Some investors choose to invest their savings in stocks while other others favor investing in directly real estate. Below is a brief list of the advantages and disadvantages of each.
Advantages of Directly Owned Real Estate
Leverage: The primary advantage of real estate is the ability to use leverage. Leverage is an investment strategy where an investor uses borrowed money to boost the potential return of an investment. Real estate is a market where it’s common to use debt, so it’s easy to use leverage.
The downside: With leverage comes risk. If an investor buys a property financed with 20% of their own money and 80% borrowed money, a 20% decline in the value of the property would produce a loss of roughly 100%.
Control: With an investment property, the owner can make all decisions related to the property – such as decisions on whether to sell, improve, lease, etc.
The downside: Unless you are going to hire a management company, owning real estate can require a lot of work, effort, and headaches. And most people don’t factor in the cost of their labor when evaluating their returns in real estate, but they should.
Familiarity: Most people are familiar with real estate, at a minimum because we all live somewhere.
The downside: Being familiar with something doesn’t make it a better investment; it just may help some sleep better at night. Additionally, real estate seems like a simple investment, but it is not. For example, there are legal issues and complex tax rules to consider, especially for those who choose to rent the property.
Tangible: Real estate is an investment that can be seen and touched. To check on your investment, you can simply drive by or, if necessary, inspect the premises.
The downside: As a tangible asset, real estate is costly to maintain and insure, and is susceptible to casualty losses such as theft, damage, and vandalism. It’s also illiquid. This not only makes it difficult to get cash out of your property if you need it, but it also makes it difficult to reinvest earnings or reduce/increase your investment by small amounts.
Advantages of Publicly Traded Equities
Liquidity: Publicly traded stocks provide instant liquidity. This allows an investor to get their money out if they need it, and it allows the investor to rebalance (buy a little/sell a little) and immediately reinvest earnings.
The downside: Instant liquidity also means that changing prices are published continuously, tempting investors to focus on short term fluctuations rather than long term value.
Diversification: Stocks allow investors to easily diversify across thousands of companies located around the globe.
The downside: Diversification means that you are investing in companies you know nothing about, located in places that are very far away, run by people you will never meet. In a way, it’s a miracle that we can do this, on the other hand, it can be unnerving. It also means you are certain to own investments that fail.
Intangible Assets: Stockholders own both the physical assets and the intangible assets of a company. These intangible assets include brand, goodwill, customer relationships, trade secrets, patents, trademarks, intellectual property, and a trained workforce. It is these intangible assets that have the ability to produce extremely high returns on capital. Returns that, quite simply, are not possible in real estate.
The downside: Intangible assets cannot be seen or touched, can be difficult to value, and companies must invest to protect their value.
Less Work: As a stockholder, you are not expected to do any work on behalf of the company. A stock investor is getting paid for providing capital, period.
The downside: It can be boring.
So which one is better? That is the subject of our next article.