomes vacant his carrying costs explode (no insurance covers vacancy)
He’s essentially in the same situation as someone who buys a single family rental (SFR), times 6.
Even with a 20% down payment, SFRs are usually cash flow negative (buyers expect appreciation will bail them out)
Which is why cap rates are much lower with SFRs (perhaps half) than with a true multi-family apartment building (1-2 vacancies not as big a deal with a 50 unit building)
Some states (e.g. California) limit your losses on your personal residence – toss the keys on the counter and walk out, no deficiency judgement allowed – but that’s not the case with investment property.
Take a hard look at how you would carry that SFR if you had to evict/saw it sit vacant for 6 months before you move into investment real estate.
Personally, I completely agree with you, Real Estate is a tough industry and we’ve got to keep on top of all the latest trends within it. Thanks for your info, it was really useful.
Look Guys,
Ive been in both. As an investment real estate
will outperform the market because of leverage. I worked so hard to put money in the market and only could take the risk of margin. I sighned my name and paid closing costs and made millions.
So stocks beat out real estate in appreciation only. Makes sense. But shouldn’t we consider leverage, the equity you build as you pay down the mortgage AND the rent that can be collected on the property? I don’t know of any property that incurs expense greater than the rental income.
I recently bought an almost new $1.6 million property consisting of 6 rental apartments. I have a 90% mortgage on this property and my monthly payment (interest and principal) is $8,700/mo. My operating expense comes to $1,800/mo and includes property tax, general excise tax, water and sewer, maintenance and insurance (I manage the rentals myself). Total debt service + other fees comes to $10,500/mo. I rent the property for $9,600/mo so I realize a $900/mo negative before tax depreciation. After the tax benefits I about break even.
But I add $1,400/mo to my net worth every month for the first year, $1,520/mo for the second year, $1,630/mo for the 3rd year, and it goes up every year for the following 27 years until the mortgage is paid off. That’s an additional 2.5%/year to the appreciation alone. Then, add in the rental income which INCREASES over time (while the mortgage payment remains static). At a very conservative 4%/year appreciation, my property will be 100% free and clear and worth about $5 million in 30 years. Plus, consider a 4% increase in rent/year, I would have made an additional $600K after taking into account inflation on non-fixed costs (anything but the mortgage).
Yes, the property may be blown away by a hurricane, burned to the ground or washed away in a flood. But insurance protects my investment. There is no insurance with stocks.
So considering a lower than average home appreciation of 4%, lower than average increase in rent of 4% and standard rate of inflation (4%), I have made $5,600,000 on a 160,000 investment and about 10 hours/mo of work. Who wants to buy stocks?
If you’re in an unusual situation, you can make a better return in Real Estate than you can in stocks. But if your situation is that unusual, you probably already know it, and know that what Ben Stein has to say is, however correct it might be in most cases, not applicable to you.
The house one lives in is not, however, an investment in the traditional sense. The primary value one receives from it is not its appreciation or direct cash flow, but utility. (Utility can be compared to cash flow by computing the cost of renting an equivalent property, but they’re still not precisely the same.) I’m not saying it’s a bad buy, since in most cases the utility value will be more than sufficient to make up for the net cash flow and the illiquidity of any apprecation beaing far inferior to other investment vehicles…but it’s misleading to speak of one’s primary residence as if it were equivalent to more conventional investments.
Great post and comments. Tom is right that the 20% invested should be what counts. Also, if it is, in fact an investment property, and it’s actually cash flowing, as well as appreciating, and you get a tax deduction against that cash flow due to expenses and depreciation, then the calculation isn’t nearly as simple as Stein suggests. Of course, it’s precisely because that calculation isn’t nearly as simple that I confuse myself CONSTANTLY with whether or not to hold on to my real estate investments.
At the end of the day, the ironic thing is, I decide to hold on to them not because of some advanced cost/benefit/ROI analysis, but because I can’t stand the thought of giving a broker 6% to sell them and I’m too busy for FSBO.
The other end-of-the-day thought usually comes down to diversification. Stock market is historically solid to be sure, but real estate is never going away. We live in a strange, strange world and who knows what could happen to all those funds. I always go back to — no matter what, I’d have a place to live. Good to have eggs in all baskets, I think.
Sincerely, Doomsday Denise 🙂
Why not buy REITS?
They invest in real estate trusts, in case you don’t want to invest in multiple homes and/or businesses.
I like real estate, everyone should own a piece of property, especially in fast growing areas such as cities and underdeveloped parts of the country side. But in the long run, stocks will greatly outperform real estate. I mean by alot.
Flexo,
I too like Ben Stein, but he completely missed the mark with his most recent column. Most people don’t buy a house as an investment; they buy a house as an alternative to renting a house. Mr. Stein also fails to mention the tax benefits of the home interest deduction which is not available to those who rent. Like you, I really can’t stand Kiyosaki, but I do like his definition of an asset (or investment) as something that makes you money.
Just my 2 cents,
Dorky Dad
Blonde Thoughts…
Most land in Maui is owned either by the gov’t or Maui Land and Pineapple… the land that most homes and oceanfront condos are built on is Fee Simple (land is owned) and not Lease Hold (Renting Land).
I own 9 oceanfront condos that cost me in down payment total just under $2M, the vacation rental on the 8 I rent covers the mortgages and association fees, leaving me with a positive flow on average of $5K.
I admit I am unique situation, but if I invested the $2M that Ben Stein suggested in the stock market rather than the real estate, both in 1998, I would have far less in my portfolio with stocks.
This is because the condos value conservatively are totaling roughly $14 million… I don’t even thing Jim Cramer could have taken $2 Million and made it into $14 million in 7 years….
It’s called leveraging and no put or call or margin in the stock market even comes close….
Though the risk’s are tsunami’s and earthquakes… but I’m willing to risk those compared to the manipulations of the stock market….
Mahalo
With Real Estate, instead of actual value additions, there are maintenannce charges and depreciation by use. So in effect there is a devaluation. But still we asee a real estate boom. Primarily due to the fact that bigger fools are there to buy real estate story.
Compared to that stocks can have value additions provided there is effort.
I wd prefer Stocks anytime.
I agree with Jeremy,
RE is not a long term investment as is stocks.
Overall they are both good investments
While I agree that residential property (owning or renting a home) will likely not beat stocks in the long-term, I do think there are many other types of real estate that can be very big winners.
The bottom line is that real estate has a fixed supply. There is only so much land on this earth and our population continues to grow at a very rapid rate. New developments are constantly being built, cities expanding, highways and bridges being erected.
With a fixed supply and an ever increasing demand it is simple economics to see that over the long-term owning a piece of land will increase in value over time. The real answer is how much it increases.
Real estate is like the stock market, you have dozens of different classes. With stock you have large-cap, small-cap, technology, financial, health care, consumer goods, etc. With real estate you have residential homes, hotels, commercial, industrial, recreation, vacant land, mining, etc.
So if you had invested in a residential property a few years ago and held on for the short-term, you probably did better than the stock market. But now if you tried the same technique you would likely under perform or even lose money. Even though residential housing is depressed the need for vacant land for development, hotels and mining parcels are still expanding very rapidly.
So I don’t think it is a safe assumption to just say real estate is a poor choice because it typically just barely beats inflation because that focuses on a very narrow conclusion that people are investing in just their home or a rental property. Sure if you are relying on one piece of property to build wealth that is no different than throwing your retirement savings into one stock or one narrow sector mutual fund.
Granted not everyone can buy a bunch of different types of real estate, but a combination of owning hard assets and REITs and realty funds that cover other areas of real estate you will likely be able to own enough real estate to do far better than inflation.
James: Here’s the review and I sent you an email.
But I think the key to real estate investing is leverage.
For the moment, lets assume his facts are correct on the appreciation, but assume the house he bought was actually for an investment. He would have had to put 20% down to get the best rates (120k). He said the market has tripled, so his 120k in the market would now be worth 360k. His house, again believing his numbers, is worth 900k. With the stock market he used his 120k to make an additional 240k. With the house, he used his 120k to make an additional 300k. Yeah, it’s close, and probably even closer when you factor in expenses (on both the gains in the market and on the house), but he’s not drawing a complete picture.
Flexo,
Is the Maui Millionaires book any good?
Best,
James
I think you hit things more squarely in your last paragraph. Owning a home is not an investment, at least not to me. It’s an expense. True, it might go up in value, but along the way you are guaranteed a net cash outflow. With rental property you get three ways to grow your wealth – rental income, property value appreciation, and increased equity value as the mortgage is paid off (by your renters). Nothing is guaranteed, of course, but that’s true in the stock market and anywhere else you take risk in pursuit of gain.