Stocks vs Real Estate — Both Down Now — Long Term? RE Still Easy Winner

Now that most of the country’s real estate is, uh, taking a breather, as is the stock market, I thought it was perfect timing to reissue a post I published about nine months ago. The post has been modified as little as possible to reflect the current times. None of the pertinent numbers have been touched.

I’ll make one comment before beginning: Remember the #1 factor in long term investing — Keeping your eye on the long term, the big picture. Know what I mean, Verne?

OK, let’s get going.

A long while back I published a post discussing the so-called debate, Real Estate VS Stocks as investment vehicles. It’s time to remind folks, as stock tips are flying everywhere again, that the stock market just doesn’t compare, especially for regular folk just looking to ensure the retirement they’ve been planning for years. Of course, this dovetails with what I was talking about the other day — 401(k)’s. They thrive or fail based upon the stock market. If in the last 10 years of your work life, the stock market takes a snooze, so does your retirement. Name the last time real estate took a decade off. Right, not even. Since the end of World War II, the next time real estate stays down, or flat for a decade — will be the first time.

Now that the stock market has done a solid imitation of the real estate market, I’m hearing more and more from folks who honestly think there’s a real comparison between their stock portfolio’s potential and their real estate investment plans. The whole, ‘We’ve reached the bottom, and now’s a great time to get into the stock market.’ Before I begin, there’s something I wanna make perfectly clear. You can get very wealthy in the stock market. Over the long haul, you can drag a bunch out of the vault for yourself. That said, you have to know which stocks to pick, when to buy, and who in management might undermine your long term plans. And much of the information on which you will want to base that info is zealously kept from you.

Your real estate portfolio is also subject to outside factors, but not nearly to the extent as the stock market. You can pick where, when, why, how, and in the end, do it all with reasonable confidence that the big picture will show you with an even bigger smile. One area is down, the next isn’t. San Diego is down now, while much of Texas is the real deal. Phoenix is waiting to bounce back, while Kansas City just keeps cooking along.

As I write this the DOW is just at or a touch below 12,000 — a hefty decrease compared to a year ago. Now everyone is trying to figure out if real estate measures up. This is predictable every time the stock market goes bullish or bearish in a big way. The mainstream media chimes in with their take on what investors should do. Those without a dog in the fight (read: any real understanding) offer the most humorous reading. The media often takes ignorance to levels air breathing mammals can’t survive.

The journalist usually ends up concluding the investor has to choose what’s better for their particular situation. That’s media-speak for “I had to write a piece on this topic and don’t know what I’m talking about, but it sure sounds good, doesn’t it?” Let’s put this subject to bed once and for all. We’ll put them in the most transparent way possible, side by side so anyone can discern which way is north on the map. Of course I’ve always maintained the media hasn’t ever done their research diligently on this topic, but we’ll give it a shot anyway.

Stocks vs. Real Estate

Here’s how we’ll do it. I contacted my Financial Planner as a source for an historically reliable annual growth rate in the stock market. I decided to use the S&P 500. For the past 55 years or so it has performed at a growth rate of approximately 8% annually. (It’s actually somewhat higher, maybe 8.5%.) Sounds impressive, but of course that’s not every year, just like real estate doesn’t always go up 40% a year. In fact, let’s be honest and say right up front that both real estate and stocks experience downturns from time to time as part of the normal business cycle. Duh. Don’t the current circumstances faced by real estate investors today speak for themselves? Ask your neighbor, the stock investor what he’s thinking about his portfolio these days.

Pick any growth region you want. Go to any 10 year period at random. In San Diego that’s a fun game I play with my new clients. They usually pick the period ending with a real downturn. It doesn’t matter. The rises have, historically speaking, given more than the downturns have taken away — by orders of magnitude almost. Nothing in San Diego has gone up as little as 5% yearly, in any decade you’d choose. It just hasn’t happened. I’m beginning with the year I got in, which was 1969. Almost four decades is long enough to make a point, don’t ya think?

Let’s set the parameters first. I’m going to grant annual growth of 10% for 10 years for the S&P. That’s about 25% over what they done over the last half century. We’ll use $100,000 as our opening capital investment amount. For real estate we’ll use an average annual appreciation rate of only 4%, buying small income properties using 10% down payments. (Note: This isn’t theory, I’ve been executing this exact scenario successfully for decades now, and have done so recently (How’s 14 times in the last few weeks?).)

As stated above, we’ll use an annual appreciation rate of only 4%. I’ll assume the stock’s annual return will be able to maintain a 10% annual growth by selling and buying different stocks as the professionals see fit. I’m also assuming the real estate investor will do one tax deferred exchange at the end of the fifth year. Though I won’t impute any costs to the buying and selling of stocks, I will burden the real estate investor with a selling cost of 8% when he exchanges.

Let’s see what happens.

After 10 years (rounding to the nearest $100) the stock investor has $259,400 — a profit of $159,400 over the 10 year period. A 10% annual growth rate on the originally invested capital.

Real estate has ended up with $458,000 – a profit of $358,000 for the same 10 year period. A 16.435% annual growth rate on the originally invested capital.

We gave stocks the benefit of 2.5 times the growth rate we gave real estate.
This still doesn’t take into account the benefits received from the real estate that don’t exist with stocks.

• Any income derived over that period generated by the real estate would not be taxable because of depreciation.
• All excess depreciation would then be allotted to the ordinary income (salary from job) of the investor, resulting in thousands of dollars in taxes not paid.
• On the other hand any dividends derived from stocks are taxable. With rare exceptions the only way the stock market investor gains any tax shelter is when he loses his money, which is far more likely in stocks than in real estate, especially over the long haul.

Now imagine what this same $100,000 could have done for you, if you’d been pressing the right buttons for the last decade with your real estate investment portfolio. In my experience, even with some bumps along the way, 10 years of prudent and Purposeful Planning, (using the Flywheel Principle) almost always results in multiplying your original capital 5-20 times, depending upon the region, your timing, (sometimes lucky is good) and how vertical the rises were in that particular 10 year period. The immediate decade past would have resulted in your $100,000 turning into at least $1.5-2MIL — if you were paying attention and exchanging when it made sense.

Note: It’s my very strong belief the next decade or so will not bring us any huge run-ups in real estate. I think even the normally high appreciation regions probably won’t experience any significant upward spikes.

What’s really cool about real estate is the ability to buy based upon regional performance. For instance, if you bought investment property in Ohio in 1997 vs buying in San Diego, you’d have been very disappointed. Real estate is local, whereas stocks are, well, stocks. By understanding the fundamentals of different regions, an investor can more intelligently place his capital. A great example of this is when we took our clients out of San Diego five years ago, and exchanged them into other, lower priced growth regions. Many of them can now look back with 20/20 hindsight and see how their capital growth rate was significantly higher outside of San Diego. This doesn’t take into account the relatively lower prices, and the far superior price to rent ratios they enjoyed elsewhere. Their cash flow, if that’s what they wanted, was easily superior when the properties were not in San Diego, or areas like it (Palo Alto?).

Before anyone jumps in to defend stocks, don’t bother. You can make a lot of money with them. But the bottom line is, you can’t use leverage without going over the top with risk. Your weak dividends are taxable. You provide no tax shelter during the holding period. If you picked one industry leader over another, you might have made it big — unless of course, you picked wrong. Folks don’t need a crystal ball with real estate — plus they have prudent leverage.

Ah, leverage. Real estate without leverage, is like — buying stocks. It’s the difference maker.

This is why folks like Ben Stein, a man for whom I have almost unlimited respect, avoids any mention of leverage when he compares the two investments. (And he made himself wealthy almost exclusively through stocks.) He knows if he did, stocks would be embarrassingly left behind. Even conservative leverage puts the regular investor way ahead. Leverage is the unfair advantage we have. And we allow it to move Heaven and earth for us, until we arrive at our magnificently abundant retirement.

Then we bask in the glow of the life we’ve earned — through real estate.

Let all this percolate for awhile. Then ask yourself whether or not you should begin taking your retirement a lot more seriously. Contact me — I’m easy to talk to.

Related posts:

1. “My 4% Will Beat Your 10% Any Day – Stocks vs Real Estate “
2. Stocks vs. Real Estate: A Debate? Really?
3. Rehabbing VS Long Term Investing — Who Has More Money In 20 Years?
4. How To Build Wealth Through Real Estate In 10 Easy Steps
5. Long Term Investment Success Doesn’t Mean It’s Uninterrupted