Stocks Versus Real Estate: It Depends On Your Luck

I've written a pretty detailed post about analyzing whether it's better to invest in stocks or real estate. Check it out if you're wondering where to put your money. I tried to be unbiased in my analysis, but due to my experience investing in both asset classes for over a decade, I came to the conclusion that real estate was my preferred choice to building wealth.

Once acquired, real estate is pretty straightforward. Maximize rent, minimize expenses, let inflation take its course, and keep tenant turnover to a minimum. You are the King or Queen of your asset.

Stocks, on the other hand, require constant re-balancing, trust in management, trust in a fund manager if you buy an active fund, and careful analysis of competitive forces that may hurt your investment.

Think about how many great companies have disappeared over the years. This is why I recommend keeping most of your equity investments in low-cost index funds and focus on asset allocation instead.

One commenter pointed out the reason why I prefer real estate is because I was lucky to have bought in San Francisco in 2003. In this post, I'd like to address his beliefs and see if we can all just get lucky with our investments. After all, it's always better to be lucky than good!

GETTING LUCKY WITH REAL ESTATE

Jeremy writes,

While I appreciate real estate vs. stock investment arguments since I enjoy both sides of the argument, your story isn’t a very realistic example. You bought low in San Francisco, and that turned out to be a booming real estate market. It’s far from the norm – look at the flip-side and see how many people are under water on their homes.

You basically *got lucky.* The market could’ve tanked and you’d be paying $2,400/mo + property taxes + maintenance + depreciation whereas you could’ve just paid $2,000/mo for a place to live/rent and come out far ahead of where you are now. I think it’s an unfortunate example to use because I’m reading the comments on here and all of these people seem to think it’s completely feasible to buy a place for 580k, rent it for 3.4k/mo, and then sell it for 30% more later on. There’s a reason why every major city is absolutely saturated with foreclosed rental properties, and it’s not because the profits on them are booming.

What you’re saying is akin to me talking about my stock experiences – I purchased into Tesla when it was ~$40/share and sold it when it was a bit over $210/share. Is that a good example for why stocks are better than real estate? Not really, just happened to be a fortuitous experience for me.

Overall, I’ve averaged about 12% yearly returns in the stock market, so nowhere near my Tesla experience, but fairly good for a completely passive approach to investing. I’m very interested in trying out some real estate investing, but I’m not hedging my bets on whatever market I invest in to turn out like San Fran did.

COMMENT COMMENTARY

1) Other people are always getting lucky. Getting told you're lucky basically discredits any work or analysis you've put into making your investment. I remember being extremely excited, yet hesitant about putting a $580,500 offer for my condo back in 2003. I just turned 26 and was hoarding cash like a mad man because working in finance gave me daily heart burn, especially after the dotcom bust. Getting into work at 5:30am was also killing my social life. And buying property meant committing to 5:30am start times for at least another five years (never buy property if you don't plan to own it for at least five years)! All I wanted to do was move back to Hawaii and bum around with the savings I had accumulated.

If you're like Jeremy and have never bought property before, then it's hard to understand that mixed emotion of fear and excitement of taking on so much debt while parting with so much cash at the same time. If you've never done something, why is it that you feel you know better?

Real estate is a very concentrated asset class. Spending a couple thousand dollars purchasing a stock is much less frightening than dropping $120,000 on a $580,000 property while taking on a $460,000 mortgage.

2) You've got to create your own luck. All of us are lucky to some degree. To not recognize our good fortune in a world full of suffering would be selfishly ignorant. I spent a day touring the De-Militarized Zone (DMZ) at the North Korea and South Korea border, and I'm completely humbled and saddened by what transpired after the Korean War. Appreciate what we have folks! Plenty of people don't even have electricity, let alone internet access. We've talked in depth about money guilt in the past, and I think it's good exercise to continue talking about money guilt as we embrace our luck to keep ourselves balanced.

If we want more, then we've got to take on risk. Keeping all your money in a savings account will never bring you outsized returns. Holding on to a safe, but boring job will never give you the fulfillment you're seeking. It's hard to have an exciting life if you don't take any leaps of faith. The fear in our mind is often much worse than reality. Remember, we come from a default setting of good fortune by living in a developed country!

3) Our experiences shape our beliefs. The reason why I love reading blogs way more than news sites is because I want to read about other people's experiences. I don't want to just read the news, I want to read an interpretation of the news by an experienced author.

My experience with my first property has so far turned out fine. Yes, there were some concerning times with the financial crisis and pesky neighbors, but for the most part, I'm glad I took some risk to buy in 2003 than not. My experience in the stock market was much more visceral because I not only invested in equities, but I also dedicated a career to equities. The turbulence was tremendous!

When I purchased my property in June, 2003, the S&P 500 was at 990. Just three years prior the S&P 500 peaked at 1,498 for a 35% drop. Investing was not as easy as now, where everything seems to just go straight up. The S&P 500 is now ~200% higher than in 2003.

The condo was purchased for $580,500 and comps have the value somewhere around $1,250,000 to $1,350,000. I wouldn't sell it for under $1 million because it is a prime 2/2, Pacific Heights condo over looking an $11 million renovated park with parking. But let's use a $1.2 million sales price to calculate a more conservative 107% return since 2003.

A 107% property return is a 50% lag compared to a 160% return in the S&P 500. The thing is, I enjoyed the return so much better due to the stickiness of the rent and much less volatility. Meanwhile, if one were to calculate a cash-on-cash return of a $116,000 down payment, then the returns would be closer to 400% if I didn't continuously pay down principal over the years.

I'm just comparing the equity amount in this particular property to what I have in my 401k, which I've maxed out every year since 2000. The property equity is at $1 million since I paid off my mortgage this year. Meanwhile, my 401K, which is now a rollover IRA is only around $420,000.

There's something to be said about consistently paying down principal, earning rental income to pay down principal, and letting inflation take its course. To me, owning this property over the past 12 years was a much better experience because it felt automatic.

4) Make some predictions and act. There's no use pontificating all day long if you never take action on your beliefs. I currently believe San Francisco is still one of the world's cheapest international cities. There's no other coastal big city that I know of where you can buy panoramic ocean view properties for under $1,000/sqft. It is my belief that San Francisco will continue to get “discovered” by international buyers who want to diversify their capital – Chinese buyers in particular.

Given my beliefs, I decided to take several hundred thousand dollars from an expiring CD in 2014 and look for panoramic ocean view properties in Golden Gate Heights for a couple months. It would have been much easier, and much less risky to roll the CD proceeds into another long-term CD.

I found two properties that I bid on. One was a dream property that went for a whopping $600,000 over ask (50%), which I lost. Discouraged, I kept on looking until I found my current place, a fixer with ugly wall paper, green carpets, linoleum floors, and a tiny 36 sqft bathroom downstairs. Nobody wanted to take the project on, which is why I was able to buy it for under asking.

Taking on a fixer takes a tremendous amount of courage because you've got to then take action to create value. Spending $120,000 to fix the place up is not luck. It's a consistent test of faith every time you cut a $10,000+ check to a contractor!

So far, the SF market has not fallen off a cliff with some comps in 2019 trading now at $1,100 – $1,400/sqft for similar views compared to under $800 / sqft in 2014. Let's see if the luck continues.

5) Manage your net worth as you see fit. Buying another property with debt in June 2014 made me uncomfortable. If investing in something gives you zero fear, then there probably isn't much of a return at all. I decided that by taking on this new mortgage, I would pay off my higher interest rate mortgage I took on in 2003 by the end of 2015.

Over the next 12 months, I aggressively paid down another $100,000 in principal from cash flow after paying down $150,000+ in principal from a mortgage arbitrage. Now the mortgage is completely paid off. Paying off a mortgage early takes a lot of discipline because there's constant temptation to use the money for instant gratification.

Managing your assets and liabilities is extremely important to sustaining wealth because our lives are always changing. There are too many incidences where someone is over-leveraged, and ends up in financial ruin when a downturn hits. Don't let the bull market convince you that you're suddenly an investing genius.

LUCKY INVESTMENTS ALL AROUND

As for getting lucky investing in San Francisco, well that's obvious. But before buying in San Francisco, I could have bought anywhere in the country, just like I could have bought any stock.

I could have bought a 2/2, 1,500 square foot condo on 22nd near Madison Park in Manhattan with two balconies and a view of the Chrysler building in 2001 for $799,000, but I didn't! That property has to be worth over $2 million today. Damn it! Now that would have been really lucky.

The main thing that prevents people from buying is generally the down payment. Was having the down payment to buy in SF luck? I guess. But don't tell my younger self that because he'd get pissed at anybody who thinks studying for 6-8 hours every day in college while living frugally in a studio with another fella after graduation in order to save 50%+ of his income for years was luck.

Let's forget about my lucky break of seeing $750,000 in equity over a 16 year time period. I just visited an old friend in Kuala Lumpur, Malaysia, whom I thought was just middle class.

Her parents owned a couple, one story houses joined together in the center of KL since the 1970s. Neither house was anything special. One house was for grandma and her in-laws, and the other house was for her parents, her sister, and her. I thought I was just going to crash in one of the rooms while visiting. Instead, I arrived at her new 6,300 square foot mansion with 15 foot high ceilings, swimming pool, and five car parking! What the heck happened in the 24 years since we last saw each other?

Well, the property her parents purchased in 1970 for 30,000 ringgit ($8,333) was sold to a Taiwanese developer for 30 million ringgit ($8,333,333)! After 44 years, now that's what I call getting really, REALLY lucky! The GDP per capita in Kuala Lumpur is only about $17,000. So the $8.33 million sale is more like a $23 million sale in the US.

Check out the picture where her property use to stand. Tall building to the left, across, and to the right. Damn, why didn't my parents buy land around her area back in 1987-1990 when we were there? We'd be so damn lucky, I wouldn't have had to kill myself in the finance world for 13 years. I could work 40 hours a week and complain why it's so hard to get ahead. But without 13 years of constant hustle, FinancialSamurai.com might never have been born!

HOPE YOU ARE ALL LUCKY IN 10 YEARS

I've rarely met anybody who has invested in the stock market or real estate market who has regretted their purchase 10 years ago, let alone 44 years ago. Meanwhile, the vast majority of people who have regret are those who didn't buy and hold anything 10 years ago. The larger your regret, the more bitter you will be about other people's lucky breaks.

My preference is for investments that don't give me a heart attack. Real estate is stickier on the way down because rents are usually the same for at least 12 months due to the standard one year lease agreement. When the markets are going up, you can raise the rent, and track your property's value online based on comparable sales.

If you can keep your calm when stocks are cratering and just continue to dollar cost average, then stocks are great due to the ease of maintenance and liquidity. I just think at the margin, based on my experience, real estate has been a more rewarding investment.

I hope we are all lucky in 10 years with the investments we make today. In 10 years, those who didn't take any risks today will call us lucky. And our response will be, “You're absolutely right!”

TO RECAP STOCKS VS. PROPERTY

1) Buy property if you think you are lucky enough to aggressively save for a down payment, feel comfortable taking on debt, and holding for at least five years. It's important to have the lucky courage to make a concentrated investment in one asset. If your property turns into a rental, then you also need to have the luck to find good tenants and resolve problems as they rise. Your average real estate tracks the average annual inflation rate over the long term. Let's hope you get lucky and logically buy in an area that should see years of job creation. If so, your cash-on-cash returns could easily be in the double digits thanks to leverage.

2) Buy stocks if you are lucky enough to hold for the long term and not freak out whenever there's a downturn. You must be lucky researching the company's financials, participating with management on conference calls to make sure they are acting in shareholder's best interest, and pressing your bets when you think there is opportunity. Or you can just invest in an index fund, or let a professional try and outperform. Stocks have returned anywhere from 6-9% historically.

3) Allocate your money efficiently. Whatever you do, at least mobilize your cash. Stocks have the lowest hurdle. If you can't be bothered with actively managing your money, then invest with a low cost algorithmic advisory like Betterment. In the long run, it is very hard to outperform any index, therefore, the key is to pay the lowest fees possible while being invested in the market. Invest your idle money cheaply, instead of letting it lose purchasing power due to inflation.

4) Invest in both property and stocks for liquidity. If you don't have the downpayment to buy a property or don't want to tie up your liquidity in physical real estate, take a look at real estate crowdsourcing. Real estate is a key component of a diversified portfolio. Real estate crowdsourcing also allows you to be more flexible in your real estate investments by investing beyond just where you live for the best returns possible. Sign up and take a look at all the residential and commercial investment opportunities around the country.

5) Get the lowest mortgage rate possible. Check the latest mortgage rates online through Credible. They’ve got one of the largest networks of lenders that compete for your business. Your goal should be to get as many written offers as possible and then use the offers as leverage to get the lowest interest rate possible. This is exactly what I did to lock in a 2.375% 5/1 ARM for my latest refinance. For those looking to purchase property, the same thing is in order. If you’ve found a good deal, can afford the payments, and plan to own the property for 10+ years, I’d get neutral inflation and take advantage of the low rates.

Create your own luck. You'll be happy you did 10 years from now.

About the Author: Sam worked in investing banking for 13 years at GS and CS. He received his undergraduate degree in Economics from The College of William & Mary and got his MBA from UC Berkeley. In 2012, Sam was able to retire at the age of 34 largely due to his investments that now generate roughly $250,000 a year in passive income, most recently helped by real estate crowdfunding. He spends most of his time playing tennis and taking care of his family. Financial Samurai was started in 2009 and is one of the most trusted personal finance sites on the web with over 1.5 million pageviews a month.

Updated for 2020 and beyond.