Understanding the ROI on Real Estate Investments vs. Stocks
When someone has money to invest, he or she is faced with the challenge of deciding where to invest it. The person has a variety of different options, such as bonds, treasury bills, real estate and stocks. While stocks have had the greatest returns over the past 60 years, real estate is still a better investment option. It posses a variety of positive attributes for investors and will bring home a positive rate return for the smart investor.
Easier to Analyze and Quantify Returns
Understanding your return on investment with stocks is an inexact science. The investor has no ability to predict the future, calculate the increase in stock value, or know the amount of a quarterly dividend. The return on investment from a rental property is easy to calculate. The investor takes the monthly rent and subtracts the cost of the mortgage plus other expenses. The calculation gives an investor an approximate calculation on how you’ll gain from making such an investment. While there is always the potential for unforeseen expenses, like replacing the hot water heater, the investor has a better sense of the return on investment than stocks.
Return on investment formula: monthly rent (-) cost of the mortgage (+) other expenses.
For many investors, real estate is easier to understand. People have been raised around real estate, and it’s a physical asset, something people can see and touch. An investor most likely owns a home and has paid rent in the past. They usually understand how real estate grows wealth, as there is little to no learning curve to understanding the basics of a real estate transaction. Stocks can be a tricky and often risky industry for those without previous knowledge of the market.
Ability to Better Manage Assets
A financial professional manages money market accounts and 401Ks. The money manager decides which particular stocks to invest in, and the only thing the investor sees is a monthly statement. That’s not the case with real estate. A rental apartment or home is a physical asset that has to be managed. The investor can decide to upgrade the bathroom or construct a new room. The investor can raise the rent or evict paying tenants. It’s up to the investor to decide how the asset is managed. Even if the owner hires a management company, he or she still makes major decisions about the property.
Historically, real estate values have been less volatile than the stock market. Since Black Monday in 1987, the stock market has seen 10 major stock market declines. Those include the late 90s dot.com bubble, and the stock decline of 2015-2016. It’s true that real estate declined significantly during the Great Recession of 2008, but real estate has posted very few yearly declines in the post World War II era. The most noticeable was in the late 1970s and a slight decline in the early 1990s.
Real estate is a tangible asset. It has physical properties like walls, floors and a roof. A person can touch and feel real estate, and that makes many investors feel more comfortable with their investment. Stocks these days aren’t even paper. They are digits on a screen. They have no real physical properties.
Immune to Emotional Selling
Investing is an emotional experience. The investor experiences positive emotions when the investment is earning a positive return. The opposite is true when the asset is declining in value. Investors often make quick investment decisions based on emotions. A person can sell stock quick after a sharp decline in the market. An investor is less likely to make that decision with real estate. It takes time to prepare and sell a real estate asset. A closing can take as long as 60 days, and it can take weeks to prepare a property to list on the market.
Real estate requires capital to invest. That means the investor must be committed to tying up capital in the asset long-term. With stocks, an investor can purchase a few shares on a web platform for a $10 monthly subscription. It doesn’t require a huge amount of capital or time. Real estate requires a large sum of money to enter the market, and that means a person has to commit to real estate investing.
Real Estate can be Leveraged as an Asset
With real estate, an investor can leverage the market. A real asset has value, and an investor can use the equity in real estate to purchase other property. The asset can be leveraged to grow more real estate holdings. The equity in real estate can also be used to make improvements to a property.
Real Estate Values Rarely Decline
Real estate has grown in value consistently since World War II. It’s true that the 2008 real estate crash caused a major decline in real estate values, but most markets have fully recovered. Real estate gives a steady return on investment, and historically it has rarely lost value. According to a survey by S&P CoreLogic Case-Shiller, real estate is increasing at a 6.2% annually and is 6% higher than before the crash.
Positive Cash Flow
If an investor buys the correct property, real estate generates positive cash flow. That means the property will put money in the investor’s pocket after expenses are paid each month. That is much better than a quarterly dividend from stocks. Real estate will continue to generate positive cash, and the board of directors at a corporation doesn’t determine the payout.
Real estate is a great hedge against inflation. Rents and home values historically have followed inflation, so real estate investment will be protected during times of high inflation. Inflation has been low in recent years, but the Federal Reserve has started to raise interest rates, anticipating inflation could become a problem for the economy.