Stocks vs Real Estate. What's The Better Investment?
I've never been someone who believed that real estate is the only way to build wealth. Sometimes stocks just make more sense.
Are you ready for 2020 to be over? I kinda feel like this whole year took forever but flew by at the same time, if that makes any sense. Every day felt pretty much the same and as I write this, I honestly have to look at a calendar to remind myself what day of the week it is. That's how 2020 was for me. How about you?
I've been meaning to write this post for literally years. But something really motivated me lately. Maybe it's that I've been watching more and more YouTube lately where it seems that every investment-related video out there focuses on either the stock market OR real estate as a way to "get rich". And while you can certainly slant the message to suit your agenda, I've yet to see a truly objective, practical comparison. So that's what I'm going to try and do here.
I know what you're thinking - "Adil, you're obviously biased. You're a Realtor". But here's the thing - I was investing in the stock market long before real estate and, as someone who makes their living based on whether or not clients buy and sell real estate, I can say objectively that real estate investing is not for everyone. And it's not even necessarily a better investment than the stock market. So I'm going to take off my Realtor hat right now (I'm going to email CREA right now and ask them to make some actual Realtor hats) and be totally objective on what makes real estate a better (or worse) investment versus the stock market.
But I'm not going to compare investment returns. Instead I'm going to focus on the pros and cons of each from a practical perspective, what it takes to own each type of investment, and why one or the other may be better depending on your situation.
Ready? Let's go.
Let's start with the "pros" of owning real estate over stocks:
1 - Leverage: I've said this to clients many times and I really believe that the only pure reason real estate makes sense as an investment is leverage. I don't know too many investments out there where you can take $100k in cash, get a loan for $400k, and control a $500k asset. Try going to a bank with $100k in your account and ask them if you can borrow $400k to buy some shares in Google. They'll look at you like you're crazy. But tell them you want to buy an investment condo and their eyes will light up and basically hand over $400k and let you borrow that $400k with less than 2% interest. Sounds crazy, right? Now if that $500k condo that you just bought goes up by 10%, your actual return on your investment is 50% because all you've invested is your initial $100k but the asset you control is up by $50k. This is why real estate investing works. I don't know any investment advisors out there who would tell you to buy a $500k investment property by paying for it in full with cash. It doesn't make financial sense and they'll look at you and probably say "why don't you just buy $500k worth of Google and avoid the hassle?" Leverage is why real estate works.
2 - Rental income: Building on my example from above, I also don't know of any investment out there where I can use $100k of my own money to buy a $500k asset, have a bank lend me the other $400k, and have someone else pay off my loan for me. Seems too good to be true, right? Well, that's exactly what owning a rental property is. There's a saying out there that goes something like "whether you rent or own real estate, you're paying a mortgage. But when you rent, you're just paying someone else's". You can't borrow money to buy stocks and have someone else pay that loan off for you. That's another big pro for real estate.
3 - The ability to refinance: You've all heard the stories of people who built their real estate empire by starting with one property, waiting for the market to increase, refinancing and pulling out equity, buying another property, and repeating the process over and over. That's the blueprint for how most people build wealth through real estate. This really ties into #1 above and the idea of leverage. Basically you buy a condo for say, $500k with $100k down, watch it go up in value to say, $600k, then go to your bank, refinance your mortgage to borrow against some of that $100k appreciation you've built, and go buy another condo. It works. And that's the beauty of real estate.
Now time for the "cons" of owning real estate over stocks:
1 - Transaction costs: It is very expensive to buy and sell real estate. Ever heard of land transfer tax? That alone is probably the single biggest reason people don't buy and sell real estate more frequently in Toronto. On a $500k real estate purchase in Toronto, you'll have to pay an additional $12,950 land transfer tax in cash on closing to the city and province (combined). For what, you might ask? Good question. And if you have an answer, please let me know because I don't have one. And when you go to sell? Well, Realtors like me don't work for free so it'll cost you around 5% (plus the beloved hst) to sell. Not to mention legal fees on the way in and the way out. It's expensive to transact in real estate, no question.
2 - Carrying costs: I remember one of my economics professors in university once said "an asset is something that pays you to own it. A liability is something you have to pay to own." That's stuck with me after all these years. Think about an investment condo. Whether or not it's actually tenanted, you still have to pay property taxes, condo fees, random maintenance and repair costs, and of course, your mortgage...doesn't exactly fit the definition of an asset according to my economics professor. This is probably the biggest con to owning real estate - you can't avoid the carrying costs, even if you don't have a tenant in place. And even after the property is paid off, it still costs money to own.
3 - Repairs: Over the past year alone, I've had to replace a stove, a microwave, fix a washing machine, repair an HVAC unit, replace carpet, fix a screen door, change two faucets, and fix a leaky sink across my investment units. At my expense, of course. And these are all condos, which are supposedly "hands-off investments". My stocks have never once called me to fix a leaky faucet. I'm just saying...
4 - Liquidity and valuation: Real estate is not liquid. What I mean by that is that even if you own a $500k condo, it's takes time, effort, and money to sell (commission, legal fees, etc). And to be honest, you're never really sure what it's actually worth until you put it on the market. Maybe all the comparables say it should be worth $500k but it still doesn't sell. Maybe it's worth $525k but you rushed and sold it for $500k before giving it enough time. All the while that money is "stuck" in your asset until you're able to sell. If you need money quick, selling real estate may not always work out as planned.
Now let's get into the "pros" of investing in stocks over real estate:
1 - Limited resources needed: Ever try to buy a condo with only a couple thousand dollars to your name. And no job? And poor credit? It's not gonna happen. To buy an investment property in Toronto (or anywhere in Canada for that matter), you need a minimum of 20% down, and be able to prove you can afford the mortgage. But you can invest in the stock market with as little as a few hundred dollars and nobody is going to "qualify" you to make sure you have a decent income, good credit, etc like a bank will if you need a mortgage. That's what makes the stock market so appealing - it's accessible to just about everyone.
2 - Transaction costs: You can buy stocks with as little at $5 per transaction. And when it's time to sell? It'll just cost you another $5. Compare that to buying that $500k investment condo where you'll pay $12,950 in land transfer tax just for the right to close on the property, then another 5% to someone like me when it's time to sell. Plus your lawyer on both ends. $10 round-trip to buy and sell stocks sounds pretty darn good, no?
3 - Liquidity and valuation: It's no surprise that the cons of owning real estate are also the pros of owning stocks. Need to sell 10 shares of Google that you own? Log in, click a few buttons, and it's done. The stock market is open from 9:30am to 4pm EST, every business day. During that time, you can buy and sell as much as you like, and you always know, to the penny, what your investment is worth because of the real-time liquidity in the market. If someone paid $1800 for a share of Google 10 seconds ago, that's what your shares of Google are also worth. With real estate, just because your neighbour sold their unit for $650,000 doesn't guarantee your unit, which may be identical, is also worth $650k. On paper, sure, but in practice that may not be the case because one sale doesn't make a market - check out my blog post here where I talk about a real-life example of this phenomenon my clients went through.
4 - You can sell as much or as little of your position as you want: I remember talking to a friend of mine about whether it's better to own one really expensive house, or to own a few less expensive houses. I turned to him and said "if you own one really expensive house and you need some money, it's not like you can sell your living room". I like that analogy :) That same concept holds true even if you just own one investment property. If you own an investment condo worth $500k and you need $50k for one reason or another, it's not like you can sell part of the condo to access the cash. But if you own $500k worth of stocks, you can pick and choose how many shares you need to sell to get that $50k. And you'll have the money almost instantly and you can keep the remaining $450k invested in the stock market. Doesn't work like that with real estate.
5 - No carrying costs, repairs, etc: It costs you nothing to own stocks. No property taxes, no condo fees, no leaky faucets that need replacing, no empty units with nobody paying rent while you try to find a tenant. Stocks fit the definition of an asset as defined by my economics professor perfectly.
6 - Dividends: With real estate, you have rental income. With stocks, you have dividends, where a company will pay you a share of their profits just for holding their shares. It's the perfect example of passive income. Do nothing, get paid. Even rental properties require at least some work. Dividend paying stocks will pay you to literally do nothing. It's a beautiful thing.
7 - Diversification: It's very easy to buy shares in many different companies with just a few thousand dollars and diversify your risk across different companies, different industries, etc. But very few people have the resources to be able to diversify their real estate portfolio in the same way. So, in a sense, when you invest in real estate you're "all in" on that one investment, that one building, and that one neighbourhood. Diversification helps smooth out risk but it's very, very difficult to do with real estate without access to a ton of capital.
And finally, some "cons" to owning stocks over real estate:
1 - No leverage: This is probably the biggest reason people say stocks are an inferior investment to real estate. You need $100k in cash to own $100k worth of Google. I'm going to ignore the idea of margin here or leveraged ETFs as it's beyond the scope of this blog, but there is effectively no way to own $500k worth of stocks without having $500k in cash. With real estate, that's precisely how the vast majority of people buy real estate. Your stock market returns are what you see. Google goes up 10%, you've made 10%. Simple and straight-forward. But it's not exactly sexy.
2 - Volatility: I hesitated on putting this as a con to owning stocks because real estate is just as volatile. The only difference is that you can see, to the penny, by the second, the change in value of any given stock. With real estate, you may only see 1 or 2 sales in your building or on your block in a month, and you assume that's "market value". So while it may be painful to see your stock portfolio go up and down on a day to day basis, the truth is so does real estate. You just can't see it.
3 - Rental income to pay your mortgage: One of the biggest pros to owning real estate is again one of the biggest cons to owing stocks. If you somehow found a way to borrow money to invest in the stock market, it's on you to pay that loan back. You can't very well find a renter to live in your Google shares and pay you rent, so the idea that someone else will pay your loan for you just doesn't exist with stocks like it does with an investment property.
So that's it! A little longer post than I envisioned but as I said, this post has been in the works in my head for years. I don't think there's a right or wrong answer if someone were to ask me if the stock market or real estate makes a "better" investment, because there are definitely pros and cons to each. And it's really up to you to decide what makes sense for you.
See you in 2021!!
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Your Toronto condo lover,
iPro Realty Ltd, Brokerage
Direct: 647-223-1679 (call/text)