Real estate vs. stocks, which is better for you and your investment goals? When you invest, you want to achieve the results you expect. So, it is important to understand the pros and cons of what you invest in and not just follow the crowd.
When you look at the most successful long-term investors, they tend to take an intelligent and diversified approach. They know that investing isn’t a monolithic single-asset-type endeavor. Instead, it’s a combination of multiple asset classes in differing ratios to get them where they want to be based on their time horizon, risk tolerance, and tax strategy.
This is portfolio construction, and it’s critically important. To be clear, I’m a principal in a multifamily-focused private real estate firm, but I still have some exposure to stocks and bonds. I also hold precious metals, business interests, collectibles, etc.
The Big Three Investments
The three largest investment asset classes are Stocks, Bonds, and Real Estate with a combined overall market size of over $100 trillion as of YE 2022. Each primary asset class has distinct characteristics, risks, tax impacts, and potential benefits for your investment portfolio.
Stocks are ownership shares in public companies. Equities is another term. Ideally, you would make money corresponding to the company’s operating performance, but that’s not really how it works. Stock investing results are driven by a massive consensus engine called – “the market.” The market is composed of millions of players worldwide with differing and, often, conflicting interests, time horizons, strategies, etc. Over time, several approaches have been used to make sense of the market. Some approaches work some of the time, but none work all the time.
Common Approaches For Investing in Stocks
Some of the most common stock investing approaches:
- Buy and Hold: A long-term strategy where investors purchase and retain stocks for extended periods, irrespective of market volatility, banking on the historical trend of stocks appreciating over time.
- Value Investing: Focuses on picking stocks believed to be undervalued compared to their intrinsic value.
- Growth Investing: Focuses on companies that show above-average growth potential in the future.
- Dividend Investing: Focuses on companies that regularly distribute dividends, offering a steady income stream alongside potential capital appreciation.
- Active Trading or Day-Trading: Involves frequent buying and selling to capitalize on short-term fluctuations in stock prices.
- Managed Investing: Managed investing refers to the investment approach where a professional or a team manages an investment portfolio based on a strategy. Many mutual funds fall into this approach.
What Are The Major Stock Indexes in The U.S.?
If you compare real estate vs. stocks, you need to understand indexes. Indexes measure the performance of the markets they follow. Stock indexes reflect the performance of the market or a portion of the market depending on what the index includes under its umbrella.
The marketplace where stocks are bought and sold is collectively called the stock market. It comprises 13 separate stock exchanges in the U.S. and sixty major global exchanges. Some of the major stock indexes in the United States are:
- S&P 500 (Standard and Poor’s 500) index reflects the performance of the top 500 companies in the U.S. This index reflects roughly 80% of the total market performance.
- Dow Jones Industrial Average (DJIA) only represents about a quarter of the overall market value. It focuses on the largest thirty top blue-chip, dividend-producing companies.
- The Nasdaq Composite Index is widely recognized as representing the performance of the technology market.
- Wilshire 5000 Index includes all publicly traded companies, making it the total market index.
Advantages and Disadvantages of Stock Investing
All investments have risks, so it’s essential to understand what the risk-reward profile looks like for each investment. Some of the advantages of the stock market are:
- An efficient market that allows for easy acquisition
- Ease of disposition or high liquidity
- Historically high returns
- Opportunity to realize returns from growth and dividends
- There is a large selection of assets and sectors to choose from
- The ability to buy various stocks together in the form of mutual funds
- Index funds simply buy stocks in the index and remove the need for active management and their associated fees
Disadvantages of the stock market include:
- High volatility in stock prices
- Risk of overexposure to one sector and individual stock-picking
- Subject to an emotional rollercoaster and the Dalbar effect, where individual investors historically underperform the overall market
- Competition from professional investors puts individual investors at a disadvantage in what is considered a zero-sum game
- Leveraging stock, or margin trading, amplifies risk in an already high-risk asset class
- Not tax efficient
Real Estate Investing
In this discussion of real estate vs. stocks, let’s turn to real estate. There are a multitude of ways to invest in real estate.
Generally, real estate can be divided into two broad categories – residential and commercial. Residential real estate is property people live in. Residential properties are single-family homes, duplexes, triplexes, and quads.
Commercial real estate is property that is used for business or investment purposes. The six primary categories of commercial real estate are:
- Hospitality (Hotel)
- Special Purpose
Special purpose real estate is that commercial real estate that doesn’t fall into one of the other categories. It includes things like storage units, land, car washes, etc.
You can invest in any of these property types as an active investor or passively. But unless you have the time, experience, and expertise required to manage these properties profitably, you’re likely better off being a passive income investor.
Passive investors invest alongside professionals to leverage their experience and expertise in the industry. This increases their odds of making money.
Passive investors have the added benefit of time freedom as they rely on professionals to manage their properties. Without management responsibilities, passive investors don’t get their hands dirty.
Note: You should not consider your primary residence a real estate investment. Successful investments should put money in your pocket. Your primary residence is your home and not an investment. Liquidity concerns, emotional attachment issues, market volatility, opportunity costs, cost-of-living, maintenance, and upgrade costs are all managed differently with rentals.
How Do Real Estate Investment Properties Generate Returns?
Real estate investment properties generate income primarily through rental income and equity growth (capital appreciation).
Real estate investors who purchase properties for cash flow can earn a steady income stream by renting their properties to tenants. This rental income can cover the rental property’s expenses, such as mortgage payments, property taxes, property managers, and maintenance, with the remainder serving as profit for the investor.
Additionally, as property value and real estate prices tend to increase over time, investors can benefit from capital appreciation. Equity also grows in the property as they pay down the debt. This means that when they decide to sell the rental property, it may fetch a price higher than the initial investment costs, resulting in a capital gain. Moreover, real estate investments often offer tax advantages, further enhancing the profit potential.
Advantages and Disadvantages of Real Estate Investing
Some of the advantages of investing in multifamily real estate are:
- Historically strong risk/adjusted returns
- Lower risk/volatility
- Hedge against inflation
- Recession-resistant nature / Evergreen asset class
- Tax advantages
- Solid diversification / Low correlation to stocks and bonds
- Can provide multi-source passive income
- Moderate leverage can be used to increase returns
Disadvantages of real estate investment properties include:
- Requires time-consuming active property management (by yourself or someone else)
- Requires expertise (either your own or one you hire)
- Access to funding can be difficult
Real Estate vs Stock Investment Returns
Data from S&P 500, NCREIF, and Bloomberg US Aggregate Bond Index
Since the turn of the century, private real estate has generally outperformed large-cap stocks. Over the same time period, real estate also outperformed the bond market (Bloomberg U.S. Aggregate Bond Index).
So, should most people divest in stocks and bonds and buy all real estate? Of course not. Nor should they go all in on stocks or all in on bonds. Instead, they should evaluate their financial wellness, risk tolerance, and time horizon.
Once they do that, they can construct a diversified investment portfolio that maximizes their returns within the level of risk they are comfortable with. The tenets of modern investment strategy and portfolio theory place a premium on diversification with non-correlated assets. Stocks, bonds, and direct real estate have a long history of being non-correlated with one another.
What Are The Major Real Estate Indexes in The U.S.?
It’s important to note that a handful of stock indexes track the performances of real estate investment trusts (REITs). This is an important distinction that some people get confused about. REITs are stocks that are traded on a stock exchange. When one invests in these companies, they invest in companies that own real estate. Therefore, REITs are stocks in the sector of real estate. That differs from owning direct real estate, and I talk more about the difference in this article.
The two most common indexes you’ll encounter for private real estate ownership are:
- NCREIF Property Index (NPI)
- NCREIF Fund Index – Open End Diversified Core Equity (NFI-ODCE)
The NCREIF is the National Council of Real Estate Investment Fiduciaries. It’s a non-profit entity founded in 1982 to inform interested parties on the performance of the real estate markets.
NCREIF Property Index (NPI)
NPI is an unleveraged composite total return index fund for private commercial real estate. It comprises roughly 12,000 properties collectively worth approximately $900 billion in asset value at the time of this writing.
These properties are located in every region of the U.S., and NPI is reported quarterly. Office, retail, multifamily, hotel, and industrial properties are all represented within NPI.
NCREIF Fund Index – ODCE
The NFI-ODCE index comprises the performance of the 26 largest open-ended core private real estate funds in the United States. Currently, it represents roughly $341 billion in gross asset value and is diversified across property types and regions.
Unlike NPI, which reports unleveraged returns from private commercial real estate, NFI-ODCE reports low-leveraged (up to 35%) property fund returns.
37th Parallel is a Trusted Partner for Real Estate Investing
37th Parallel Properties is a private real estate acquisition and asset management company specializing in multifamily real estate.
We’ve been in business since 2008 and have maintained a 100% profitable track record over more than a billion dollars in transaction volume.
We’ve made our investors money in good times and bad, in bull and bear markets, and across multiple recessions. That’s because we know what works and put our investors first. We write articles like this one because it is crucial to help educate current and potential investors about the more nuanced parts of how to invest in real estate.
We Specialize in Evidence-Based Multifamily Property Investing
Just as doctors follow evidence-based medicine to do what is best for their patients, we practice evidence-based investing for the benefit of our clients. A balanced portfolio often includes stocks and bonds, but there is room for real estate.
After all, the research is clear. Over more than twenty years, a portfolio of stocks and bonds did not perform as well as one that included real estate. And with multifamily properties being the best long-term real estate category, it’s undeniable that most people should take a long, hard look at investing in apartments.
Don’t think of it as real estate vs stocks. Instead, it’s real estate and stocks. 37th Parallel Properties Income and Total Return Fund can be a great way to diversify into direct real estate and complete that ideal asset allocation right for you.
Contact Us Today for a Consultation
If you’d like to get started with 37th Parallel Properties or have any questions, schedule a time to speak with a member of our team.