There has been a lot of debate regarding whether you should put your money in real estate or in the stock market. There are benefits to both, of course. Stocks make it easy to begin making returns with only a small amount of money. Whereas real estate can be much more complicated for beginners.
The barriers to entry are much higher in real estate, it requires much more work on your part. You can quickly put a few thousand dollars in the stock market, but you might need tens of thousands of dollars, or even hundreds of thousands, to enter the real estate market depending on your location.
My answer is: You should be investing in both.
Diversification is key when investing. However, I prefer to put most of my money in real estate instead of the stock market. While I’m saving, I put my money in stocks. I like to watch my savings increase with the market. Then when I’m ready, I pull out of stocks and invest all the money I’ve saved, which has increased with the value of the stock market, and place it in real estate.
The way I see it, I do not buy homes. Rather, I buy income streams.
Below is a infographic of how much you will need to have invested in high-yield divided stocks in order to reach a certain level of income that those dividends pay, taken from this article on Medium.
In order to earn $1,000 a year in dividends with Coca-Cola stock, you will need to have invested over $30,000. That is just $1,000 a year. AT&T appears to be the better option, with close to $14,000 invested to earn $1,000 a year. So to take in a yearly income of $50,000 a year, you will need to have invested $700,000 in order to see that kind of return.
As you can see, it takes a lot of money to make passive income in the stock market. This is of course assuming that dividends and yields continue to be what they have been historically.
The S&P 500 has returned a historic annualized average return of around 10.5% since its 1957 inception through 2021 (Investopedia). This isn’t a bad rate of return by any means. This number, however, is that it doesn’t factor in inflation and other fees that brokers or mutual funds charge you.
The inflation rate for consumer prices in the United States moved over the past 61 years between -0.4% and 13.5%. For 2021, an inflation rate of 4.7% was calculated. Mutual fund fees are expressed as a percentage, or expense ratio, of your overall investment. They typically range from .5% to 1.5% for actively managed funds, and .2% for passively managed funds. Assume 1%, and that means your money actually only grew by 4%, taking inflation and fees into account.
Meanwhile, according to the U.S. Bureau of Labor Statistics, prices for housing are 850.54% higher in 2022 versus 1967 (a $850,536.40 difference in value). Between 1967 and 2022: Housing experienced an average inflation rate of 4.18% per year.
While incomes have been stagnant, housing prices have skyrocketed.
Now let’s also consider rent. Average rent prices have increased at a rate of 8.86% per year since 1980, consistently outpacing wage inflation by a significant margin. According to this article on iPropertyManagement.com, rent prices increase 12.5% faster than wages.
Although you can get into the stock market with very little money, in order to experience the kind of returns that you can make in real estate, you would need to invest significantly more.
In April of 2021 I put $40,000 down on a single family home that I rent for $3,500 a month. This property alone brings in $42,000 a year. My mortgage is roughly $1,400 a month with a rate of 2.875%. This rate will never increase, while inflation and rents do, meaning each year the rent I charge increases by 3%. My cash flow is $2,100 a month. If invested for dividends, I would have had to invest $1,400,000 in order to make the same kind of returns. But I was able to make these returns with just $40,000 invested.
Not to mention the depreciation I write off, coupled with property appreciation—the choice between investing in the stock market or in real estate is a no brainer.
Naturally, real estate investing is much more hands on than investing in the stock market. As I mentioned previously, you should be investing in both. Self-directed IRA’s and other retirement accounts allow you to also invest in real estate, so long as the money that you earn stays within the retirement account.
Real estate also provides you with more options than the stock market does. A home can be improved upon and its value can be increased significantly through renovations. Multi-family homes are valued by the income they produce, single-family homes are valued by condition and location.
The structure can be added to or an entirely new structure can be built altogether on the land. Older homes can be modernized with new technology such as appliances to increase their value. Market downturns will not hurt as much if there is no immediate need to sell the home. During a market downturn, the property will still produce cash flow, resulting in a continued passive income stream.
The property can be leveraged with a cash-out refinance and used in order to purchase more rental properties. 1031 exchanges allows the owner to sell the property and purchase another within the allowed timeframe to defer taxes.
There are a myriad of other benefits to owning real estate, from passive income to tax deductions. I see stock market dividend investing as a long-term strategy and real estate with the possibility of immediate gain through rental income. Regardless, I like to not have all my eggs in one basket and diversify between real estate and the stock market. But I see it as a balance for present gain as well as value appreciation over time. Real estate will do both of these for you.
I refinanced a rental property in New York City and used the cash to purchase a home in Florida that now produces $3,000 a month in rental income. After expenses, I net about $2,150 in monthly cash flow. This cash flow I invest in the stock market in the meantime while I build up my savings to invest in the next rental property.
I am aware that this can be risky because the market can turn bearish at any given time, as it has done in the last couple of weeks, and it can wipe out my savings. The way I see it, I can wait out the downturn and not withdraw my funds at a loss. This is another risk with the stock market, depending on your age and how risk averse you are, you do not want to be at near retirement age and wait for a bear market to wipe out 20-30% of your life savings.
A real estate market downturn might very well do that all the same, however as long as your properties are producing cash flow every month the losses are only on paper—your monthly income is the same, and you can afford to wait out the recession.
Many people who lost money during the crash of 2008 were not able to hold onto their properties. The ones who were able to saw their property values almost double by 2013. As long as you are able to make your mortgage payments (or as long as you have tenants in place who are able to make their monthly payments) you can wait out recessions and even make good returns while you wait for the market to turn bullish again.
