I have stated multiple times that real estate is my favorite asset class to build wealth. Therefore, choosing between real estate or bonds is a fairly straightforward decision. Real estate all the way.
However, as I fill out the chapters for my new book, Buy This Not That, I thought it would be a useful exercise to determine which type of investment is best for whom and when. After all, I own both real estate and bonds and so do many of you.
Both asset classes have performed well for decades. Further, we've got real estate tycoons and we have bond tycoons. Therefore, you can get rich in real estate or bonds. A lot of it depends on your interest.
Real Estate Or Bonds: Which Is The Better Investment
Today, real estate is desirable. With billions of people spending more time at home, the intrinsic value of real estate has gone up as well.
I'm trying to buy as many rental properties and multifamily properties as comfortably possible to take advantage of the current weakness in the market due to high mortgage rates. I expect interest rates and mortgage rates to come down over the coming years given inflation peaked in mid-2022 and has steadily declined.
Bonds are also looking attractive given the much higher yields. You can now get 5%+ owning Treasury bonds, which is a great deal given inflation is below 3.5%. So the question between real estate or bonds is a tougher one now!
Real estate has more upside as interest rates decline due to the rental income and principal upside component. However, bonds have a steady return with a high interest rate.
Bonds Offer Diversification From Stocks
But the funny thing is, ever since I started writing about investing bonds in 2009, I've received the same negative feedback about bonds.
Yet, any objective investor realizes bonds have performed well over the past 20 years. Some bond funds have even beaten the S&P 500 over the past decade or two as well.
Bonds outperformed stocks during the 2000 Dotcom meltdown, the 2008-2009 global financial crisis, the 2018 correction, and the March 2020 coronavirus-induced meltdown. Therefore, don't count out bonds just yet.
Could it be that people tend to dislike what they don't really understand? The bond market is ~80% larger than the stock market. Below is a great chart showing the performance of long-term bonds versus the S&P 500. However, this is before 2022, the worst year for bonds in history.
Why Invest In Bonds?
Historically, bonds have been the #1 public investment alternative to stocks. Bonds tend to outperform when stocks are doing poorly and underperform when stocks are doing well. Therefore, you may want to invest in bonds to dampen portfolio volatility.
Another reason why you may want to invest in bonds is due to capital appreciation. As you can see from the chart above, the long-term bond fund, VWESX, has performed very well since 2000.
Yet another common reason to invest in bonds is for the income they generate. Most bonds pay a coupon payment semi-annually. The interest rate you get is determined by dividing the annual coupon payment by the price of the bond. As the bond increases in value, the interest rate declines and vice versa.
In some cases, such as with US Treasury bonds and municipal bonds, the coupon payments may not be taxed on the federal or state level or both. Hence, some types of bonds produce highly tax-efficient income.
Here's a detailed post on how to buy U.S. treasury bonds and other bonds. Just know that bonds also go down in value, as they have in 2022 and 2023. However, if you hold treasury bonds to maturity, you will get all your money back plus all the coupon payments.
The Different Types Of Bonds
Not all bonds are created equal. The least risky to most risky types of bonds are: Treasury bonds, Agency bonds, Municipal bonds, and Corporate bonds. Then there are bond mutual funds and ETFs, which invest in various types of bonds.
Municipal bonds are rated differently. The higher the rating, generally the lower the risk and the lower the coupon payment. The lower the rating, generally the higher the risk and the higher the coupon payment.
In terms of corporate bonds, you have regular corporate bonds issued by companies like Apple Inc or Coca Cola. They pay a higher coupon than municipal and Treasury bonds, but are taxed and generally riskier.
Today, for example, Apple issued $6.5 billion in corporate bonds. The four-part offering includes $2.3B of 1.400% notes due 2028, $1B of 1.700% notes due 2031, $1.8B of 2.7% notes due 2051 and $1.4B of 2.850% notes due 2061.
The 40-year security yields 0.92 percentage points above Treasuries. It is highly unlikely a company with $100+ billion in cash will ever default on its bond obligations.
Then there are junk bonds or high yield bonds. These are corporate bonds from companies that have a higher chance of defaulting. They offer higher interest rates to compensate for the risk.
Certificates of deposit are like bonds issued by your bank. You essentially loan the bank your money for a certain period of time for a guaranteed fixed rate of return. CDs are guaranteed up to $250,000 per individual.
Related: Real Estate Or Stocks?
Why Invest In Bonds Over Real Estate
Now that we know some reasons why you might want to invest in bonds, the next question is why to invest in bonds over real estate. Here are some reasons why:
1) You don't have enough money to come up with a down payment to buy real estate. Although, you can dollar-cost average into private real estate funds offered by the likes of Fundrise. The investment minimum is only $10 and the company invests in residential and industrial properties mostly in the heartland.
2) You're looking for a lower-risk way to invest your down payment to buy a house or rental property
3) You like the 100% passive nature of investing in bonds and dislike managing tenants and dealing with maintenance issues
4) You're in a high-income tax bracket and appreciate tax-free income from municipal bonds or federal tax-free income from US Treasury bonds
5) Bonds provide for an easier and clearer way to diversify your public investment portfolio
6) You've already got a sizable real estate portfolio
7) You're bullish on a corporation, but don't want to buy the company's equity
8) You believe interest rates are heading down and bonds provide a more direct way to capitalize on lower rates than real estate
9) You dislike paying annual property taxes
10) You're getting close to retirement and don't want to risk losing a lot of money
As you can see, there are plenty of reasons to buy bonds over real estate.
Why Invest In Real Estate?
Real estate is one of the best ways to build wealth for the average American. At the very least, real estate acts as a forced savings account where each amortizing mortgage payment builds home equity. Once the mortgage is paid off, you own your home free and clear.
Inflation acts as a tailwind for real estate prices and rents. Therefore, owning real estate makes you a beneficiary of inflation. Whereas renting makes you a price taker. Just like how you wouldn't short the S&P 500 over the long-term, it's not wise to short real estate by renting long-term.
The combination of higher rents and higher property prices can build incredible wealth over time. Inflation tends to really sneak up on you 10 years later.
Living in and owning your primary residence makes you neutral real estate. To go long real estate you must own more than one property or invest in real estate investments such as REITs, private real estate, real estate ETFs, and real estate-related stocks.
Finally, real estate can be improved upon. Whereas with a bond, you are a passive investor who has little-to-no way of making the bond perform better. Your investment is at the whim of company management, the company's competitors, and various macroeconomic factors.
Why Invest In Real Estate Over Bonds?
Now that we know some reasons why you might want to invest in real estate, the next question is why invest in real estate over bonds. Here are some reasons why:
1) You desire to own a primary residence
2) You could potentially make greater returns in real estate, partially thanks to leverage
3) You are particularly bullish on a city or region, e.g., 18-hour cities or Gateway cities
4) You have the ability to improve the value of a property through remodeling or expansion
5) You want to invest in tax-efficient opportunities such as through an Opportunity Zone fund
6) You are bullish on a particular real estate asset, e.g., multifamily, build-to-rent, industrial
7) You can collect a higher rental yield than a bond yield, which is often the case
8) You enjoy living life and staying at your vacation property
9) You want to build a rental property portfolio to give your children something to do
10) You're looking to do a 1031 exchange to defer paying capital gains tax
11) You like the $250,000 / $500,000 tax-free profits for singles / married couples upon sale
12) You are in a high income tax bracket and appreciate the ability to take non-cash amortization expenses to reduce rental income tax
The upside potential with real estate over bonds is great. In fact, I view real estate as a bond plus type of investment.
Historical Returns For Bonds And Real Estate
From 1926 – 2016, the historical return for the aggregate bond market is about 5.4 percent compared to a historical inflation rate of 2 percent. Bonds continued to do well through 2020.
Meanwhile, the historical return for real estate depends on the type of real estate, the location, and the duration.
According to the Case-Shiller Housing Index, the average annualized rate of return for housing increased 3.7% between 1928 and 2013. Housing has continued to do well through 2021.
According to the National Council of Real Estate Investment Fiduciaries (NCREIF), the average 25-year return for private commercial real estate properties held for investment purposes was 9.4%.
Residential and diversified real estate investments did a bit better, averaging 10.5%. Meanwhile, real estate investment trusts (REITS) performed the best with an average annual return of 10.5%.
My Reasons For Investing In Bonds And Real Estate
In my 20s, I invested heavily in stocks and real estate. However, before and after the dotcom bubble burst in 2000, I transferred about 20% of my stock investments into bonds. Between 2000 – 2002, the 10-year bond yield was between 5% – 6.7%, which I found attractive.
In the summer of 2001, I had also changed jobs and cities. Therefore, I was quite uncertain about my future and wanted more stability. At the same time, I wanted to get long property with the funny money I made in 1999-2000 from internet stocks.
In 2003, I bought my first property in San Francisco. After that, I viewed real estate as a bonds PLUS type of investment. Real estate served as a way to diversify my stock portfolio and career in equities. Therefore, I stopped buying bonds until 2017.
During the Global Financial Crisis in 2008-2009, roughly 20% of my public investment portfolio was in bonds. I definitely wish I had more. Although bonds still declined during that time period.
Bonds And Online Real Estate For More Simplicity
In 2017, I sold my main rental property and reinvested $550,000 of the proceeds in a California muni bond fund and various individual California municipal bonds. My main purpose of these investments was for tax-free income.
I then re-invested the remaining $600,000 of the proceeds in stocks and $550,000 in real estate crowdfunding. My main goal for these investments was capital appreciation without debt. By selling the property I wiped away a $815,000 mortgage.
At the time, I felt bad giving up a property I had bought in early 2005. It was going to be a key part of my retirement income portfolio. However, I just couldn't take the headache of being a landlord for this property anymore. Thankfully, the reinvestments worked out.
Investing In Both Bonds And Real Estate Today
Today, I am buying bonds with the 10-year bond yield at roughly 4.8%. It's great to earn a higher interest income with my cash.
I'm also actively investing in private real estate funds through Fundrise and searching for individual commercial real estate deals offered by CrowdStreet.
For most investors, dollar-cost averaging into a diversified real estate fund is the way to go. If you are an accredited investor with interest and time, then building your own select real estate portfolio through CrowdStreet makes sense. Just make sure to screen each deal and sponsor thoroughly.
Questions And Subscribe
Readers, what is your preference between real estate or bonds? How do you view them similarly and differently? What are some other advantages and disadvantages of the two asset classes I may have missed?
For more nuanced personal finance content, join 60,000+ others and sign up for the free Financial Samurai newsletter. Financial Samurai is one of the largest independently-owned personal finance sites that started in 2009. To get my posts in your inbox as soon as they are published, sign up here.Â
Great article. In addition, I take into consideration my Social Security as a bond class asset. Therefore, when I feel I need to invest in a bond ETF, I remember my bond that I already have in the SS.
Excellent point! For over 20 years, I have written off Social Security to be there for me when I’m in my late 60s. My fingers crossed, at least 70% will still pay out!
The only reason I can see for bonds lately (for me) is if I wanted to put money (say two or three years worth) some place where it might (possibly) not be much affected by a recession\depression\correction\bubble-burst etc.
I believe we have enough passive income lined up in retirement that we can defer drawing from retirement accounts until the market has had time to recover (say three years, maybe?).
Naturally, this will change when we get to RMD age but it looks like that will move to 75 years old, sometime in the next year or so, when Congress gets around to it.
I don’t want to personally manage real estate (done it, what a hassle, not to mention source of sudden problems), or be hostage to the performance and vacancy rates of just a few rentals.
So I go mostly with the stock market. But I don’t want to have to follow all the news and reports constantly so, except for a few personal stock picks, I pick funds with managers that have an established record for excellence. They take care of keeping it balanced, dropping the dogs, and getting into the good stuff, all for a very low management fee.
My main concern at the moment is that, outraged by Peter Thiel’s five billion dollar Roth IRA, members of Congress are now looking at yanking the rug out from under anyone with even a million or so in retirement funds. As readers of this site know, that is lunacy. The whole idea of saving and investing is so we can get a million or more tucked away before we retire, even if we have always worked for less than a six figure salary.
And, if you manage that or a bit more, it becomes possible to have many millions about the time RMDs come due — the same time frame in which your medical bills are likely to soar and you may need to hire help and maybe even a visiting caregiver to help you stay in your home.
I would tend to agree that billions are excessive for Roth IRAs, regardless of how they got there, but to drop three (THREE!) orders of magnitude and say that a few million is excessive is to ignore reality. Hell, some of us live in the greater New York City municipal area (and I just got back from a trip to California where I saw what REALLY expensive living looks like). What are we all supposed to do? Say goodbye to everything and everyone we know, family included, and go live in Wyoming (although nothing’s wrong with Wyoming if it’s already your home) when we retire?
How about just buy a dividend-paying RE stock, such as ARCC? It consistently pays $0.40+ every quarter. At $20 a share, it’s 8+% return with relatively low risk. Not a bad place to park money.
Not bad at all if it continues to return 8% a year. How did it do in March 2020?
My analysis showed real estate stocks and public REITs dropped worse than the S&P 500 during downturns.
See: https://www.financialsamurai.com/how-does-real-estate-get-impacted-by-a-decline-in-stock-prices/
Does the federal government’s willingness to have an endless eviction moratorium change your analysis? I am strongly considering selling my 1 rental property in Washington, DC if my current tenant (who pays on time, fortunately) moves out. In addition to the federal eviction moratorium, in DC we also have a local eviction moratorium that bars landlords from evicting their tenants for any reason whatsoever, including if they are committing crimes at the property. I always considered rental property to be a pretty safe investment but the last year has shown that the government can essentially confiscate our rental properties at any time and I’m not sure that’s a risk I want to bear in the future.
Question on Deferred fixed Annuity
Hi Sam
I have been following you for years and love your blog. I feel you are very honest on your recommendations and feedback.
I have researched a bit on Deferred Fixes annuity for some guaranteed return. I am 50 years old, can leave my job in 2 years with medical benefits (no pension). I have some money in market, some in CD and some just cash (all 3 total approx 1.5 mil). I would like to use the cash to buy some guaranteed return fixed deferred annuity since i wont need the money till i am 60 anyway and cd/money market rates sucks right now. Any advice?
Rene
Great article, Sam. I’m a real estate guy by default, and I’m certainly overweight in that category. I’d like to transition some NW into municipal bonds, but it’s just been easier to focus payoff of the mortgages on my rental homes. It’s felt doubly sweet to pay down the note and watch the values soar over the last decade. I know the good times won’t last forever, it sure is fun getting rent checks and not having mortgages on the properties.
I prefer real estate, but it is more work.
Recently, I moved about 10% of our investment portfolio from stocks to bonds. It was quick and easy. I guess I could do the same if I go with REIT.
Either asset class is a great alternative to the stock market.
A big cash postion is what I tend to avoid.
Great post as always, Sam. I’m waiting for a correction to pick up more shares in $O. I’m facing the same conundrum as most of the other folks who read your blog: where to safely invest cash in the short term? Where is the safest place to get decent returns over the next 1-3 years? You should do a post on that! All the best.
Happy to hear your ideas!
Sam,
Have you purchased any individual bonds? I bought a small number of Pemex bonds last year which are paying nearly 5% with a maturity in 2024; they are rated Ba3/BBB but I seriously doubt Pemex will default. They have gone up in value since I purchased them but my plan has always been to hold them to maturity.
I am less inclined to purchase bond funds since any small increase in interest rates will negatively affect the NAV, whereas if you hold a bond to maturity, that risk is mitigated.
Yes, own an assortment of individual California municipal bonds. Also have zero coupon bonds as well.
Haven’t gone down below prime ratings yet bc I’ll just go to real estate or stocks. Glad your investments have worked out.
Depending on your age, RE and Bonds can both play a role in one’s portfolio. I prefer the simplicity of REITs over individual property investing; I do know I give up certain benefits; however, I am okay with the tradeoffs. Physical property is riskier, but the rewards can be much more significant. To me, physical land is too illiquid and requires much more headache than ETF/mutual funds.
I utilize REITs at a 20% exposure and am comfortable with higher risk at this stage in my life. Bonds are something I have held in small quantity due to my backtesting of different portfolios, though that will likely change as I age to increased exposure.
Fidelity published a paper in 2013 highlight how REITs complement traditional stock and bond portfolio construction, leading to higher risk-adjusted returns. So, why not both?
Fidelity paper: https://www.fidelity.com/bin-public/060_www_fidelity_com/documents/REIT%20Stocks%20-%20An%20Underutilized%20Portfolio%20Diversifier_Fidelity.pdf
Main thing with Bonds that is different than in the past is the upside is limited to the coupon unless you think rates are going to zero or negative. When bonds were at 5%, you could make money off interest and principal. Today at 1%? It’s the worst of both world. You make nothing on stated and unless you think there is someone willing to take less than 1% your principal is at risk
Both make sense in certain situations. Personally, I have gravitated towards real estate for the yield, appreciation, tax advantages and principal paydown on mortgages and think that is enough to offset any extra effort or risk when compared to bonds. I find that comparing bonds and real estate is similar to comparing a multi-vitamin to fruits and vegetables. You eat them to accomplish a similar goal (yield), and there may be slightly more risk to eating a fruit/vegetable off the tree/vine compared to a dialed-in lab manufactured vitamin. Although you may take a bite out of a bad apple, the odds are that over time you will be better off from the wholistic benefits of fruits and vegetables compared to taking a multivitamin.
The best answer is… both! I don’t own much of either unfortunately. Sort of ditched the housing dream in the Bay Area to funnel money into index funds and a couple more speculative bets. Currently working to replenish my dry powder for another drawdown or, hopefully at some point, real estate opportunity.
Hi Sam,
Always appreciate your views on real estate. Can you expand a bit more on your build-to-rent investment? Is that through Fundrise and how would you recommend folks to get exposure to this particular asset.
Hi Sam,
Great post ! I have been a guest at the Hilton Dallas Southlake Town Square on several occasions. The Dallas Fort Worth Metroplex location is an excellent one, attracting both leisure & business travelers with nearby large corporate offices. Would you be willing to share if this particular investment opportunity though Driftwood has materially changed since your investment ? I am a newcomer eager to invest in real estate. If someone with your expertise is invested in this property it makes me keen to put in the effort / due diligence to investigate if this opportunity is the right one for me.
Hi Mark,
The opportunity has only just commenced. Hence, I won’t know for a while. They plan to invest $5 million remodeling the place.
Driftwood bought the property at a favorable price in Dec 2020. So IMO, it’s kind of like rewinding time to get a better deal as they syndicate some of their ownership out.
Sam
I started reading all your post this year. Thank you for sharing your knowledge and experience with candor, honesty, open mindedness and transparency. You are a gifted blogger. I totally agree with misconceptions about Asians but I’m pragmatic and stoic. This has positives and negatives and I use them to make and get the best outcomes. I also totally agree one has to learn the most on stuff one do not understand or dislike. It is like the saying keep your friends close and your enemies closer, haha . I also did not realized I have been practicing stealth which is the term you use. I now have a terminology for it.
Lastly, I now literally have to think plan what to do if I do retire completely at 51. Realize I maybe FI but not really totally yet ready for RE. I just have to redefine my individual definition of RE. Currently at 0.8FTE so it is like I work about 9 months out of a year, that is how I look at it right now but others may think of it differently.
Again, just want to say, thank you and I also thank God and the people who help you become a gifted blogger that led you towards the Financial Samurai blogging path.
You bet! And thanks for reading. Best of luck on your FI journey!
Samuri, on the average where have you experienced higher returns (equity crowd street vs growth fundrise). Thank you for the education you provide to us all.
Fund returns are in the high single digits (7%-9%).Individual investments have gone as high as a 25% IRR to a loss.
So it really depends on your wrist tolerance and objectives. I like to invest mostly in funds (80%), because I don’t have the time to track everything. And then I will surgically invest in individual deals that I think for the most attractive.
I do the same thing with stocks as well. At this point in the cycle, I think diversification is more important.
Hi sam,
Great read totally agree with real estate! But with bonds, here’s an idea why not invest in high yield corporate junk bonds? They have been returning above 8% compounded return since the 90’s and has a better risk adjusted return compared to the s&p 500. You can buy them through etfs or mutual funds to spread the risk of default. Since stocks are quite expensive on an earnings basis this might be a better alternative for now.
What do you think?
I feel fortunate to own both bonds and real estate. I got into bonds first and then added real estate when I had enough saved up to buy physical real estate. I didn’t know about real estate crowdfunding until a few years ago. Had I known, I think I would have invested in REC much earlier to gain exposure while I was still building capital to become an actual homeowner. Anyway, great analysis in your post, another classic I will teach my kids about when they’re older. Thanks!
Sam, which hotel project are you invested in Dallas? I am in DFW.
Hilton Dallas Southlake Town Square, a 248-key, five-story hotel located in the Dallas suburb of Southlake, approximately 10 minutes from the Dallas-Fort Worth International Airport. Driftwood Capital acquired the asset from Hobbs & Curry family limited partnership.
You familiar with it? Thoughts on the location? I thought the terms of the offering were solid as they offered investors a December 2020 price and they got good financing terms. They plan to invest $5 million remodeling
So interesting. I have followed you for the past year and you were the one who enlightened me about crowdfunding to further diversify my RE holdings. I invested in the exact same hotel offering-for the same reasons.
Can you explain how you deal with taxes implications on this Driftwood deal? I am thinking to buy in to same deal but have never had a K-1 to deal with at tax time. And the details talk about UBTI, and read the tax rate is very high on this type on income. Is there more to the story with K-1 and taxes for investors that already have day job (receiving W-2)?
K-1. Pretty standard. Best to ask them for more details.
Related: Tax Docs For Real Estate Syndication Deals
thanks for the reference Link Sam.
I vote for real estate over bonds today. I’d change my tune if rates ever dramatically increased. However, I don’t see that happening. I add to my TLT position when the 10 year is over 2 percent and I trim when it’s under 1.5. This has been pretty profitable over the last 5 years. With real estate I just buy and so far hold forever. That’s why I vote for real estate. For the average investor, which I am one, I always seem to do better over the long term when I just buy and hold.
Buy and hold works in low cost areas, but it’s difficult if looking to upgrade in coastal areas. It’s almost impossible to not sell and use existing equity to come up with 20% of 1 million+ unless making a ton of dough. I guess if someone was willing to do lateral moves the hold and buy strategy be doable in expensive areas, but past the lateral move stage.
Readers, what is your preference between real estate or bonds? How do you view them similarly and differently? What are some other advantages and disadvantages of the two asset classes I may have missed?
Given I am relatively young, I do not view bonds as a viable investment given the low current yields. Ultimately if rates rise and they generated attractive risk adjusted returns relative to other asset classes, it is something I would consider. One can sleep well earning a nice yield.
In the current environment I prefer to invest in real estate (in good markets) where there are strong demographic trends and long term home price appreciation.
I really like your plan with investing in the Muni Bond fund. Tax free income is a no brainer. I always overlooked muni bonds until i really started doing more research about them. If im going to put money in real estate it would be in a Reit fund. I still like the security if Treasury bonds. You cant go wrong with the safety of them.
VWESX
Jul 2001 $8.60
Jul 2021 $11.30
+31%
———-
VTSMX
Jul 2001 $27.00
Jul 2021 $110.00
+300%
———-
There’s no comparison. No?
Not from a straight principal value comparison, no. It’s the same thing with real estate versus stocks.
But we need to also take into account the income that has been generated along the way.
What are your thoughts about bonds versus real estate, given this is the subject of the post? How was your portfolio position for these two asset classes. Thanks
https://stockcharts.com/freecharts/perf.php?vtsmx,%20VWESX