Deepak Malhotra, Investor & Landlord, Cheney WA,  99004

Differences Between Investing in Stock and Real Estate


If you’re looking to invest your hard-earned money, you might be debating between investing in stocks vs. real estate. What’s the right option for you? Should you put your hard-earned money into the stock market, or should you buy real estate? Many people find themselves asking these questions as they seek ways to grow their wealth and make their savings work for them.

Investing in stocks involves buying and selling shares on a stock exchange, while real estate investment involves the purchase, holding, and sale of physical property. Some major differences include liquidity, diversification, taxation, return profile, and risk. Moreover, ownership structures and fees associated with each type of investment also play a role in differentiating between the two.

What is Investing in Stocks?

Investing in stocks is one of the most common long-term investments. It involves purchasing shares of individual stocks or investing in mutual funds, exchange-traded funds (ETFs), and other investment vehicles that are managed by professional money managers. A major benefit of investing in stocks is the potential for diversification of your portfolio, along with the chance to earn a profit from a stock’s increasing value. With stocks, you can buy into different industry verticals, companies at different stages of growth, or across borders to minimize risks and maximize returns. On the flip side, however, there is a greater chance of loss due to stock market volatility. It’s also important to note that when investing in stocks, you may have to pay taxes on dividends or capital gains if you plan to sell or trade your investments. Investing in stocks comes with its own set of advantages and drawbacks which should be weighed carefully before making an allocation to this asset class. Now let’s take a look at how real estate investing differs from this form of investment.

What is Investing in Real Estate?

Investing in real estate is a great avenue for gaining passive income over time. It primarily involves buying, owning, managing, and/or selling real estate properties to open up streams of income while securing your financial future. Property investments can involve physical property such as houses, apartment complexes, condos, land, multi-family dwellings, or office buildings, as well as investment products around these, such as REITs (Real Estate Investment Trusts). Real estate investments have many potential benefits, including building equity over time, earning revenue through rent payments, and the potential for appreciation if you decide to sell.

Buying property offers more tangible benefits, such as equity growth and tax deductions from rent payments. Investing in stocks requires less maintenance than owning real estate assets. However, an investor needs to be aware of the risks associated with each investment opportunity before committing any capital. Real estate investing – like stock investing – is a financial commitment that must be thoroughly researched before any investment is made. As with any other endeavor related to finance or investments, it’s important to seek professional guidance before making decisions involving significant sums of money. With the right help and knowledge, you should have all the information required to weigh up whether investing in stocks or real estate is best for your individual situation.

One significant advantage of real estate investing is a greater level of control than you may have over stocks. When you buy property, you decide who lives in it, how much you charge for rent, when upgrades or renovations take place and more. This sense of control over your investment may sway some people towards real estate as their preferred means of growing wealth. You also don’t have to worry as much about market fluctuations, economic changes, or changes in interest rates on your ability to generate income. You know what rental income to anticipate each month, your monthly loan payments are fixed, and you can plan accordingly, which is a relief for many investors.

There are many advantages to investing in residential rental real estate over investing in stocks – ways that can benefit a range of investors, from first-time investors with a single-family home to seasoned investors with multi-family properties such as duplexes, fourplexes, and apartment complexes.  One of the big ones is tax consequences. I stopped contributing to my 401k when I realized that the whole idea of 401ks is that you are deferring taxes into the future, and would pay tax after you retire, presumably at a lower rate because your income would be lower. I am now thinking that even in a lower bracket, future tax rates may well be much higher than present tax rates. Our country has a huge debt and that is not sustainable. At some point, services have to be cut and revenue has to be increased or both. With real estate, (and I’m not talking about buying a self-directed IRA) you don’t defer tax, you substantially avoid tax as part of your earnings strategy.

Advantages of Buying Residential Income Property

With rental property, you get to deduct actual expenses but also get to deduct a fictional depreciation amount. After you have done that, you can have positive cash flow and still pay no income taxes, depending on your income and expenses. No tax sounds better to me than in tax-deferred into the future when tax rates may be much higher than at present.

Tax Advantages

Another big difference is leverage. A 20,000 dollar down payment towards rental real estate can control a 100,000 dollar asset. Assuming your rent covers your expenses, if that property goes up in value by 10% in one year, you have a 50% rate of return on your cash. Your $20,000 equity has grown to $30,000. That kind of return is extremely difficult to obtain with stocks. Anyone who says that stocks and real estate perform similarly is completely ignoring the advantage of fixed interest rate leverage that is common with real estate. In some cases, you can get away with even more leverage, such as if you use an FHA 3% down loan to buy a fourplex and you live in one unit. Sure, you can buy stocks on margin, providing leverage, but your income from dividends (if any) is unlikely to cover your interest payment and at best you’re probably looking at 50% leverage. Also, your margin interest rate is not going to be fixed for 10 or 30 years but will float with the market, and could easily sink you. Long-term fixed interest rates are a huge advantage of buying rental real estate.

Deductions

Buying real estate properties can provide real estate investors with a continual monthly income, or cash flow, through their monthly rent payments. Generating a steady income is an appealing factor in real estate investing. A positive cash flow covers expenses such as loan installments, taxes, operating costs, etc. It is essential to have a positive cash flow in order to make a profit from a real estate investment. Positive cash flow is the difference between the rental income generated from a property and the expenses associated with owning and operating it.

Leverage 

Compared to investments such as stocks, investing in residential rental income generally poses fewer risks, particularly if it is held for an extended duration. Long-term possession minimizes the possibility of any losses due to declining home values as the Fed has a goal of 2% inflation per year. With inflation, materials and labor costs more every year so even if new construction could keep up with family formation, the cost of new construction will go up every year (except in rare periods of deflation which the Fed tries to avoid at all costs). As new construction costs increase, so do values of resales as buyers evaluate both when considering purchases. They can usually buy more square feet for the same prices with older construction. What’s more, investing in property will always have value as it is a tangible resource, compared to paper investments which may decline at any time. Investing in real estate is a great way to secure your financial future as it is a reliable form of income. Unlike stocks, real estate investments are not subject to the same level of volatility. The value of real estate can remain relatively stable even in times of economic downturns and market fluctuations. This is because real estate is a tangible asset, meaning it is something that you can physically touch and see. You can also more easily understand the income and expense numbers without needing an accounting degree.

Cash Flow

Buying real estate properties can provide investors with a continual monthly income from the monthly rent payments. Generating income with a positive cash flow is revenue that covers all expenses such as loan installments, taxes, operating costs, etc., and still leaves a profit. The secret, of course, is investing in real estate that provides a positive cash flow. It can be easier said than done to find positive cash flow rental properties. Much comes down to timing and buying during recessions, or when interest rates are coming down.

Less Risk

If there is inflation, rents, and values tend to go up. Meanwhile, your mortgage principal and interest are fixed. You are paying back your loan with money that isn’t worth as much.

What is inflation?

Those who don’t understand how the Federal Reserve manipulates money would say inflation is when the cost of goods and services goes up. I believe that a more accurate definition is an increase in the money supply. That is the real cause, while an increase in the cost of goods and services is the effect. Banks make money when there is inflation. The Federal Reserve is controlled by banks. You can bet they want inflation. In fact, they have a stated goal of 2% inflation. Banks make money through the fractional reserve banking system through leverage plus inflation. This same strategy of leverage plus inflation can be employed by real estate investors.Anyone wanting an education on the causes of inflation should watch videos by Milton Friedman. Milton Friedman was an American economist and statistician who received the 1976 Nobel Memorial Prize in Economic Sciences for his research on consumption analysis, monetary history and theory and the complexity of stabilization policy. For example, this video provides a quick education about inflation: https://www.youtube.com/watch?v=GJ4TTNeSUdQ

The Federal Reserve, after the past recession, first brought interest rates down to zero and, when that didn’t have the desired effect, printed money through “quantitative easing.” Quantitative easing is effectively printing money like a counterfeiter. You or I would go to jail if we printed money out of thin air. This is what caused the current high rates of inflation. Because of the COVID crisis, there was recently unlimited quantitative easing. That eventually caused drastic and almost uncontrollable inflation. When this happened, rents and real estate values went up. Property owners in certain areas may experience higher appreciation rates than others.

With stocks, you own a piece of a business. A business will lose money as the cost of inventory and labor increases with inflation unless the market bears higher prices for their goods and services and if the businesses raise prices faster than their suppliers. During periods of zero interest rates, investors were willing to bet on tech companies that produced no revenue but that had a growth in viewers or subscribers. They were hoping for a unicorn that would eventually generate profits. Now that interest rates are higher, investors can get a return on a Certificate of Deposit. They are less interested in gambling in companies that do not generate income or that generate losses. That is why the NASDAQ has been struggling lately.


Simpler to Understand 

Another big difference is that it is a lot easier to understand the income and expenses for rental real estate than with stocks. Have you tried to understand the balance sheet of a publicly traded company? Some companies use creative accounting methods that are hard for regular investors to understand, making rental real estate a more straightforward option for potential investors. Remember the Enron scandal?  http://en.wikipedia.org/wiki/Enron_scandal

Key Differences:

  • With real estate, you own a hard asset that you can see and touch.  With stocks, you have a piece of paper and substantially zero control over the actual company (unless you own a very large number of shares, not common with most regular individual investors).
  • With stocks, you pay the market price when you buy.  With real estate, there is a possibility of bargain hunting.  Finding repos or other underpriced properties and buying at a discount.  I feel that I am quite good at this myself.
  • With stocks, there is no opportunity for you to increase the value.  That is up to the market.  You can only hope for the best.  With real estate, you can increase value by raising rents, making improvements, landscaping, evicting bad tenants, adding basement bedrooms, etc.
  • With stocks, you usually have very little income.  There is sometimes a low dividend if you are lucky.  With rental real estate, you have a substantial (relative to your investment) amount of rent coming in every month.

Real Estate is a Good Hedge Against Inflation

Stocks are not as predictable as real estate investments: prices go up and down according to the performance of the company, sector, and even external factors like politics. Furthermore, inexperienced stock investors may be at higher risk of losing money due to their lack of knowledge about the market— expertise is key to success in this arena. However, the stock investing process and outcomes vary, and what works for everyone may be different depending on their location, risk tolerance, and financial goals.

Disadvantages of Investing in Real Estate

Real estate investments can require more time than stock investments. Although it’s fairly straightforward to acquire properties, that doesn’t necessarily mean that taking care of them, particularly when possessing rental properties, is a stress-free task. You have to make decisions about when to perform maintenance and some items, such as roofs and central AC units, are big ticket items. You may have problem tenants and need to make difficult decisions about evictions. Increasing rent to market rates can also be very difficult for landlords if it will mean that their tenants will be unlikely to afford the new rents. There are make-ready expenses whenever tenants leave. Selling real estate involves large payments in the form of closing costs, which can amount to up to 6-10% of the final sale cost. Recouping your investment is not a guarantee. Home values usually increase with time, yet there still remains a chance of selling the asset at less than the original value – a lesson learned from the 2008 economic disaster. Though who purchased in 2022 may also be in a difficult position if they need to sell soon. The same principle applies to investments in the stock market. Lastly, if you need to sell, real estate is less liquid than stocks. It could take weeks to months to get your money out of your investment.

Advantages of Investing in Stocks

Stocks are very liquid, quick, and easy to sell. They are also flexible, and can even be reallocated into a retirement account—tax-free—until you start to withdraw the money. Also, many stocks can do considerably better than real estate in one year. Due to the volatility of some stocks, it is not unusual to see companies that are averaging 20 percent or even 50 percent growth in one year. investopedia.com

Disadvantages of Investing in Stocks

Investing in stocks can be a lucrative long-term investment, as it provides the potential for higher returns than cash investments and offers riders the ability to diversify their portfolios. However, stock investments come with more risk and are susceptible to market volatility, leading to potential losses that should be taken into account. When investing in stocks, investors must also be aware of taxes they may incur on dividends or capital gains. Real estate investing is different from stock investing, generally providing much higher cash on cash returns on the down payment due to leverage, plus potential positive cash flow, and more control over the asset as a property owner, but with more time and effort required.

Ultimately, those considering investing in stocks should research companies and factors that influence stock prices. It is important to remember that stock investments come with their own set of risks, including loans and debts that the invested company may have.  This is why it is important to do your research when investing in stocks. It is essential to understand the financial health of the company you are investing in, as this can have a major impact on the success of your investment.

Important Point to Remember

“90% of all millionaires become so through owning real estate.” This famous quote from Andrew Carnegie, one of the wealthiest entrepreneurs of all time, is just as relevant today as it was more than a century ago.

Common Questions

What makes more millionaires stocks or real estate?

The real estate sector has seen more consistent growth throughout the last decade. Despite the 2008 financial crisis, home prices rose nationwide by 5% per year in that period and have only continued to go up since then, with a slight dip during 2020 due to the coronavirus pandemic. Overall, real estate investments tend to be less volatile and less risky than stocks, which makes them a good option for long-term investments in various areas. Due to leverage, your cash on cash return (return on your downpayment) is typically much higher than that 5% unless you don’t use a loan.

How has the real estate market performed over the past 10 years?

If you’re looking for a long-term investment, real estate may be the better option for you and many others, as it generally provides more stability and control over the asset in comparison to stock investments. There are no guarantees, but real estate tends to appreciate in value over time. Appreciation plus leverage multiply your gains. In fact, many people have made their fortunes by strategically investing in this area. If you are looking for a more passive investment, on a comparison basis, stocks may be the way to go as they require much less of your time. You should not expect the same increase in net worth, though, with stocks versus leverage rental real estate.

Is it better to own real estate or stocks?

Investing in stocks and real estate both involve a certain level of risk, though the nature of the risks may vary. When investing in stocks, investors should consider the potential for market volatility, which can lead to losses in value. Other risks may include macroeconomic factors like inflation and economic recessions, as well as company-specific risks such as changes to management or the business itself going bankrupt under any given name.

When investing in real estate, there are also financial risks to contend with, such as changes in landlord-tenant laws, potential bad tenants, and increased taxes. Additionally, since real estate investments tend to be less liquid than stocks, there is also a greater chance of having difficulty selling them if you purchased at a time of low cap rates and need to sell quickly after purchase. Other potential risks include maintenance costs, unexpected repairs, insurance issues, and zoning changes that could lower the property’s value.

What kinds of risks are involved when investing in stocks and real estate?

Overall, both stock and real estate investments can add value to one’s portfolio, but investors should be mindful of the risks associated with each type of investment before committing to their funds.

Investing in stocks and real estate both have different tax implications that investors should be aware of.

When it comes to investing in stocks, the taxes come from short and long term capital gains. Any money earned from stock investments is considered income and, as such, must be reported on your tax return. Depending on your income level, different rates may apply. In addition, you may also be liable for ordinary income taxes on dividends depending on which stocks you invest in.

What are the tax implications of investing in stocks and real estate?

On the other hand, when it comes to real estate, there are various types of taxes including capital gains tax, property tax, transfer tax, and capital gains tax. Capital gains tax refers to any profits earned from the sale of a property and the amount will vary depending on how long the property was owned and other factors. Real estate held for more than one year will be taxed at a more favorable long term capital gains tax rate. Rental income often ends up being tax-free after deductions, including the depreciation deduction, if the property was purchased using a loan. Property tax needs to be paid each year and is based on the value of the property, whereas transfer tax is typically when selling a property. Depreciation recapture occurs upon sale of a rental income property. A small portion of that fictional depreciation that you were able to deduct over the years must be paid back when an income property is sold. Finally, it should be considered that with real estate, capital gains taxes may be deferred using 1031 exchanges, where proceeds from the sale of one investment property are reinvested into another more expensive property. There are tight deadlines required for identifying and purchasing replacement properties with 1031 exchanges with but such exchanges, capital gains taxes do not need to be paid immediately. It is possible to keep exchanging until death, at which point heirs inherit a stepped up basis and all capital gains taxes are avoided.

Overall, it is important to understand all of these different taxes when it comes to investing in stocks or real estate as they can have a big impact on profits over time.

If you’re looking for a long-term investment and leveraged capital gains, often resulting in double digit rates of return on the actual cash you invest (your down payment), real estate is usually the better option. There are no guarantees, but real estate tends to appreciate in value over time with inflation, as the money supply is increased and the value of paper money goes down. Real estate tends to strongly appreciate when interest rates decline, after recessions, as lower interest rates mean buyers can buy more house for the same monthly payment. If you simply don’t have the stomach for potentially needing to evict tenants, and aren’t able to delegate to a property manager, or enjoy the thrill of picking stocks, or don’t have enough cash for a down payment of an income property, stocks may be a better option.

Contact Deepak Malhotra if you need help with real estate investing. Even if you are not looking in Cheney, Medical Lake, Airway Heights, or the Spokane area, mentoring services or referrals can be provided.