Round 1. Fight!
Okay, it’s not a video game, it’s your life savings and you’ll lose a lot more than a wasted pile of quarters in an arcade machine if you lose the fight. In truth, both investment vehicles are good things, but we’re here to get into the nitty-gritty numbers and see which is better on average. That said, this article is going to be strictly about those numbers rather than other, functional factors. I covered most of that last week when I gave you my “Top 8 Reasons to Invest in Real Estate.”
Before we launch into our comparison, it’s important to understand how returns in each case are measured. With the stock market, it’s pretty simple. You buy stocks (or a group of stocks packaged in a mutual fund) and they either go up or down in value. If you bought shares of XYZ at $10 per share and it’s $11 per share at the time you want to measure your returns, you gained 10%. If you have collected dividends, you can add that to the total and figure out the percent return on investment from there.
With a real estate investment, it can be more complicated, depending on if you are holding and renting or just flipping something. Obviously if it’s a straight sale, you can compare the sale price to the buy price, subtract all the costs incurred during your holding period as well as the transaction, then get your ROI from there. For example: you bought a home for $140,000, spent $60,000 fixing it, and held it for a year where you paid $4000 in property taxes. You sold it for $250,000, but paid 5% to realtors so really made $237,500. In total, your profit works out to $33,500, or 16.4% ROI.
If instead you are holding a property as a rental or commercial lease, then your returns are measured by the annual income from the property vs. the current value of the property. For a more complete picture, you have to figure in loan costs (“debt service”), but also consider tax benefits. At then end, you may also profit from a sale and that gain would have to be factored in to the final measurement.
Of course, these quick example scenarios don’t take into account income or gains taxes, but those factors can both be mitigated depending on the nature of the investment vehicle or next investment (1031 exchanges, for real estate come to mind).
Allllll that said, the only way to do a meaningful comparison is to look at the averages in each market over time. The best you can do when making such decisions is to play the odds and give yourself the best probability of success. So, the crux of this article comes down to…
- 20-year average returns in the stock market, as measured by the S&P index, have been approximately 8.6%.
- Average 20-year returns in commercial real estate have been approximately 9.5%.
- Residential / mixed-use returns have a 20 year average about 10.6%.
- Real estate investment trusts (REITS) have a 20 year average of 11.8%.
These averages span the last 20 years and include the big crash in 2008.
In truth, I feel the best strategy is a mixed one. I like the idea of investments where I can effect the value, as with any standard real estate investment. I also like the idea of passive income, as with stock index funds or REITS. Anything in which your money is working for you instead of you trading hours for dollars is a win.
If you’re interested in a more granular look at the numbers, see this article on Investopedia.