Essential Knowledge Series
Ever wonder what is the better option for your money? People fight with themselves every day to determine what is the best option for them.
If you turn to the online community, you'll find gurus telling you one direction or another is the way to go. I won't be specifying what option I believe is the direction you should go, but rather give you insight into both options and let you make the decision.
I will be outlining the 3 most important factors for each investment approach.
Startup costs and availability.
Rates of return and volatility.
The cost of holding each investment.
1. Startup Costs and Availability
Depending on where you are located, this answer will vary. With real estate, you are going to have higher startup costs and lower availability than stocks. You are going to need money for the down payment and closing costs in order to purchase your first, second, or third property. This might not seem like the biggest burden for someone who lives in an area where homes are relatively cheap, but for others where real estate is expensive, this will be a significant burden.
Let's go through some examples.
Example #1: Purchasing a condo in Edmonton, Alberta, Canada.
In Edmonton, you might be able to find a condo rental investment opportunity for $100,000. In order to purchase this property, you will only need a down payment of $20,000 and closing costs in the $1,500-$3,000 range. Let's contrast this with example 2.
Example #2: Purchasing a condo in Hamilton, Ontario, Canada.
In Hamilton, you might be able to find the same size condo unit for around $500,000. In order to purchase this property, you will need to have a lot larger down payment of $100,000. On top of this, your closing costs will be in the $7,500 range. A pretty significant difference in terms of the cost to start in the real estate investment game.
This isn't to say it can't be done in either market, but your investment location will have a big impact on how much real estate you can purchase and the types of returns you will receive. In addition to the amount it costs to enter the real estate market, the availability to purchase is relatively low compared to stocks. Real estate is more scarce than stocks and you will have a much easier time finding a stock you like compared to a suitable property. Not that it can't be done, but there are thousands of stocks to choose from, while the number of homes you can actually afford will likely be in the single digits.
Let's move on to stocks. There is a small startup cost when it comes to investing in the stock market. Starting with $1,000 will get you a lot further in the stock market than it will in real estate. In addition, you have thousands of options to choose from. The major downside; all of those options can lead to you second-guessing yourself and might cause you stress when trying to choose. That, along with trying to create a diversified portfolio can make stock trading difficult. The last aspect to think about when it comes to stock trading is the fees associated with trading. Although it is nothing compared to the closing costs in real estate, be aware that you will have account fees along with trading fees. If you aren't careful, this can add up and eat into your returns quickly.
Whether you are looking at stocks or real estate, it might not be choosing one over the other but rather what can I afford now and in the future. Remember the words of Ghandi, "To lose patience is to lose the battle".
2. Rates of return and volatility.
The answer to this question is tricky because, in both avenues, you can experience amazing returns along with tremendous volatility. At the same time, there are times when returns might be negative or stagnant with minimal volatility.
With that being said, let's start with real estate and the examples we mentioned in the first section. Example #1 included a $100,000 home in Edmonton. In this case, the same reason the real estate is that cheap is the same reason your returns might not be as good. This is an example only so I won't be quoting exact stats but you might purchase that property for $100,000 and only be able to sell it five years later for $125,000. A 25% return. However, compared to example two, this 25% might seem ridiculous. That $500,000 home in Hamilton might appreciate to $800,000 in 5 years - a 60% return.
You can see why I said investing in real estate really matters where you are purchasing. Some of you are probably already thinking, "Alex, you forgot all about rental income and the fact that you leveraged your money". I haven't forgotten about either of these things. First, most of the time the rental income won't cover all of your expenses. When it does, that's fantastic. In those scenarios, you'll likely only net $50-300 per month. This is better than nothing but not useful for our scenario. The second part of that observation is the use of leverage, in other words - borrowed money. This is where you gain the most from purchasing real estate.
If you sold that $500,000 at $800,000, you would receive the $100,000 back (assuming minimal mortgage paydown for the sake of this example), plus another $300,000 for the home appreciation. Wow, just wow. That's $400,000 total from investing $100,000 initially - a 300% return! That is the power you can unlock in real estate while using leverage. This example didn't include closing costs and sale fees, but even if it did, you'd still be significantly positive. One thing to note is that leverage can work for you, or against you. If your home decreases in value, you'll be in a lot of financial trouble.
When it comes to stocks, the answer to the return question is pretty simple. There are going to be stocks that can make you 100% returns and stocks that can lose you 100%. Can this happen in real estate? Of course. But in North America, we've generally seen consistent increases in home prices. The same could be said about the stock market. However, as I mentioned before, with so many options to choose from, people can become confused and freeze up and not end up investing in anything. Alternatively, they invest in very risky assets altogether and miss out on the natural growth of the market.
In either investment, I always go back to the saying, the higher the risk, the higher the reward.
3. The cost of holding each investment.
When it comes to purchasing stocks, there isn't too much maintenance. If you have a long-term investment objective, you purchase the stock and hold it in your investment account until you want to sell. Pretty straightforward. I won't discuss options, shorts and other types of trading because unless you are a very experienced stock investor, you shouldn't be looking into those options anyways.
Real estate is a lot different. In order to be a successful real estate investor, you have to be willing to either renovate homes and flip them or hold homes and rent them. Both come with their own challenges. Flipping homes can be difficult if you aren't in the trades yourself and timing the market can be tricky. Holding a home and renting it out can be difficult because of the ongoing relationships you will have to maintain with tenants. Not to mention, vacancy, repairs and all of the maintenance costs of owning a property.
Overall, investing in real estate or stocks has its pros and cons. Is there a correct answer? No. Everyone knows their own situation and what they want to deal with. If you're someone who is okay with good returns and doesn't want to maintain a property, stocks are the way to go. If you're someone who loves building those relationships and maintaining properties, maybe real estate is for you.
One last note - this is not financial advice. Before you make any decisions, you should always talk to your financial advisor to help make the best decision for you!
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