Why I like stocks over real estate

There are two main reasons one might prefer stocks (and bonds) over real estate for the small time investor.

The first reason is diversification risk.  Houses are expensive, and unless you’re extremely leveraged, it is difficult to buy a lot of houses across a lot of different markets.  If your small area takes a hit or something goes wrong with your single rental, you don’t have a lot of other investments to balance that out.  It’s also more difficult to manage houses over a large number of markets than it is to just buy an index fund.

Now, you could just do a REIT, which is like stocks for real estate, but again, that’s focusing your money into one market.  Having some REIT makes sense as part of your portfolio if you don’t own your own house, or your own house is a tiny portion of your overall portfolio.  However, on average the REIT is going to match the stock market, so only focusing on real estate doesn’t trade off enough return for the lack of diversification.

The second reason is laziness.  It is easy to buy and sell index funds.  There’s always a buyer at market price.  If you need to unload stocks quickly by a certain date to turn into cash, you can.  You don’t need a good credit rating or the bank’s permission to do those kinds of things.  You just need money or stocks.

Directly managing real estate lowers those transaction costs that you have with longer-distance diversified real estate, but also adds more hassle.  You’re the one who has to deal with tenants, contractors, etc.  It’s a pain.

In addition, there’s a time factor.  Buying or selling an index fund takes no time at all.  Directly owning investment real estate can take hours.  Yes, your effort produces more value, but so would your effort in other directions.  Some people enjoy the small business aspect of real estate, but I do not.  I would rather earn more money through my day-job or other side projects.

Again, if you enjoy the process of buying and selling real estate, and you like dealing with repairs and tenants and so on, real estate investment can be a fun side project.  But if you don’t get utility from such actions, index funds are just as good on average and take a ton less time and emotional energy.

Have you ever dipped your toes into real estate investing?  Do you know anybody IRL who has done well with it?  Any horror stories?


33 Responses to “Why I like stocks over real estate”

  1. eemusings Says:

    I don’t know anyone in NZ who hasn’t done well, no. (Though I did read a horror story in the paper the other day about a LL who got screwed over by some nightmare tenants…) Our market keeps growing and growing. I don’t think I have the stomach for property investing, though.

  2. NoTrustFund Says:

    We have the vanguard REIT fund and our house but that is the extent of our RE portfolio. I know people who rent out a house or condo because they could not sell it at a price they were excited about. I don’t know anyone who has bought a piece of property with the intention of renting it out.

  3. plantingourpennies Says:

    We’re big fans of real estate – or rather, fans of cheap real estate. From 2009-2011, we went on a buying spree in our town in South Florida and bought as much as we could while prices were crashing. We ended up scooping up right near the bottom of the market in our neighborhood, same for our duplex, and near the bottom for our undeveloped canal lot, too. We like our own little version of a diversified RE portfolio. If prices were the same, we’d still be buying… but they’re far from the same, so the margins would be completely different.

  4. The frugal ecologist Says:

    I like the idea of real estate for income from rent, not as an investment that appreciates and will be sold as a profit. To me, if the net rental income is positive I thinks it’s worthwhile (sort of like dividend investing?). This is also assuming that you have a reasonable amount of equity and aren’t over leveraged. But you have to like dealing with tenants, maintenance, etc otherwise, totally not worth it.

    The RE investors that I know who got into trouble were flippers rather than landlords. I think the strategies & risks are very different.

    • nicoleandmaggie Says:

      The “on average” includes rental income. Same as stocks include dividends! (I got me some dividends today!)

      We know some landlords who have gotten into trouble. Heck, you can read about how everything went south when the box car kids got a tenant who wouldn’t pay and wouldn’t leave: http://www.theboxcarkids.net/wordpress/about-2/

      There’s also vacancies, which is a big money drain, though not as stressful as bad tenants.

  5. Moly B. Denum Says:

    Thank you so much for posting this! As a grad student with (maybe) enough savings for a down payment in an cheap housing market (but not in SoCal where I live) it has been very confusing trying to figure out what to do with my savings. I’ve come to the same conclusions you did, except that I feel like being in my 20s, the diversification is more important. If I make a bad decision or have bad luck, making it up will be much harder than if I did the same thing in my 30s. Who knows if that’s right. That said, I’ve been scratching my head for a while wondering what I was missing with all the PF bloggers so excited about real estate; it’s wonderful to know I’m the only one who isn’t 100% sold :)

  6. Linda Says:

    In general, I’m in agreement. However, I can think of an exception I’m comfortable with: being a live-in landlord. Here in Chicago, two and three-flat housing is quite common and it often can yield some great rewards for the owners that live on premises. You do still have to secure good tenants, but since you live on the premises you can pick up on those “bad decision” tenants much faster. You’re also exempt from the Landlord Tenant ordinance which gives you a bit more power. If you’re wise and purchase a two-flat at a price that you can pay the mortgage without securing top dollar rent, then you can take longer to find the perfect tenant. And since the property you live on is also a business investment, you can write off a lot of maintenance and improvements on your taxes.

    Before I started renting out spare bedrooms in my house, I talked with a colleague who owned a two-flat about her experiences in finding tenants, leases, etc. She told me with a big smile on her face that when she accounted for the cost of running the building (yard maintenance, snow removal, upkeep and repairs, etc.) she lost money every year. The loss is a tax write off, so essentially she gets a tax break for sharing her building with another person. Nice!

    I can say that it as worked out the same way for me. When I took on roommates/tenants, I wasn’t looking to make a profit on the rent, simply supplement my monthly income so I could build assets after my divorce. I was willing to collect a monthly rent that was a bit lower than average from people I thought would be better tenants/roommates. Adding up the costs to me (insurance, utilities, maintenance, etc.) I “lose” money. Of course, I would be paying for the maintenance and a good portion of the utilities without the tenants/roommates anyway, but now I get a tax deduction from it. :-)

    • nicoleandmaggie Says:

      ” exempt from the Landlord Tenant ordinance which gives you a bit more power” is cool

      My sister has a beautiful townhouse and rents out her bottom floor suite to a friend. I wonder if she gets tax benes.

      • Linda Says:

        Well, there is also the issue of depreciating the asset, too. I don’t quite understand it all, but I consulted with my accountant to make sure I wasn’t messing myself up before I started renting rooms. He wasn’t discouraging and fills out all the proper tax depreciation forms each year. I suppose if one was not wanting to risk getting a smaller “profit” when selling property (assuming that anyone thinks their home will appreciate at all these days) then this route would be less attractive. However, there’s also the issue that if one didn’t claim the income that came from rent then it would be tax fraud. So if you have to claim the income, then why not claim the expenses? Right?

      • nicoleandmaggie Says:

        Those all sound like good reasons to hire an accountant.

  7. Pretired Nick Says:

    Personally I have too much real estate and am looking to move some funds from that area to the market (if I can sell one of my buildings). Both can be great avenues for investing, but I find surprise repairs are a lot more common than surprise market crashes. My advice is to buy high-quality, low-maintenance property. It may seem more expensive at first, but it’s cheaper in the long run.

  8. Debbie M Says:

    Same here. My one house (that I live in) was over half my net worth until very recently, even though when I bought it, it cost only about 60% of the median price for houses in my city. I really did not know how to make it a smaller percentage of my net worth except by contributing as much as possible to my retirement funds, but my income was not cooperating. (1993: bought house for $61,500 with an income of just under 20K. 2013: House is supposedly worth 160K; income has merely doubled.)

    I have thought of getting house and having a property manager do all the work or switching to a duplex or something. But as you said, it’s just a big pile of money.

    I do use a REIT index fund for 10% of my IRA investments. So that’s about 2.5% of my total investments (my house is still almost 1/2 and my pension is still almost 1/4).

    Reading this did give me the idea that buying a REIT that’s highly correlated with my own house could be interesting. If both skyrocketed, I’d get extra income to help pay my skyrocketing property taxes and vice versa. I wouldn’t think there is such a thing as REITs made out of houses in an old neighborhood, though.

    I guess that’s similar to owning half a duplex or building a mother-in-law/garage apartment on your property. If values go up, your taxes go up, but you could also charge more rent.

    One issue is that if you never sell your house, it’s a weird kind of investment. For me, having a paid-off house means I don’t have to pay rent, but I do have to pay property taxes, more insurance than just renter’s insurance, more utilities than apartment dwellers pay, and repairs. But then if property taxes get too expensive, it’s probably because the house is worth a lot, so I could sell the house and have a lot of money to do something else with.

  9. investfourmore Says:

    I want my entire portfolio to be Real Estate! I love long term rentals for multiple reasons.
    1. As soon as I buy a property and fix it up, I am increasing my net worth by $20k to 30k dollars because the repairs add value and I buy them at 15% to 25% below market.
    2. I have control over my returns. I choose what property to buy, what to repair and who to rent to as well as how to pay off my mortgages. With stocks I have no control except which one to buy. Then I have to hope the company and the market does well.
    3. I only buy properties with great cash flow potential. I am getting over $500 a month cash flow from each property and my average property costs 100k. My cash on cash returns are all at least 24% in the first year. That does not include possible appreciation, mortgage pay down leading to equity increase or the incredible tax benefits.
    4. My properties are all single family homes and take very little management. All my income is basically passive with no work involved.
    5. I am in it for the long haul and because my cash flow is so high, even if rents drop 50% I will still be making money. If values drop it does not get me in trouble because I have no need or want to sell my properties anytime soon.
    6. When I retire I will be able to love off my passive income without eating into any principle balance of my investments. I won’t have to guess how long I will live or how well the market will do because I will have steady income flowing in from cash flow.
    7. By buying three properties a year my income projections show I will have over 300k in income a year after ten years with over 3 million in equity in my properties. And that is not adjusted for inflation or take into account any appreciation.

    I detail all of this in my blog if anyone is interested.

  10. MutantSupermodel Says:

    My grandfather did both and as he got older, he moved more into stocks and out of real estate until there were no real estate investments left. My youngest brother, I think, is going to end up just like him. Right now, he invests in stocks BUT he just bought a condo. It really is perfect for him right now. He is 27 years old and completely single. BUT it’s also a great future rental if he wants/needs it. Personally, while I understand the allure of real estate investment, it’s not for me.

    • Debbie M Says:

      I bought my house when I was single and, because I am attracted to mostly programmers and engineers, I figured I’d eventually want to move out into his pricy place, and then I’d rent mine out to college students.

      Turns out I’m with a late-starting, underpaid (i.e., barely richer than me) engineer who loves the location, so I won’t be renting it out after all. And it turns out that I don’t like the houses of my (engineer/programmer) friends after all. They are all too pricy for my blood (I don’t like working), too big (I don’t like mopping, etc.), too far out in the middle of nowhere (I don’t like driving), or some combination of these. So getting to stay put in a paid-off house and not move is a relief.

  11. chacha1 Says:

    My sister and her wife are buying a house in small-town North Carolina that they live in, and another that they rent out. After refinancing at least once per property, and doing extensive renovations to attract better tenants, they are finally starting to see some income that is not immediately consumed by repairs. It has been at least eight years since they started this process, and an early intention to become multiple-property owners has been abandoned. They have improved both properties significantly and should get a good return when they sell, but the thing about real estate is you have to sell it to see that return. They haven’t yet decided whether to accept the stupid sh*t that North Carolina is doing and stay there, or not.

    Some friends of ours have bought, renovated while lived in, and sold numerous properties here in Los Angeles. They purchased three multi-unit properties as well which they are managing as rentals, keeping aside one unit for when they are in town. Meanwhile, they are resident managers of a county recreation area and are living in a 35-foot RV. Both have been self-employed throughout their residence in the U.S. so they consider the rental properties their “pension.”

    My parents own a large and exhausting house on an estuary in Florida. They moved there because there was no state income tax, forgetting that “retirement” means you don’t have income subject to that tax. Property taxes, insurance, utilities, and maintenance on that property add up to approximately what DH and I spend for our large Beverly Hills apartment.

    DH’s partners used to own an old row house in San Francisco. They still live there but have a reverse mortgage. We don’t know what the hell they are going to do when they can’t manage the stairs anymore.

    DH and I are sort of planning to buy a property out of town for retirement. However, a lot depends on what happens with our parents. We may well end up being lifelong renters.

  12. Holly@ClubThrifty Says:

    I love real estate!!! It is a personal interest of mine and I even had my real estate license at one point. Anyway, I do agree that being a landlord can be a pain. My personal real estate philosophy is buy and hold. We bought our rentals when we were young, so they will be paid off before our kids go to college. Our plan is to use the rental income to help pay for their college then to help supplement our retirement.

    It definitely isn’t for everyone, but I do enjoy owning rentals….most of the time =)

  13. hush Says:

    To me, I have different feelings about investing in residential real estate vs. commercial real estate. My uncle started buying up residential apartments in LA in the late 1960s, and early on did all of the management and the repair work on them himself, then got big enough to outsource, and now in his 70s he has quietly become a multimillionaire for decades now, making money while he sleeps. But the thing is, he is comfortable letting his tenants live in not-so-nice places. He does not care if the exterior looks like crap. That is not my personality. I care too much about other people, and I am far too sentimental about the notion of home. I would spend way too much on making things look nice, and also, I hate when things go wrong in my own house. I don’t want to own any more houses – one is enough trouble! Commercial real estate though, that’s something I’ve invested in professionally, and it is a lot more comfortable for me personally. Not huge returns, but not losses yet either.

    • nicoleandmaggie Says:

      Some of the commercial real estate in our town has been doing badly for years. It’s insane– prime properties vacant for ages. They finally demolished buildings where the two main drags in town meet and are building something new there.

    • chacha1 Says:

      I appreciate your point about not wanting to be a slumlord. I wouldn’t want that either, after some of the crap places I’ve had to live I would never wish that on another person … no matter how profitable. :-)

      My friends with the rental properties laugh about their “transitional” locations, but they take good care of the properties.

  14. Leigh Says:

    I’m not really interested in becoming a landlord or owning multiple properties. When I don’t want to live in my condo anymore, I’ll sell it. I invest in stocks in my 401(k), my Roth IRA and a bit outside of there too.

    This real estate thing is crazy. Comparables put my place at now worth about $50k more than what I paid for it almost a year ago. I’m sticking around though. I’m really starting to like the place. It could also drop $50k in another year. Who knows. That’s okay, I still like it. I feel like I need to name my condo now? Suggestions? Or maybe I should at least name my plant.

  15. Carnival of Personal Finance: Weekend Trip Edition » Frugal Portland Says:

    […] from Grumpy Rumblings presents Why I like stocks over real estate, and says, “Nicole and Maggie discuss why they prefer passive stock investing to active real […]

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