Everyone over the age of twenty has heard the saying “Buy land, God isn’t making any more of it” before, which does a great job of pointing out the supply issues of a gradually overcrowding planet, but is real estate really a better investment than the stock market when it comes down to dollar for dollar return?
In the hopes that I could answer this question quickly, and move on with my day, I did as any efficiency-conscious businessman would do: I google’d it. Much to my dismay I could not find a clear, concise, and seemingly accurate answer (especially considering that I was not interested in national averages and other general data).
The realization that there wasn’t a solid (locally relevant) answer to the real estate vs. stocks question told me that I had to break out the reading glasses and crease some pages on my own.
I started by pulling historical data on the stock market and the housing market, and quickly arrived at the conclusion that I had to get more specific with regards to the housing market area. There are two reasons that I was not interested in national data for the housing market: 1. our readers are interested in how this applies to their Los Angeles County properties, and 2. I didn’t want the lack of demand for property in Podunk, Middle America to skew our data!
Furthermore in order to keep our data congruent, for both stocks and real estate, I decided on a time frame of 30 years.
Following these rules I pulled data from 1982 to 2012, for the Los Angeles housing market and prepared it for comparison to the stock market’s historical return data.
To represent the stock market I chose the S&P 500 index, as it is un-weighted (as opposed to the Dow Jones Industrial Average) and it is spread across 500 stocks, giving it a well-rounded and accurate depiction of the overall market.
Starting at the beginning, in 1982, I found that the median home price in Los Angeles County was roughly $119,259 and that the price of one share of the S&P index was $152. Fast forward 30 years and we are at a median home value of $365,000 and one share of the S&P for $1,430.38 (the price at the time of writing). Now before you jump to any conclusions you should know a few things:
- One of the biggest benefits to investing in real estate is the unparalleled ability to leverage the purchase using debt.
- There are large tax benefits when it comes to paying a mortgage.
- There are tax consequences when it comes to selling stocks.
- Real Estate allows for the ability to pull money out and reinvest in other investments.
Let’s discuss these in more detail so that we can better understand the auxiliary inputs which immensely affect these investments.
First and foremost is the ability to employ leverage through the use of a mortgage. Essentially by investing $10,000 as a down payment on a house, and signing a piece of paper, you are receiving an investment worth $119,000 (back in 1982). This ability to defer the difference of $109,000 and spread it over 30 years, allows one to acquire a large investment without a great outlay of cash. Now I know what you are thinking, the payments on the mortgage need to be taken into consideration, and you are correct. So let’s say that you had a mortgage at 6% for 30 years, $10,000 down and the principal balance on the loan is $109,259, which gives you a monthly payment of roughly $655. After the 360th month you will have made a total of $235,822 in mortgage payments. Add in the $10,000 down payment and you end up with a total investment of $245,822. In return for that $245K you end up with a property worth $365,000.
Compare that to the alternative, investing $10,000 in the S&P 500 index in 1982 would have grossed you approximately $94,000 after 30 years. If you take into account that you would’ve been saving the $655 monthly mortgage payment, then you end up with a portfolio worth $329,822 ($235,822 in cash + $94,000 in stock).
This still clearly illustrates that the real estate was the better choice in this scenario.
The next benefit to investing in real estate is the tax benefit. By writing off the interest portion of your mortgage payment, you are effectively cutting the monthly payment that is actually made toward your investment.
Unfortunately stocks do not share this tax benefit. In fact quite the opposite is true, as there are tax consequences associated with selling the stocks in your portfolio. These consequences are known as Capital Gains Taxes, and suffice it to say that the government does not hold back when it comes to taxing what they consider an alternative form of income. These capital gains taxes must be taken into consideration as they cut into the profit created from stock appreciation.
Last but not least is what I like to call the real estate multiplier effect. Similar to way leverage is employed when first obtaining a house, with a mortgage, the same principle can again be applied to draw upon the investment you have already made. As your property appreciates you end up accruing equity, which can then be drawn upon, to finance other purchases. By leveraging the equity you have accrued, you can multiply they number of investments you have in your portfolio (without having to sell anything or contribute any more cash to the equation).
Taking all of these factors into consideration we are left with an investment that is truly superior: Real Estate. While there is the opportunity for greater returns in the stock market, it becomes pure speculation and extremely risky (as it often requires investing heavily in a few stocks, as opposed to diversifying over a large number of them).
Oh, and one more thing to consider: when it comes to property, even if the market crashes and the property has no monetary value, you still have a tangible asset to hold on to; however with stocks, if the market crashes or a company folds, all you end up with is a pretty certificate that is worth nothing at all!
The New Year looks to be promising for real estate. The conditions in the market are favorable for any investor looking to grow his portfolio, as price are relatively cheap and interest rates are at record lows.
It is for these reasons that the Bull’s best friend in 2013 will be the real estate broker!
I hope this article has helped to shed some light on the real estate vs. stock argument; however if you have any questions or comments please feel free to leave them below and I will be sure to answer them.