Real Estate Vs. Stock Investments – What’s Better?

In the world of investing, there has always been a debate between stocks and real estate regarding the better investment. Over the past 50 years, real estate and stocks have been popular choices for investors looking to secure their financial future. This article will dive into the performance of both asset classes and an analysis of the costs of managing each investment and associated taxes to help you determine which could be a better choice for your portfolio.

 

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A historical overview: Stocks versus Real Estate

The U.S. median home price in 1973 was $33,500, and by today’s standards, it has increased to $431,000. This growth represents an average annual return of 5.24%. In comparison, if you had invested that same $33,500 into the S&P 500 in 1973, your investment would now be worth a staggering $5.1 million, translating to an annual return of 10.59%. On the surface, this data suggests that stocks have generated higher returns compared to real estate over the past half-century. However, there are other factors to consider in this comparison.

Leverage and investing in Real Estate

One significant advantage of real estate investment is the use of leverage. Leverage is using borrowed money to buy a property, which can potentially lead to greater returns. In real estate, you typically make a down payment, take out a large loan from the bank, and then rent the property. This strategy allows you to amplify your investment gains (or losses).

However, a higher return comes with a higher risk, as the debt burden of a property investor is typically more significant than a stock investor. This leverage implies that the returns discussed earlier are not an apples-to-apples comparison.

Cost of managing Real Estate investments

When investing in real estate, a critical aspect is the costs associated with managing and maintaining properties. The average mortgage rate for a rental property currently stands at around 8.5%. Additionally, if an investor opts to hire a property management company, they can expect to pay an additional 8-12%. Nearly 20% of rental income is spent on managing the property.

In contrast, the majority of stocks require little to no management. Investing in stocks usually means owning a part of a business, and as a result, the investor is not responsible for managing the day-to-day operations. This difference makes comparing stocks and real estate more complicated, especially when factoring in ongoing maintenance, repairs, insurance, and other costs that accompany property ownership.

Tax implications for Real Estate and Stock investments

The tax treatment of income derived from both real estate and stocks also plays a role in determining the overall benefit of each investment. Rental income is taxed at a higher rate than dividends or long-term capital gains from stocks.

For real estate, rental income is subject to the investor’s ordinary income tax rate, which can vary based on their income level. This rate can be as high as 50% for top earners. On the other hand, investments in stocks held for over a year are taxed at 15% for most taxpayers and 20% for those in the higher income brackets. This means that stocks provide a significantly more attractive tax environment than real estate.

See median real estate taxes from U.S. Census Bureau

Conclusion

The long-standing debate between real estate and stocks as the better investment is multi-faceted and dependent on various factors such as timeframe, personal preferences, risk tolerance, and tax considerations. While historical data suggests that stocks have outperformed real estate over the past 50 years, investors must also consider the advantages of leveraging with real estate investments and evaluate the costs associated with managing and maintaining properties.

As an investor, it is crucial to thoroughly analyze the available investment opportunities, considering factors like potential return on investment, risk, taxation, and overall goals. Ultimately, a well-balanced and diversified portfolio of both real estate and stocks may provide the most robust foundation for building long-term wealth.

Frequently Asked Questions

What is the historical performance of stocks versus real estate?

Over the past 50 years, stocks have generally generated higher returns than real estate. If you had invested $33,500 into the S&P 500 in 1973, it would now be worth around $5.1 million, with an annual return of 10.59%. In comparison, the US median home price in 1973 was $33,500, and today it stands at $431,000, representing an average annual return of 5.24%.

What is leverage in real estate investment, and how does it impact returns?

Leverage is using borrowed money to buy a property, amplifying your investment gains (or losses). Real estate investors typically make a down payment and take out a large loan from the bank to purchase a property. While this strategy can potentially lead to higher returns, it also comes with more significant risks and a higher debt burden than stock investment. When accounting for leverage, the returns from real estate investment cannot be directly compared to those from stocks.

What are the costs involved in managing real estate investments?

Real estate investments have several costs, such as mortgage rates averaging around 8.5% for rental properties and property management fees ranging from 8-12%. Nearly 20% of rental income is spent on managing the property. Additionally, ongoing maintenance, repairs, insurance, and other costs accompany property ownership. In contrast, stocks usually require little to no management. See housing costs from the U.S. Census Bureau.

How are taxes different for real estate and stock investments?

Rental income from real estate is typically taxed at the investor’s ordinary income tax rate, which can be as high as 50% for top earners. In comparison, investments in stocks held for over a year are taxed at 15% for most taxpayers and 20% for those in higher income brackets. This means that stocks provide a more attractive tax environment compared to real estate.

Which is the better investment: real estate or stocks?

The answer to this question depends on various factors, such as personal preferences, risk tolerance, time frame, and tax considerations. While historical data favors stocks, the benefits of leveraging in real estate and the costs associated with managing properties must also be considered. A well-balanced and diversified portfolio of both real estate and stocks may provide the most robust foundation for building long-term wealth.

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