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Stocks vs. Real Estate

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stocksvsrealestate.pngMay's Money Magazine tries to answer the Stocks vs. Real Estate question (see page 94). I had thought that real estate was going to come out the big winner. I know that real estate has been really popular of late, but I had it as the favorite due to the value of leverage.

Money Magazine declared stocks the winner, but I think they glossed over the leverage factor. For one they took a 2 year time-line for the real estate and then deducted a lot of one-time costs. That didn't seem to be a particularly fair shake to me. So to the left you'll see my attempt at the running the numbers in Excel. In the example, I assume the investor has $40K to put to work. For stock picks, I assume a 10% (for better or worse) gain. I also took a cue from my early physics classes and ignored friction - in this case it's the cost of buying stocks. The Real Estate column assumes the investor puts 20% down allowing them to buy a $200K home and pays 10K in closing costs (closing costs from the article). The Real Estate AC (after costs) factors in a 6% sales commission (though I believe this can be less), paying off of the mortgage, $3,600 in preparing the house for the sale (gleaned from Money Magazine), plus the original 40K investment.

I'm not 100% that my chart is accurate. I've edited it a few different times realizing a couple of errors. However, each of the charts showed the same trend. Real estate seems to out perform in the short term, but at some point in the 25-30 year mark the 10% return of stocks takes over the leverage of real estate. However, if one were to lock in the gains of real estate at year 8 (around $125K), the person could use the gains to buy three more $200K homes getting more an more leverage. Leverage can be a dangerous thing as a loss can spiral just as much in the negative direction. It still makes me think that there are a lot of gains to be had in real estate in general.

If you are planning to execute on this plan, remember that it's not a get rich quick scheme. In today's real estate market, I believe you should be prepared to hold onto a home for a minimum of 6 years (while being prepared to hold for 10 years). Trying to fix up and flip a home within a year opens you up to short term price pressures and fixed costs. You should also be aware of other factors mentioned in the Money Magazine article apply. One such important one to remember is that a home is not a very diverse investment. Another one is that real estate investing takes a lot of work, while investing in stocks is relatively quick and easy.

Last updated on January 27, 2013.

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30 Responses to “Stocks vs. Real Estate”

  1. Moneymonk says:

    I do agree. Real Estate is more complicated than stocks. I love investing in stocks (ETFs, Mutual Funds) because it is easy and convient for me.
    Real Estate takes more time and risk. With stocks if you feel you are losing money, you can quickly get out. RE is not that simple to get out.

  2. silverbax says:

    I’m commenting on this blind, since I haven’t read the article. But is the article comparing actual real estate investing versus owning a home? They aren’t the same thing. If I own a rental home, the monthly rents plus the depreciation, as well as the equity growth usually provide returns of 13% or higher for the long term, and sometimes much higher – with somewhat less risk.

  3. Lazy Man says:

    Moneymonk, it’s true that you can get out of stocks quicker, but I might say that’s a bad thing. This would be against the buy and hold strategy.

    Silverbax, I have forgotten some of the Money magazine article, but I think their logic was to apply to both cases even if they aren’t the same. I ignored all cash flow issues (both positive and negative) of the real estate situation. I have an investment property now that’s cash flow negative, which I hope will be cash flow positive in the upcoming months. This article ignores that and focuses on just the appreciation of the property, which I believe is close to 5% per year. I’ve seen it quoted as high as 6% long term.

  4. Diversify, Diversify, Diversify for long term

    leverage leverage leverage to get rich form other people’s money.

  5. Q says:

    Do both. I own a 4 family apt building, and I own stocks. The building is cash flow positive, yet runs a large tax loss due to depreciation. Wow, this one apartment building has been a major boon to our finances. Our Federal Tax owed plummeted.

    I am tempted to buy a 2nd one, but realize I must build up a sizable pile of equities first. Plus, the building does take some of our time. I am comfortable with our time committment now, but wonder if we could handle a 2nd one.

  6. MossySF says:

    The only problem with real estate projections is the numbers you get to work with are completely gameable. Most numbers you will find will be from the NAR or home builders or mortgage broker associations. All of them have vested interest in people thinking appreciation is higher than reality. A quick example is the stat that shows median house prices have roughly gone up about ~5% the past few decades. Too bad it doesn’t account for house size — the median house in 1960 was 1200 sq ft, the median house now is 2500 sq ft. Factor that in, price appreciation seemingly matches inflation — which is not too surprising because the limiting factor controlling house buying is (1) income and (2) credit.

  7. dong says:

    I don’t know if I agree with making leverage a judgement factor. While I realize it’s much easier to be more highly leveraged with real estate, leverage can be used for any kind of investment. I think Money magazine too quickly dismissed the use of options to leverage yourself in stocks just because you could lose everything, but that’s not really any different from borrowing 300,000 with downpayment of 20,000 and then having the house drop 20,000 and be left with nothing in equity. If anything options are safer than pure leverage play since you can cap your loss. Not to say I endorse the use options to make such a maneveur, but rather leverage isn’t the best criteria to differntiate stocks and real estate.

  8. Brad says:

    I see various articles and blogs address this from time to time. It’s interesting and provides some additional information with which to make a decision, but there are lots of assumptions that can make the analysis go either way. Particularly when the analysis is for a general situation rather than a specific purchase decision. Real estate markets are so regional, plus what assumptions are used for taxes, interest, inflation, appreciation, maintenance, remodels, etc.

    Most of these articles address homeownership vs. renting and I think that decision is (should be) dominated by the local market and the individual’s desires. I suspect that based on nationwide averages (or means), the best financial decision (mathematically) is to rent. However, I don’t think it is a huge difference and if you like gardening, projects around the house, etc. then buying makes sense. If you don’t like mowing the lawn, maintenance etc. then rent and invest the difference. After all, isn’t the reason we save and talk about returns so that we have the financial freedom to buy or do things we enjoy?

  9. Real Estate Guru says:

    Well if you like to park and pray, go ahead and invest in stocks and bonds. If you want to take true control of your financial freedom, take the time and risk to invest into the real estate market. You can invest with less risk than the stock market, plus you can make a lot more faster than the stock market. If stocks and bonds are so good then why are IRA’s down 2 trillion dollars. There is only one thing that there is a limit to, and that is real estate. There is only so much of it, and someone is always buying.



  10. hey, i just posted on this too!

    what was it about great minds thinking alike? ;-)

    If your stock gave off dividends wouldn’t you re-invest those? similarly you need to consider the rental income for real estate too. after 30 yrs, the house is free and clear so you should consider the rents as a dividend. assuming you bought in California and the rents are 0.06%/mo of the value of the house, you should consider 6% as the annual dividend off the future value of the house.

    anyway, like you i think the article isn’t accurate.

  11. MossySF says:

    I am currently working on the ultimate housing buy vs rent spreadsheet where every factor ever brought up in these buy/rent arguments is modelled. When done, we can finally settle this issue once and for all! (Once and for all = some specific location, some specific time in history, possible direction of stock/housing markets, etc, etc, etc.)

    BTW, most landlords historically considered 10%/year as the target number for rental income. 6% is borderline unsustainable. And some coastal areas of California are seeing as low as 3% as the annual rent:price ratio — I’d like to see somebody attempt to push 3% as a good buy number.

  12. Lazy Man says:

    MossySF, while I agree that real estate prices should be close to inflation, I think it’s definitely harder to buy a home now that it was for my parents – even one of the same size and quality. That would suggest that it’s not just inflation. I’m comfortable saying that it’s appreciating 5% without too much gaming – that’s just 1% more than inflation, but it’s more due to the leverage.

    Dong, I will say that I don’t know much about options investing. However, I think Money magazine was afraid of leveraging stocks because they swing so wildly. They did mention the ability to use margin accounts, but again, I don’t see it as being an overall successful strategy. One more thing, you can’t live in (or collect rent from) your leveraged stocks.

  13. MossySF says:

    Lazy Man, you may be looking at previous generation through rose-colored eyeglasses. I remember it was damn tough to buy a house for my parents. They spent years saving up — got up to about 10% when they received a small inheritance to get to 20%. Then they spent easily 40% of their income on the payments. So while we think “oh it must have been easy to buy a 100K house back then”, getting the 20K required was a tough job when salaries were 15K-20K. Nowadays, it’s probably about par to getting 5% on the typical house today. Except that means with the higher home prices due to easier credit, the banks are making much more off the monthly payments.

    Which actually comes back to the matter of inflation. Perhaps both you and I are right — 5%-6% could be accurate now because that’s true inflation after you factor in the money supply expansion from looser credit standards. Previous lower inflation numbers were based on 20% down tighter credit. This means the typical inflation X% factor perhaps should be applied to other asset classes. If you thought stocks were 10% (3.5% inflation 6.5% real return), that 2% inflation for housing is probably there bumping up stocks to 12%. Example, people can borrow much more money leaving much more money to put into either the stock market (more demand pushing prices up), spending the money (more cash for companies improving results) or putting it into savings (more reserves for banks to lend even more money). I suspect we are in a global credit bubble that’s pushing up returns on all asset classes — housing, stocks, bonds, commodities so the only real way comparison is to base it on historic real returns.

  14. Lazy Man says:

    I guess what I mean by it being easier for the previous generation is that they typically bought homes with one income and a shorter work week. Society has changed and there are many more dual-income families. That means more money nowadays for many families. I think housing prices have risen to match. Perhaps it’s like how if you have a big house, you always buy enough stuff to fill it up.

  15. Weekly Roundup – 04/20/07…

    Here’s a quick look at some of the articles that caught my eye over the past week…

    FMF asks if going to grad school is a financial mistake.
    JLP talks about teaching high school kids about personal finance.
    Flexo broke down his 401(k) stat…

  16. […] Stocks vs. Real Estate – It is a battle of the titans; who will prevail? The Lazy Man has done some work in comparing total returns on the two in order to find out if Money Magazine is correct or just blowing smoke. […]

  17. The question is an important one, but I have never been convinced that there is a “right” answer to it.

    The number of express or implicit assumptions in any comparison is huge and that makes it easy to “prove” or “disprove” whatever conclusion the writer wishes to reach or to reach a conclusion of dubious worth even when trying to be as objective as possible.

    As an example, one of the problems with analysis is finding the right comparison. It is easy enough to take a well recognised index as a proxy for investment in stocks (factoring in dividends)- you can always invest in an index fund to achieve the benchmark return. However, finding a sensible proxy for property is a lot harder. National or even regional average data for sale prices of real estate are not meaningful because, as individual property investors, we will be investing in specific properties in specific (local) markets.

    I concluded that an investor can do very well out of an investment in stocks and can do very well out of an investment in property.

    That said, the analysis is still well worth doing as it forces me to think about what makes a good investment. My retirement plan calls for investment in both equities and real estate.

  18. Joel says:

    Nice try, but homes don’t appreciate at anywhere near 5%. You conveniently chose a time period to calculate the average appreciation that includes the biggest housing bubble in the history of the US, skewing the reality. Sure, if you buy at the beginning of a boom and sell at the top you could stand to make a major profit, but how do you know you are at the beginning of a boom? And then you take the risk that you sell to late, after the boom takes a downturn. And even if you magically do everything right you no longer have a house and since all home prices have gone up you end up spending all of the money you earned to get into another house.

  19. Lazy Man says:

    The 5% was a number that I pulled from a reading a long time again, but that data went as far back as the 1950s. I think that catches a lot of datapoints. Also that data was 5-6%, so I took the conservative estimate. The Money magazine article quoted a return of 8.6% from 1974-2004 (http://money.cnn.com/galleries/2007/real_estate/0704/gallery.stocks_v_realestate.moneymag/index.html). By taking 5%, I think I’m sufficiently compensating for this “bubble.”

  20. CPA1298 says:

    Why not do both – leverage a home into equities? I am planning on paying off our house the next couple years, because I can’t itemize deductions and I think equities are priced too high. After the prices of equities corrects, I plan on re-borrowing against the house and plowing it into foreign/domestic index funds.

  21. […] caught my eye this week. It’s by Lazy Man and Money, who provided an analysis and comparisons between stocks and real estate and how they perform against each other. He critiqued a CNN Money article that arrived at the […]

  22. […] Stocks vs. Real Estate by Lazy @ Lazy Man and Money. Lazy gets into the numerical mode and churns out some numbers to compare returns from stocks with those from real estate investments. According to him, real estate investment has an edge over stocks. Personally, I have always felt that real estate stuff is not for the common man. The whole process of buying, maintaining, and then selling a house is just too intimidating to indulge in regularly…for someone like me. Stocks? I can pick some in my lunch break. […]

  23. […] Both Digerati Life and Lazy Man have interesting comparisons of investing in stock vs investing in real estate. […]

  24. […] would offer a better return between stocks and real estates, after Lazy Man at Lazy Man and Money takes on the issue.  Without getting into details of the arguments made in the original, my feeling is over the […]

  25. David Bethoney says:

    If we are comparing stocks vs. real estate and leverage, real estate clearly wins this battle. There are so many more variables to answer the stocks vs real estate question though like short term vs long term investment, costs, taxes, effort, volatility, diversification and so on. The sad news for all you real estate investors is stocks win most of these battles (stocks are easily diversified, less effort and subsequent issues and less cost). If you are looking for the long term investment and we look at historical data, stocks crush real estate in performance. If we compare short term performance, real estate far outperforms stocks.

  26. Main Line Real Estate says:

    To me real estate is by far the better investment. Stocks, well you have to know exactly which ones to buy and exactly when to sale.

  27. Lazy Man says:

    Main Line Real Estate – Mutual Funds and Index Funds are included in the my definition of stocks here… I’d say that real estate is more difficult because you can’t diversify unless you go with REITs. REITs are more like stocks, you don’t seem to get the 5-1 leverage that you do with a typical mortgage.

  28. Davis says:

    The best thing about a real estate marketing script, whether it’s targeting FSBOs, expireds, or whatever you choose, is that they’ll help you save you time while making money.

  29. Bill says:

    How is your Donald Trump status these days? Money Magazine is correct. They tout stocks for the long run and the S and P 500 handily beat real estate as the better investment since November 2000. A meager 2.8 percent average annual gain. It is rare for such a dismal decade. But it still beat rentals in most markets.

  30. anonymous says:

    Nice post, I’d like to add that… It is important that you diversify your investments as much as you can. Remember the old saying: do not put all your eggs in the same basket. Instead of buying a quantity of stocks from the same company, look for other investments. However, you should also learn when to strengthen your positions when you find a great investment.

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