Should You Invest in Stocks or Real Estate?

Should You Invest in Stocks or Real Estate?

 

When I decided to write my book The Alternative Investment Almanac: Expert Insights on Building Personal Wealth in Non-Traditional Ways, I did so with the hopes of shedding some light on common misconceptions that exist in the investment world. I think, by far, the biggest misconception that exists is that an investor feels that they have to switch strategies and allocate 100% of their portfolio into something new and better, when in reality, they just need to tweak or adjust what they are already doing. Too often, I run into a real estate investor who sold all of their stocks to buy real estate, or a stock investor who thinks that flipping houses and single-family rentals is the only available option to investing in real estate, so they choose to never look into it further. Both of these all-or-nothing strategies are variations of the chase the shiny object syndrome (CSOS) that too many investors suffer from.

 

Are You a New Investor?

 

Whether you are a brand-new investor or Warren Buffet, the barriers to entry in the stock market are almost nonexistent. If you are a new investor, the widespread popularity of brokerage accounts that offer free trading have made investing in stocks incredibly easy and cheap. I am old enough to remember the days when I paid for my stock trades, and those trading fees made purchasing small amounts of stocks impractical.

There is also the ability to sell a stock at any time that’s appealing to new investors. The idea of investing for an extended time period can be daunting when you have student debt and other major life events to save for.  

Real estate, on the other hand, still has a significant barrier to entry: It requires more capital to get started. There are crowdfunding platforms that allow for smaller investments, but significant funds are generally a prerequisite for most deals. When it comes to the lower minimum investments, sometimes it’s better not to do a deal and to save your money rather than to invest in the first deal you come across.

There is also the option to purchase real estate yourself, but this involves much more active participation from the investor; for the sake of comparing apples to apples, I wish to only compare somewhat passive investments. No investment is 100% passive, but there is a clear difference in your involvement when you purchase a stock and when you purchase a rental property. A fault that I find in many articles that discuss this very topic is trying to compare stocks to buy and hold rentals or fix n flips. The more appropriate comparison would be stocks with professionally managed real estate, whether it’s through a private equity company or a crowdfunding platform, etc. The logistics are similar for the two types of investments. You do your research before you buy and, for the most part, your involvement stops after the investment. You’re not expected to become the CEO of the company whose stock you buy, and the same goes for the investments you make in the professionally managed real estate company.

 

Who Can Invest in Professionally Managed Real Estate?

 

When I researched this topic for my book, I was surprised that the discussion around the stock vs. real estate debate focused more about some of the general pros and cons of each rather than the big picture of investing and whether the investor is accredited or not.

This is the most common definition of an accredited investor, according to the U.S. Securities & Exchange Commission (SEC):

A person must have an annual income exceeding $200,000 ($300,000 for joint income) for the last two years with the expectation of earning the same or a higher income in the current year. An individual must have earned income above the thresholds either alone or with a spouse over the last two years. The income test cannot be satisfied by showing one year of an individual’s income and the next two years of joint income with a spouse or has a net worth over $1 million, either alone or together with a spouse (excluding the value of the person’s primary residence)[1].

Once an investor becomes accredited, the discussion changes so significantly that it actually becomes a completely different conversation. Many high-earning professionals or retirees fall into the accredited designation but are unaware that they have access to a whole world of investment options that don’t involve changing toilets and evicting problem tenants. These options allow them to invest in institutional-quality investments where they are not expected to be involved in the management decisions similar to how they would invest in stocks. There is also a common misconception that investing in real estate investment trusts (REITs) is similar to investing in private investment deals—trust me, it’s not!

 

I Do Invest in Real Estate—I Own REITs!

 

The main reason an investor invests in real estate is to diversify their portfolio because of the  low correlation to the stock market. In simple terms, just because the stock market goes down 10%, which it regularly does on an annual basis, doesn’t mean the apartment building you invested in has gone down 10%, as well.

The benefits of having an asset with low stock market correlation goes out the window with REITs. Given their high yields, REITs are supposed to weather the market decline relatively well because their yield creates a natural downside buffer. However, sometimes the buffer is more theoretical than REITs advocates may have you believe.

During the 2020 COVID decline, when stocks—including REITs—saw a correction of 35%, yet most private commercial real estate, except retail, hardly moved.

Most private deals paused, saw an adjustment in their business plan, and moved on. Very few deals traded hands during the COVID sell-off, resulting in an exceptionally calm market during incredibly unknown times compared to the massive price movements that were happening daily on Wall Street. The buffer of the high yield was nowhere to be seen.

 

Image credit: Yahoo! Finance

 

How Do I Invest for Income in the Stock Market?

 

These words are ones that I myself used for many years as I frustratingly went through one income investing strategy after another. During those years, I traded options, bitcoins, growth stocks, value stocks, closed-end funds, master limited partnerships (MLPs), utilities, REITs, and dividend-paying stocks. But every time I thought I was on to something promising, my strategy unraveled. Take for example my income strategy with MLPs in the oil and gas space. MLPs are billed as midstream companies that are “toll collectors” that are supposed to have very little commodity price exposure to oil and gas since the companies themselves don’t explore and sell the commodity. All you have to do to see that this is not the case is pull up performance records of the largest MLPs during the 2020 oil crash to see the correlation between their stock price and the price of the commodity.

I came to the realization that the stock market was a great tool for asset appreciation, but unfortunately, the benefit of its almost universal liquidity comes with unlimited volatility which, in turn, creates income uncertainty. So, in a way, I answered my question after eight or so different strategies failed on me: You don’t invest in the stock market for income.

 

Leverage Your Personal Knowledge and Network

 

Your network is your net worth” is a credo in the alternative investment space, especially real estate. As an investor in a stock, you usually don’t have access to the CEO of the company in which you hold ownership. (Aside from being impractical, that would probably be considered insider trading.) With stocks, you are forced to rely on analyst’s coverage to make decisions but in the private real estate space, you are given “inside information” on your investments readily and regularly, usually on a monthly or quarterly basis from the operator or as often as you would like (within reason) by reaching out to the operator yourself directly. This is because your investments aren’t traded on the open market so there is no unfair advantage by disclosing the information. Even more important, you also have the option to network with other investors, who are a great source for “inside” information on their deals. Think about the exponential learning curve if an investor of five private real estate deals can network with five other investors who each have their own five deal portfolios. While some deals may overlap, you may be able to leverage the combined knowledge of 30 deals within a short period of time. This means you can know which markets, operators, and business models are working prior to your next investment decision. The ability to network with other investors and operators removes a layer of passiveness but at the same time increases your odds of filtering information from your own network and not just the overwhelming amount of Wall Street opinions.

 

The Differences Between Stocks and Real Estate in a Different Light

 

If an investor can look through at the differences (a.k.a. the pros and cons) of both, they can actually see very complementary assets.

Almost every article I came across during my research mentioned liquidity as a pro to stocks and a con to real estate, but isn’t that oversimplifying matters? What about when the market is in a free fall like during the Covid 19 correction? Suddenly, liquidity becomes a tremendous negative for stocks, and the lack of liquidity becomes a stabilizing force for private real estate.

There is also the ease of getting started in stocks that private real estate can’t match early on, but private real estate makes up for it when the investor is accredited and has built a network that they can leverage. An investor does need to factor in the time it takes to build up their investment network, and it’s comparable to an investor picking individual stocks vs. investing in index funds, with the latter requiring considerably less time to be effective. An ideal asset allocation should match the investors’ overarching needs. My personal preference is to use 1% of my investment mental bandwidth on a low-cost index fund and save the other 99% of my mental bandwidth for alternative investments like real estate. By doing it this way, I still get to participate in the stock market’s long-term appreciation, but account for the index fund’s inefficiency at producing income. As I write this article, the yield for most index funds is under 2%—typically around 1.5%. That’s just $1,500 worth of annual income for every $100,000 invested. Most private real estate deals offer considerably higher yields even with the fees associated in investing in such deals. And while most private deals have the potential to appreciate as well, it’s the income component of private real estate that complements the stocks’ ability to appreciate so well.

 

Stocks and Real Estate

 

For most stock investors, a well-diversified portfolio means a well-diversified stock portfolio, whether it’s exchange traded funds, mutual funds, or bonds rounding out their diversification.

And for most real estate investors, a well-diversified portfolio means a well-diversified real estate portfolio whether it’s single-family rentals, apartment buildings, or other commercial real estate rounding out their diversification.

While there are just a few examples mentioned in this article, and there are many other pros and cons to stocks and real estate to consider when deciding on your portfolio allocation, I think investors need to start thinking that it’s not an either/or scenario; instead, they should think about ways to invest in both stocks and private real estate in a way that helps them reach their overarching investment goals.

[1] “Updated Investor Bulletin: Accredited Investors.” Updated Investor Bulletin: Accredited Investors | Investor.gov, 31 Jan. 2019, www.investor.gov/introduction-investing/general-resources/news-alerts/alerts-bulletins/investor-bulletins/updated-3. 

 

 

If you liked this article and wish to continue on your path in learning about alternative investments, please make sure to check out my other educational articles as well as my bookThe Alternative Investment Almanac: Expert Insights on Building Personal Wealth in Non-Traditional Ways

Disclaimer: The information presented in this article is for informational purposes only and does not constitute professional financial or investment advice. The author does not make any guarantees or promises as to the results that may be obtained from it. You should never make any investment decision without first consulting with your own financial advisor and conducting your own research and due diligence. Even though, the author has made reasonable efforts to ensure that the contents of this article were correct at press time. The author disclaims all liability in the event that any information, commentary, analysis, opinions, advice and/or recommendations contained in this article results in any investment or other losses. Your use of the information in this article is at your own risk.

 

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