Real Estate VS Stocks

In my first blog post, I discussed the pros and cons of investing in a syndication versus a REIT. Now I want to talk more broadly about the merits of stocks versus real estate. This is an age old argument and for most people, it boils down to personal preference. However, comparing the two based on yield, total return, tax advantages, leverage, scalability, and barriers to entry shows that real estate is a far superior asset by which an investor can sustain long term growth as well as current income. We can explore each of these metrics for both stocks and real estate.

First on the list is yield. Yield means the amount of income the asset produces relative to the asset’s price. For stocks this is known as a dividend while for real estate this is called a cap rate. Some growth stocks don’t even have a dividend while The Vanguard High Dividend Yield Index (VHDYX) delivers a 2.89% dividend and came up on Investopedia.com as the number 1 dividend index. A 2.89% yield in the real estate world is laughably low. The only place to find this low of yield is in extremely safe and overvalued markets such as New York City and Silicon Valley (two of my favorite places!). More moderately priced markets have yields (cap rates in real estate terms) in the range between 6% to 9% while still not taking on much risk. Additionally, there are two major factors that further differentiate this higher yield coming from real estate compared to stocks: leverage and tax advantages. I have already written a few blogs about the tax advantages of real estate (go read them!) but basically if structured correctly, these real estate yields should be tax-free. Contrastly, the taxes on stock dividends are usually 15% and at least another 15% in long term capital gains tax when the stock is sold. This further separates the returns of real estate from the returns of stocks. Leverage, another term for debt, is another beautiful advantage to real estate investing. When cost of debt is lower than the yield then the asset’s returns grow with more leverage. For example, buying an apartment building with a 25% down payment allows an investor to purchase a property four times as expensive than if he or she were to buy it with just their cash! A piece of real estate is “positively leveraged” if it has a cap rate (yield) of 8% and cost of debt (interest rate) is 5%, which is average in our current lending environment. This spread of 3% of yield versus debt results in huge returns. With a 25% down payment, the return goes from the original 8% yield to 17%! Comparing a 17% return to a 2.89% return of stock dividends is a tough realization to swallow. This begs the question: why aren’t more people selling their stock portfolio and investing in income producing real estate. The answer is it seems daunting and it is difficult. I will be writing future posts about how to identify good deals as well as manage property. But just because real estate is difficult doesn’t mean it is a good idea to gamble in the stock market just because it has gone up for most of your life. The unfortunate difference that many fail to understand is that just because a stock goes up significantly in value, the passive income from the stock is not enough to supplant one’s day job income.