Real Estate Investments Vs. Stock Investments: Which Is the Better Strategy?
By Dr. Mark Skousen, Chairman, Investment U
Tuesday, October 17, 2006: Issue #594
Real estate gurus such as Donald Trump and Robert Kiyosaki think real estate is the best way to become rich. Warren Buffett and Peter Lynch see stocks (or businesses) as the better way to go.
There are, of course, lots of ways to climb to the top of a mountain, but which is better: real estate investments or stock investments?
Having invested in both, here's my take. Let's start off with real estate...
Real Estate Is a Good Inflation Hedge, But...
Trump and Kiyosaki like investing in rental properties because they're tangible assets you can see, feel and visit. You can leverage real estate investments with a mortgage or two, allowing you to control a valuable asset with very little money. That's why "cash poor" investors are attracted to it.
If the property goes up in value, you can multiply your wealth. And real estate is usually a good inflation hedge. Residential prices have risen steadily year after year and spectacularly in some hot markets.
Investing in real estate also has tax advantages. You can:
- Depreciate the property.
- Deduct taxes and mortgage interest, and
- Pay only 15% capital gains tax when you sell.
Sometimes you can avoid taxes entirely with a like-kind exchange (Tax Code 1031). Or if it's your home, you and your spouse can avoid tax on the first $500,000 profit, and 15% thereafter.
Not surprisingly, real estate has made lots of millionaires and even some billionaires. Eight percent - 32 billionaires - have made the Forbes 400 Richest Americans List this way, including Trump.
The Dark Side of Investments in Real Estate
Closing costs - commissions, fees, points, and taxes - can add up to thousands of dollars at the time you buy or sell the property. You have to be a good negotiator. Renting the property can be a nightmare if you have the wrong tenants. (I've had my share of sleepless nights from tenants who don't pay and don't leave.)
Negative cash flow is common if you have borrowed too much. Leverage is a two-edged sword. Real estate prices don't automatically go up every year; sharp declines can occur. And selling can be a major difficulty if the real estate market is in a slump or slowdown. (Don't buy into the myth that land can only go up in value because "they aren't making any more of it.") Your property can sit on the market for months. Not everyone is comfortable taking on massive debts.
Donald Trump complains about friends who invested in a stock and lost everything. But he fails to mention that, while a billionaire today, he has gone bankrupt three times through investments in commercial real estate.
Stock Investments vs. Real Estate: Liquid, Tax-Friendly And Positive Cash Flow
Investing in stocks and mutual funds has some clear advantages over real estate. With few exceptions, stocks and funds are extremely liquid and can be bought and sold in seconds. If you find yourself in a losing stock, you can get out fast. "Closing costs" (commissions and bid-ask spreads) for most stocks are almost non-existent in today's competitive brokerage business.
Stocks once lacked tax advantages, but not anymore. If you hold a stock for a year, you can qualify for the 15% long-term capital gain. Granted, profits on short-term trades (less than a year) are fully taxable as regular income, but they can be offset by short-term losses, or can be postponed indefinitely inside a tax-deferred retirement account (IRA, 401(k), etc.). And dividends are now subject to a 15% rate, just like real estate.
Finally, investments in stocks offer leverage without borrowing huge amounts of money. It's not uncommon to find publicly traded growth companies that increase 30%, 40%, even 100% or more during a bull market. You can leverage further if you wish, with margin accounts or options, which are far less risky than a busted real estate deal.
Stocks even offer positive cash flow and potential capital gains, with real estate investment trusts (REITs), oil & gas trusts, business development companies and bond funds. You still have to worry about the possibility that the company will cut its dividend, but the risk is certainly lower than the risk of a tenant failing to pay his rent.
Keep in mind, though, that liquidity in the stock market is a two-edged sword. Stocks are far more volatile than real estate. Some tank and even go to zero if the company files chapter 7. That's highly unlikely with land or rental properties. You have to do your homework in picking good stocks, or you could get burned.
The Golden Mean
In sum, when stacking up stocks versus real estate, I suspect many of you think like me. You may own stocks and mutual funds, and perhaps you own or you're looking into some real estate either in the form of rental properties or your own home.
It pays to diversify. Treat real estate as a long-term inflation hedge, and your stock portfolio as a way to profit from free enterprise and, if you wish, as a short-term investment strategy.
Good trading, AEIOU,
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Today's Investment U Cribsheet
- In a recent IU interview with professor Robert Shiller, Yale's top gun fires away on real estate and stocks, and delivers his #1 secret to successful investing.
- Shock Stocks... A Takeover Special - JLG Industries Inc. (NYSE: JLG) climbed 33% Monday, after Oshkosh Truck Corp. (NYSE: OSK) announced it would buy the access equipment maker for $28 a share - a 35% premium to JLG's closing price on Friday. This is just one buyout amid growing Merger & Acquisition activity. Here's another deal scheduled to hand shareholders a substantial sum by November 30, 2006.