Real estate is something you can physically touch and feel – it is a tangible asset, and therefore, for many investors, it feels more real. For many decades, this investment has generated consistent wealth and long-term appreciation for millions of people. Depending on the location of your real estate, you can enjoy considerable returns on your investment.
There are two main types of real estate: commercial and residential. While there are other types (mobile home parks, shopping malls, apartment buildings, office buildings, storefronts, and single-family homes), they generally fall into those two categories. However, making money in real estate is not easy. Some people take the “return from home” route, looking for distressed properties, restoring them, and selling them for a profit at a higher market value. Others are looking for properties that can be rented to generate a steady income.
In general, a down payment of up to 20 percent of the purchase price can be made, with the remainder being financed through a mortgage.
Advantages of investing in real estate
There are many positive benefits to investing in real estate, including depreciation (amortization of the wear and tear of a commercial property), tax deductions, and finally, you can sell the property through what is known as a 1031 exchange, and you won’t have to pay. Capital gains taxes, as long as you invest the money in a similar type of property.
Disadvantages of investing in real estate
Like all investments, the real estate sector also has its drawbacks. Most importantly, the investment is illiquid. When you invest in a property, you generally cannot sell it right away. In many cases, you may need to hold the property for several years to realize its true earning potential. Plus, the closing cost can add up to thousands of dollars and include taxes, commissions, and fees.
Also, real estate prices tend to fluctuate. While long-term prices generally rise, there are times when prices can go down or remain stable. If you have borrowed too much against the property, you may have trouble making a payment on a property that is worth less money than the amount borrowed.
Finally, it is often difficult to diversify if investing in real estate. However, diversification is possible in real estate, as long as you are not concentrated in the same community and have a variety of different types of property. That said, there is an additional way that you can diversify into real estate through real estate investment trusts (reits), under which you can buy a trust that is invested in a large portfolio of real estate and will offer you a dividend as a shareholder. However, in general, stocks offer more diversification because you can own many different industries and areas throughout the economy.
A good compromise when deciding between investing in the stock market and investing in real estate can be owning a REIT, which combines some of the benefits of stocks with some of the benefits of real estate.
Stocks
Using the s & p 500 as a benchmark to illustrate the performance of stocks, the stock market has had an average annual rate of return of 10.31 percent between 1970 and 2016. It is important to use this figure as a benchmark only. For the performance of US stocks as there are several other major indices globally.
With a share, you receive ownership of a company. When times are good, you will benefit. In challenging economic times, you may see a decrease in funds as company profits plummet. Taking a long-term approach and being balanced in many areas can help build your net worth at a much higher rate, compared to real estate.
As with real estate, equity financing allows you to use margin as leverage to increase the total number of shares you own. The downside is that if the stock’s position falls, you could have what’s known as a margin call. This is where the equity, relative to the amount borrowed, has fallen below a certain level and money must be added to your account for that amount to rise again. If you don’t, the brokerage company can sell the shares to get back the amount borrowed.
The advantage of stocks
Stocks are very liquid, fast and easy to sell. They are also flexible and can even be reassigned to a retirement account, tax-free, until you start withdrawing money. Additionally, 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 have an average growth of 20 percent or even 50 percent in one year.
The downsides of stocks
Stocks can be very volatile, especially when the economy or business is facing challenges. Furthermore, stocks are often emotional investments, and your decisions within the market can often be irrational. Ultimately, bankruptcy is always in the back of the active investor’s mind, as it should be, as your investment will dissolve in this case.