Real Estate Vs Stocks Vs Bonds
Updated: Dec 1, 2022
Inflation is currently very high at the time of writing this. This past year, it has been recorded at over 7%. Finding proper investments is as important now as ever. There are three primary vehicles to invest in: stocks, bonds, and real estate (commercial). Real estate when mentioned in this article is commercial real estate having the purpose of providing a profit, not a primary residence. Below are the average returns of the stock market, bonds, and real estate. Besides comparing and contrasting returns, an investor must consider liquidity, tangibility, transaction costs, leverage, cash flow, appreciation, and tax implications with different investments.
Stocks - Average Return Since 1970
Bonds - Average Return Since 1992
Real Estate - Average Return Since 1928
One of the largest advantages of owning real estate over other investment vehicles is its tangibility. Real Estate is real property. Real property cannot disappear or be taken (unless taxes are not paid). It will always be needed and it can be passed down from generation to generation.
Although not necessarily quantifiable, having a real asset brings safety and peace of mind. Businesses come and go, due to popularity or leadership, but real estate is forever. Bonds are more stable than stocks, and if buying a municipal bond or similar, it is backed by the government. However, a return backed by the government is not as competitive with the rest of the market due to the low risk. A corporate bond will likely offer a slightly higher return than a municipal bond but is still based on the business. A real asset brings benefits that other vehicles cannot provide.
Real Estate is a tangible asset that lasts forever, however, with that comes a higher transaction price. Real estate has many costs upon purchase and sale, usually anywhere from 5-8% each time. Each state has a different transfer tax requirement and if leverage is used, there are costs to that as well.
Stocks can be traded in a few clicks. There may be small fees associated with a purchase or sale depending on the platform a user is trading on, but it is low compared to the transaction costs of real estate. Bonds are usually traded by a broker and have transaction fees, but similar to stocks, they are minimal.
Another aspect to consider is the liquidity of the investment. Stocks have the highest liquidity of the three vehicles. Stocks can be traded instantly and the value that is shown is the value that is received. After a stock is sold, it takes only a few days before the cash is deposited in a bank account.
Bonds are much less liquid than stocks. Bonds are intended to be purchased and held until maturity (maturity usually between five and thirty years), however, if an investor needed to cash out bonds, they could do so. There may be fees involved and the value would be less, however, the bond could be sold and the funds returned within a few days if done online. If done by mail, expect three to four weeks.
Real estate is the least liquid investment. Real estate is costly to transfer and the transfer itself takes a few weeks at least. Even in a cash purchase, it takes at least ten days for a title company to process. When leverage is used, it often takes forty-five to sixty days to close a sale or purchase.
Barrier to Entry
Stocks and bonds have a low barrier to entry. Stocks and bonds can be purchased in small or large amounts and at any time. If an investor only has a small amount of capital to invest, they can choose to invest in a less expensive stock or purchase a small number of shares. The same applies to bonds, the face value and number of bonds are up to the investor.
Real estate's barrier to entry is high. An investor is likely to need a minimum of 25% down in most cases, sometimes more. That means if a property costing $500,000 is purchased, an investor needs $125,000 for the down payment, plus closing costs. Plus, if leverage is being used, the investor must qualify for the loan. Although necessary, there is much more preparation needed than investing in stocks or bonds.
Real estate may have higher transaction costs and be less liquid, but it has the massive tool of leverage available. Leverage increases the return of the asset dramatically because the cash needed to purchase is much lower. For example, an investor can purchase a $1,000,000 asset for $250,000. This increases cash on cash return, ROI, and IRR. Keep in mind, that leverage does increase the risk of the investment as there is debt involved.
Stocks and bonds do not have leverage available unless an investor is considering a personal loan or line of credit which is extremely risky, and not advised.
A unique offering of real estate is its ability to produce ongoing cash flow which increases as inflation increases rents. Bonds will produce a monthly, quarterly, semiannual, or annual interest payment for the life of the investment which is consistent. Stocks will not produce cash flow.
Real estate also offers highly prized tax benefits. Real estate benefits from the use of depreciation and cost segregation which reduces the investor's taxable income. Often, investors can show a "paper loss" from depreciation which allows them to show a loss on their taxes which offsets gains from other investments even if they receive distributions from the investment. However, there will be tax at the sale of the asset just as there is with the sale of stocks.
When investing in stocks, the returns are not controllable. The investor is at the mercy of the company and the market. When investing in bonds, the investor knows the value they will be receiving from the start, and it remains the same. When investing in real estate, the investor carries out a strategic business plan. The business plan should be modeled around increasing income and decreasing expenses to increase the NOI and therefore, increase the value of the property. This business plan is controlled by the investor, forgoing any macroeconomic impacts, for better or worse.
So, which investment vehicle is the best?
As you may be guessing, it depends! An investor must identify their goals for investing, their risk tolerance, and their financial situation. That being said, here is our conclusion.
If an investor is looking for a small capital investment and high liquidity, the stock market would be a good fit, given the higher risk.
If an investor is looking for small capital investment, low liquidity, and low risk the bond market would be a good fit.
If an investor is looking for higher returns, stability, cash flow, tax benefits, generational wealth, and passive income, we recommend real estate.