There are may benefits of owning stocks over real estate. We’ve already discussed why I prefer real estate over stocks for most people. Now it’s time to argue the other way.
I’ve been an investor in both stocks and real estate since the 1990s. Both asset classes are core asset classes to own for most people. Roughly 30% of my net worth is in stocks and 50% of my net worth is in real estate.
Out of my estimated $380,000 in annual passive investment income, roughly $75,000 of the income comes from stock dividends.
The Benefits Of Owning Stocks Over Real Estate
I was expecting much more backlash from coastal city folks in my article on why I preferred real estate. After all, real estate is more expensive on the coasts to own. You tend to dislike things you can’t get.
But I also got heat from folks who live in the Midwest. The general feedback was that Midwesterners never felt anti-housing rage and that I’m a fool for preferring real estate over stocks since they’ve made more money in the stock market.
Well obviously you aren’t going to feel a lot of anti-housing rage if you can buy a beautiful house for $280,000 a couple years out of school! And obviously you have a better chance of making a larger absolute return on your investment with stocks since housing is so cheap. We already know that in the long run, stocks outperform real estate, un-levered.
The Midwest Has The Greatest Investment Opportunity
What I do predict with great confidence is that 20-30 years from now, the anti-housing rage will have spread to the Midwest. Money is fungible. It will go where the returns are highest. Residents from San Francisco, LA, Seattle, New York, Washington DC, and Miami will bring their bags of cash and either buy up non-coastal real estate directly through REITs or through real estate crowdfunding deals.
Making a fortune is about predicting long-term trends, and I’m certain diversity will continue to spread across America. Technology will make paying $4,600 a month for a two bedroom in a congested city like San Francisco no longer necessary because you no longer need to work in an office. By 2030, there will be more freelancers than W2 workers because today already ~35% of the American workforce are freelancers.
Every opportunity will eventually be arbitraged away. Thankfully, such trends can take decades to play out. Face reality or get left behind.
Why I’m Always Going To Own A Good Amount Of Stocks
After selling my SF rental house and reinvesting the proceeds, I’ve got roughly 30% of my net worth in stocks. Although stocks give me zero pleasure or utility, they are a necessary component of my asset allocation because history has shown that stocks outperform inflation by 3-5X.
Here are some of the benefits over owning stocks over real estate.
1) Higher rate of return.
Over the past 60 years, stocks have historically returned ~7-10% a year compared to 2-4% for real estate. You can also go on margin to boost your stock returns. However, I don’t recommend this strategy given your broker will force you to liquidate holdings to come up with cash if things go the other way. With real estate, your bank can’t force you to come up with cash or move out so long as you continue paying your mortgage.
2) Stocks are much more liquid.
If you don’t like a stock or need immediate cash, you can easily sell your stock holdings. If you need to cash out of real estate you could theoretically take out a home equity line of credit, but it’s costly, needs getting approval, and takes at least a month to open up a new account.
I tried unsuccessfully to sell one property in 2012. It took a stressful 45 days to finally sell the same property in 2017 for $1 million more. So thank goodness for illiquidity in saving myself from myself! With stocks, it’s so nice to be able to simply click a couple buttons and be done.
3) Stocks have lower transaction costs.
Online transaction costs are now free, no matter how small the position you buy or sell. The real estate industry is still an oligopoly which fixes commissions at a ridiculously high level of 5-6%. The cost of selling a house is egregious.
You would think with the growth of companies like Zillow and Redfin transaction costs would significantly decline, but unfortunately they’ve done very little to help lower expenses for the consumer.
Check out this detailed breakdown of how much it would cost to sell a $1,850,000 home. If they charged a 6% commission fee, the cost would be $18,500 more!
4) Stocks require less work than real estate.
Real estate takes constant managing due to maintenance, conflicts with neighbors, and tenant rotation. Stocks can literally be left alone forever while paying out quarterly dividends. Without random maintenance issues you’re able to focus your attention elsewhere. You can spend more time with family, grow your business, or travel the world.
If it made you feel more comfortable, you could hire a money manager for a fee of under 1% to manage your investments. Or you could just track and manage your portfolio yourself for free like I’ve done for the past 25 years.
5) Easier to diversify with stocks than with real estate.
Unless you are super rich, you can’t own properties in Honolulu, San Francisco, Rio, Amsterdam and all the other great cities of the world. With stocks you can not only invest in different countries, you can also invest in various sectors.
A well-diversified stock portfolio could very well be less volatile than a property portfolio. People forget that buying property is a highly concentrated bet, often with debt, in a single asset.
6) Easier to invest in products you care about.
One of the most fun aspects about the stock market is that you can invest in what you use. Let’s say you are a huge fan of Apple products, McDonald’s cheeseburgers, and Lululemon yoga pants. You can simply buy AAPL, MCD, and LULU. It’s a great feeling to not only use the products you invest in, but make money off your investments as well.
As soon as we started actively using Netflix in 2011, we bought some shares that have done well (wish I put my life savings in the stock in 2006 when Reed Hastings, the founder spoke at my Berkeley MBA commencement!). As soon as my wife signed up for Amazon Prime in 2016, we also bought some shares.
7) Tax benefits.
For capital gains and qualified dividends, the maximum tax rate is 15% for taxpayers in the lower tax brackets. For those in the highest tax bracket, the tax rate is 23.8%, including the 3.8% Net Investment Income Tax, associated with the Patient Protection and Affordable Care Act. Short-term capital gains tax (<1 year holding period) will be taxed at the normal marginal income tax rate.
Although these tax rates are quite reasonable, they can’t compete with the $250K/$500K tax free gains for singles/married couples who sell their homes after living in it for 2 out of the last 5. Now that’s some great tax savings!
8) Protecting your investment in a downturn is easier with stocks.
If you think the end is near you can easily sell a stock or short it. But if the real estate floor gives way, there will be no reasonable offers as vultures will start swarming.
If you think the real estate market is about to implode, you can short homebuilder stocks like KB Homes, a homebuilding ETF like XHG, a real estate play like Home Depot, a REIT like O, or mortgage backed securities. But these hedges are inefficient. At least with physical real estate, you can buy insurance. But is buying insurance really a benefit when no insurance is required to buy stocks?
Here are some ways to make money in a downturn. Here’s also a bear market checklist to thrive as well.
9) Less taxes and fees with stocks.
Holding property requires paying property taxes usually equal to 0.5 – 2.5% of the value of the property each year. In 40 – 200 years, you’ll have paid for the full value of your property in taxes alone.
Then there’s maintenance costs, insurance costs, property management costs, and transaction costs to deal with. With stocks, you can build a portfolio of ETFs for free on Fidelity. Or you can have a digital wealth advisor build and maintain your investment portfolio for just 0.25% a year.
From a property tax perspective, the only states that seem reasonable to own property are Hawaii (0.28%), Florida (1.06%, no state income taxes), Washington (1.09%, no state income taxes), Wyoming (0.61%), Colorado (0.61%), Utah (0.68%), South Carolina (0.57%), Louisiana (0.51%), Arkansas (0.62%), Alabama (0.43%), and Nevada (0.86%, no state income taxes).
Characteristics Most Suitable For Real Estate
* Believe wealth is made up of real assets not paper.
* Know where you want to live for at least five years.
* Do not do well in volatile environments.
* Easily spooked by downturns.
* Tend to buy and sell too often.
* Enjoy interacting with people.
* Takes pride in ownership.
* Likes to feel more in control.
Characteristics Most Suitable For Stocks
* Happy to give up control to those who should know better.
* Can stomach higher levels of volatility.
* Have tremendous discipline not to chase rallies and sell when things are imploding.
* Likes to trade.
* Enjoys studying economics, politics, and researching stocks.
* Don’t want to be tied down.
* Have a limited amount of capital to invest.
The Main Reason Why We Own Stocks Today
Real estate is a younger person’s asset class. I had all the energy in the world in my 20s and 30s to buy, manage, and remodel real estate.
Now that I’m in my 40s and have a wife and children to take care of, I simply do not have enough time or desire to manage real estate. As a result, I’m actively investing in private real estate funds like the sons offered by Fundrise, which are 100% passive.
The same thing goes for buying and selling cars. I had 10 cars between 22 – 34 because I was a car addict. I loved meeting up with people on Craigslist to haggle. Now, I’m happy to own one car for 10 years if it lasts that long.
If you want to own real estate, build your empire when you’re young. You won’t have the energy or two once you’re middle-aged. I’m thankful the 2/2 condo I bought in 2003 is fully paid off. I’m also thankful I bought panoramic ocean view fixers in 2014 and 2019 that are both fully remodeled. We’re never going through remodel hell again!
Now, we just want to own stocks, Treasury bonds, REITs, and real estate crowdfunding with our incremental investments. A simple life is a happier life!
The benefits of owning stocks are many. Just be prepared for the occasional 10% – 30% correction. Over the long run, stocks have provided positive returns to help millions achieve financial independence.
Invest In Real Estate More Strategically
If you don’t have the downpayment to buy a property, don’t want to deal with the hassle of managing real estate, or don’t want to tie up your liquidity in physical real estate, take a look at Fundrise, one of the largest real estate crowdsourcing companies today.
Real estate is a key component of a diversified portfolio. Real estate crowdsourcing allows you to be more flexible in your real estate investments by investing beyond just where you live for the best returns possible. For example, cap rates are around 3% in San Francisco and New York City, but over 10% in the Midwest if you’re looking for strictly investing income returns.
Sign up and take a look at all the residential and commercial investment opportunities around the country Fundrise has to offer. It’s free to look.
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I didn’t think about owning real estate at all in my 20s because it just didn’t seem feasible. It felt so far beyond my reach. So all of the investing I did in my 20s was in stocks and ETFs. Fortunately, I worked hard, saved, controlled my spending, and had enough to add real estate to my investments in my 30s. Now that I’m in my 40s it’s hard to imagine my finances without both stocks and real estate. And bonds and treasuries too for that matter. Finding ways to diversify as my investments grew really helped my returns and lowered my stress as well.
I thought that it was interesting when you compared real estate to stocks in regards to investments. I have been trying to find ways to invest but I haven’t been sure how I should do it. I will be sure to consider buying an investment property as a secondary way to make money.
I like the summary of characteristics for real estate versus stock investors. Fairly accurate, IMHO for most rental-ish real estate investments.
Much like stocks, real estate is not a single class of investments. Most of the comments focused on rentals and the trials of managing tenants or management companies. I’m heavily invested in real estate, but only own 5 rentals that equity is less than 10% of net worth.
Real estate notes are, for a non leveraged investment, a much better solution, at least for me. It’s not set and forget like stock market. As a real estate investor, I like control. Currently the portfolio has 20 loans in 11 different cities. The terms are generally 12% and 2 points for 6-9 months with a 1 point extension. Meaning I can roll the loans about 1.5 times a year making for a 14%ish return on this money. Some years I beat the market, others I don’t.
Another option is to purchase performing or non-performing longer term mortgage notes. The returns can be similar to the above and in some cases much better.
Investing both the stock market and real estate has multiple options, it seems, however that most people are only familiar with rental real estate with crowd funded options starting to gain more attention.
I have never owned real estate and never had the desire to until we had kids. We were perpetual grad students and made no money but were also always on the move going from one postdoc to another. We have never been in one place for more than 4 years. The problem with renting isn’t space. It’s the horrid clientele within buildings. People are so disrespectful of common space and neighbors. We tried renting from a private landlord within a condo building thinking that would be more civilized as those tenants are stakeholders and in turn, ended up with a worthless landlord. Our fridge stopped working and he told me I must have set the temp wrong and refused to send a repair guy. I had breast milk I needed to keep frozen. I had it repaired myself, sent him the bill, and he then refused to deduct it from my rent. We got fed up, left the place in perfect condition at the end of the lease, and he refused to give our deposit back. In the end, we had to hire a lawyer. We have a credit score of 820, quiet family, were friends with the neighbors, and never paid our rent a day late. Landlords can screen tenants. The reverse isn’t as true.
Every scenario has issues. Renting has headaches. Owning has a different set of headaches. Generally, I have liked renting because it allows us the flexibility to move if a better career opportunity pops up. In addition, jobs are not as secure as they were in the last generation. I just think there is more freedom in owning stocks and I value freedom above all else.
I’ve rented over 20 years and have never had an experience like that with an owner. Thanks to investing the difference and not paying years of insurance, mortgage interest, property tax, maintenance fees, I have over a million in investments.
Eric Moreno says
I greatly appreciate the quick reply and taking the time to read my comment. I am only here for one more year and then who knows where the Airforce will send me. Sucks I just got out of the barracks but Im glad to have been able to find a cheap way of living while pocketing in all my military Tax-free BAH and Cost of Living allowance money.
Eric Moreno says
Hey FinancialSamurai, first and foremost, thank you for inspiring me with these blogs and continuing to create them. I’ve spent the last couple weeks reading all of them (maybe I missed one or two).
Anyways I wanted to ask for your opinion or if anyone else reads this, please chime in. I’ll go over quick details, I’m 24, credit score 760, drive an old car, I’m active duty air force, invested 5k in REITs, 1k in Stocks, 5k in savings (I wasn’t to bright growing up), currently living in Oahu, Hawaii, renting a small room for $600 and meal prepping to only spend $300 a month on food, my income is around 4k a month (21% of my pay going to TSP). If you were me, would you invest in a condo in Oahu using a VA loan where condos are 300k or keep renting so cheaply and buy a home when and if I go back to the mainland? I really want to get into real estate, but Hawaii man…. extremely expensive. Just looking for an opinion, and maybe some insight on Hawaii if you have any. I know I must do my own due diligence and trust my gut. Thank you!
Financial Samurai says
I’ve noticed rents really weaken in Honolulu as a lot of new condos come online. I’d continue to rent for cheap, hoard your cash, and wait another year or two. Guess it depends on how long you plan to be there.
Both stocks and real estate can be pretty darn stressful. I bought some stocks yesterday during the dip and used up the available cash I had sitting in my accounts. That was the first time I’ve traded in a long time. I’m going to try and do a better job of legging in when I have cash on hand little by little. I focus on 0 commission ETFs most of the time. I also have a long time horizon plan for my stocks and fortunately don’t get tempted to sell very often. I don’t watch the markets that closely, even though I probably should pay more attention, which is why I don’t get the itch to sell. The downside is I don’t lock in gains, but with a long term game plan I feel okay with that most of the time.
Paul Herbert says
Really disappointed. The market will not outperform SF real estate in any environment. Since you don’t suggest trading on margin, and since you favor diversification; we should compare a free and clear SF rental to a 60/40 stock to bond mix. Over a long haul, SF real estate appreciates about 9% per year. Your positive rental income after vacancy, maintenance, taxes and management (now the rental has minimal hassles) produces on average an additional return of 8% on investment. That’s a combined yearly return of 17%. You haven’t considered the real estate tax depreciation advantage. You havent considered that in a real estate downturn; rents decline a fraction of what the real estate declines, and since the real estate is free and clear and you are living on that rental income…you are still mostly good for that downturn period. Property taxes (with Prop 13) are really a non issue, especially since I’m considering net income after taxes. Let’s not forget that rents increase faster than the rate of inflation over any period, so you are hedged there. SF real estate is fairly liquid, list it on a Friday and have 8 offers by the weekend, all offers with quick escrows. In a real estate downturn it’s not as liquid, but you wouldn’t be a seller in that environment anyway. Because you are not going in and out of the real estate the commission and closing costs on a one time sale, many years down the road, are minimal. Owning SF rentals is like owning the SP 500…if the SP 500 appreciated over a long haul at 9% and paid an 8% dividend that was hedged against inflation. And since the market doesn’t perform that well, maybe you should have hired professional management, and kept your rental.
Financial Samurai says
Don’t be disappointed. It’s not that big of a deal. Read this post to feel better: Why Real Estate Will Always Be More Desirable Than Stocks
What does your SF property portfolio look like? Are you buying more at these levels?
Paul Herbert says
All of my rentals are in southern and central CA. I just used SF numbers since that’s where your property was. With regards to purchasing at this point in the cycle: I have found that CA real estate up-cycles tend to last 8-10 years. CA (as a whole) started appreciating in 2012 again, so I think we have a few decent years left. However, when I buy a property today, it’s at a fairly healthy discount from retail…or I pass. And, I have only been able to buy those better deals the last couple of years in central CA.
Financial Samurai says
Got it. How do you find properties discount to market and what is the price point of the central California properties?
If I can only get a 3% absolute return on a property, I’d rather just buy something completely risk-free with no hassle At this stage in my life.
Paul Herbert says
I totally agree about a 3% return, and real estate in much of the country barely outpaces inflation…but CA is a whole different animal. But I do think that even with CA real estate there is a correct time to cash-out and move into equities. When home values over many years of ownership rapidly increase, but their rents don’t increase at that same pace, your return, not on your initial investment, but on the money tied up in the property drops. When that gets to out of whack it would be a good point to move the money into equities and just kick-back with a reasonable withdrawal rate in retirement.
Central Valley CA prices are all over the board, but as an example: a bread-and-butter rental in Bakersfield has a market value of around $120,000 today and rents for $875 per month. At the bottom of the market in 2008/09 you could buy that property right out of the multiple listings for $60,000 and get $750 rent.
Today in order to get an acceptable return you need to buy the property under market (so not listed on the open market). More times than not my method to finding the great deals is direct mail. Buying that $120,000 property at a 25-30% discount an a cash transaction. Now you have a nice investment with built in equity. If the upward real estate cycle continues for another couple years (which it will) and even if the next down turn is deep (which it shouldn’t be with tighter banking), and even if you had to sell at the bottom (which you shouldn’t because this is your retirement income), you would still get out with all your money back.
Financial Samurai says
Got it. At my age, I just can’t get excited about receiving $875/month in rent, gross or net. If I’m going to deal with people, liability, maintenance, etc I need much more. Even if a $120,000 property appreciates by 100% in 5 years, it’ll feel great, but it doesn’t really move the needle any more.
Perhaps I should bring the conversation back to comparing real estate to online businesses. There really is no comparison with which is better after trying both for years.
Which cities in SoCal are your rentals in? Is it completive to rent? I’ve looked at a few areas on Zillow (Pasadena, Glendale, etc) a lot of properties seems to just sit there due to high rent or rents are decreased from 3% to 5% every 15 to 20 days if the property sits there. There also seems to be a rent cap based on number of bedrooms and the cap is consistent.
Paul Herbert says
Pasadena and Glendale are expensive “white collar” neighborhoods. This is an investment for you, not a home that you are going to live in with your family. Try looking at “blue collar” areas of So Cal (Lancaster and Palmdale would be a good place to start).l, the numbers will pencil out much better. Buy four or five rentals in these areas rather than a single expensive rental someplace else. This way when a roof goes, or a tenant turns bad you have spread your risk and still have the cash flow in that particular year from your remaining rentals. With the lower priced houses you will find very little in the way of rental rate fluctuations.
Sam instead of buying SF property years ago, wouldn’t you have had a better return and less headache putting it all in the stock market? I’ll take it even further, put it all in the stock market and rented in SF? When the big one hits do you really want to be or own in SF? Did you know emergency contingency plans of your surrounding communities are in place to receive the masses evacuating SF? What happened to SF real-estate in 1989? I have a beautiful place in KY and I rent around the world. Variety is important to me.
Financial Samurai says
I’m looking at the returns from when I bought stock and one property in 2003, and real estate crushed the returns.
The property I bought in 2005 and sold in 2017 also did well, but not as well. Still, it cleared $1.7 million after taxes and fees from $320K down. Compared to the $320K I invested in the stock market around that time, it still doesn’t match up b/c of leverage, paying down debt, tax shield etc. See: Why I Sold My Rental Home
But I think you will love this post: Buy Utility, Rent Luxury: The Real Estate Investing Rule To Follow.
When you say “when the big one hits”, which fault line are you referring to? If the Hayward fault goes off (being predicted as the sleeping giant) then SF is not going to result in much damages whereas the East bay along the 880 will see damages. Loma Prieta in 89 did hit and a lot of the homes in the bay area (built in the 70’s and 80’s) held up. A lot of the new homes built since that time have better earthquake codes and standards to withstand a higher magnitude.
Financial Samurai says
You don’t think SF will get rocked if the Hayward fault causes a 7.0 earthquake or higher? The Hayward fault is 1.5 – 2 hours drive closer than Loma Prieta, which was a 6.9.
I hope you’re right that there won’t be much damage in SF. Lots of buildings have ben retrofitted and improved.