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Why Invest in Real Estate over Stocks & Bonds?
Last Updated: August 15, 2o24
Steve Nabity
August 15, 2024
Introduction
You have probably heard the phrase “not putting all your eggs in one basket”. Diversification is an important concept for all investors including hard-working entrepreneurs. To preserve and grow wealth, one needs to diversify across asset classes. Among the most popular asset classes are stocks, bonds & real estate. Each of these has its own characteristics, upsides, and downsides.
Stocks and bonds are, perhaps, the most popular instruments to invest in. However, not as much is spoken about real estate. The asset class has the potential to offer regular cash flow, capital appreciation, tax benefits, and much more.
Your Investment Goals
Let’s face it, we earn and invest money to fulfill those goals. We don’t do it just to watch the dollar number grow. For some, the goal of investing may be to build regular cash flow either to pay for some expenses or to retire and live off the passive income stream.
For others, investing may be simply buying and holding and letting wealth compound over decades, something popularly known as long-term wealth creation. Growth isn’t everything. Certain folks may actually be more interested in preserving capital, maintaining what they already have.
Given the uncertainties of markets and life, an investment plan has to achieve a reasonable level of portfolio diversification so that you are hedged against market volatility.
Your personality is also a major factor in shaping your investment strategy. Are you comfortable investing in intangible assets like cryptocurrencies? Or are you someone who prefers tangible asset ownership? Taking advantage of tax benefits when investing can also influence your investment decisions.
Traditional vs. Modern Real Estate Investment
The benefits of investing in real estate are multifold. Those looking to get started can consider two approaches. The traditional methods of real estate investment are focused on direct property ownership. While owning the property means you also own all its income, one has to manage the entire acquisition, hold, and exit process. This approach is a hands-on one unless you are large enough to hire your own team.
Modern forms of real estate investment include alternative options such as REITs, REIGs, and syndications. This is a passive approach where you invest your money with an entity and that entity/sponsor takes responsibility for the management of the assets.
The catch is that you have to pay a fee to the sponsor/entity who manages the property on the investor’s behalf. However, what you hope to get in return is a reduced workload and professional management. With REITs and institutional entities, you get diversification as larger entities will invest your money across multiple properties in multiple geographies.
Different Real Estate Investment Strategies
Business owners may want to spend as much or as little time on their investing activities. Those aggressively involved in building a business may not want to get distracted while those looking to transition into a new role may want to be more involved. There is a real estate investment strategy for everyone.
Hands-on investors could fix-and-flip. This involves buying properties that are not necessarily in the best condition, renovating and improving them, and then selling them for a profit. A variation of this strategy is the live-in flip where the investor lives in the property being upgraded and then sells out for a profit.
Some individual investors also like buying single-family-rental (SFR) properties and then letting them out to earn a yield on their investment with periodic rent bumps. Then there is the concept of house hacking where investors rent out a portion of their property while utilizing the remaining areas and earn some cash flow to make mortgage payments.
For the passive investors, investing in REITs is an option. The security of the REIT is listed on the exchange and can be readily traded as long as you have a trading account. REITs and REIGs offer shared ownership of one or many properties and offer professional management of those properties.
Real Estate vs. Stocks: A Comparative Analysis
Let us compare the most popular asset class, stocks, with real estate. Firstly, they both have very different risk and return profiles. Stocks are considered to be a riskier asset class than real estate. Logically, they also tend to offer higher returns, historically speaking.
Real estate is not as volatile as the stock market. So, its returns over the long term are slightly lower than those of stocks.
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Stock Market Volatility
The stock market is impacted by a host of factors such as economic events, geopolitics, market sentiment, earnings results, and liquidity. Each one of these factors can cause stock prices to fluctuate unpredictably.
Real Estate's Relative Stability
Real estate returns tend to be more stable than those of stocks. Studies have shown that the standard deviation of the S&P 500 is higher than that of the NCREIF Property Index.
Historical Performance Comparison
The following is a study conducted by real estate services firm CBRE where it compared 4-year rolling returns for the S&P 500 and NCREIF indices. Stock returns, in general, were higher than real estate with some exceptions.
Limited Control in Stocks
An ownership of a company’s stock implies a part-ownership in the business. However, that may not necessarily mean control over the decisions made. As minority shareholders, this may be even more significant as decisions made by the management impact the benefit derived from the business by the shareholder.
Tangible Asset Ownership & Control in Real Estate
In the case of real estate, the control and influence factors are more diverse. Owners of a property are in control of how the cash flows from that property are utilized. They are in a position to influence the process of cash flow generation, unlike a passive shareholder. With REITs, however, the sponsor/management drives the decision-making.
Transparency in Real Estate Investment
From a transparency point-of-view, both publicly listed companies as well as real estate entities give out information periodically. They are governed by norms and laws that mandate regular reports and updates.
Real Estate vs. Bonds: A Comparative Analysis
Real estate and bonds are both income-oriented asset classes. The goal of investing in these is usually income generation. However, the nature of the income and the risk associated with the generation of such income are where the differences lie.
Bond Yields vs. Rental Income
CBRE has conducted a study analyzing the historical trend of global corporate bond yields and yields from property. Real estate has outperformed bonds in that regard as the graphic below demonstrates:
When we talk about bonds, we don’t mean property bonds, but rather government bonds (10-year for e.g.) or corporate bonds.
Inflation Hedge
Bonds come with two types of risks, credit risk and interest rate risk. Credit risk arises from a scenario where the issuer of the bond (borrower) fails to repay the principal or defaults on the interest payments. Interest rate risk can arise if higher inflation pushes up interest rates which leads to a fall in the price of bonds. With income-generating real estate, there is some degree of inflation protection as rents can be increased to keep up with inflation.
Appreciation Potential in Real Estate
Capital appreciation occurs in bonds as well as real estate. Capital gains can be short-term or long-term. Most real estate investors enter the asset class with long-term capital as longer time allows for the compounding effect to play out. The appreciation happens due to increases in rents, upgrades made to the property, general growth of the micromarket, the performance of the economy, and inflation.
Remodeling or Expansion
Buying an older property and renovating it is a common strategy for improving property value. Such deals are known as “value-add” in the industry. Flipping properties also means the same thing. Expanding the property by building new usable area on an unused portion of the plot is another way to add value.
Limited Growth Potential in Bonds
A bond is a relatively more structured asset class. It has a pre-defined interest rate and maturity date. The factors driving its price, such as interest rates and credit risks, are also well-covered by the media and analysts. Hence, they can be somewhat predictable. So, the potential for large price swings is not very high. Real estate, on the other hand, is influenced by many factors and has a higher risk associated with the returns it generates. So, there is potential for a large price move over a longer period.
Advantages of Real Estate Investment for Business Owners
Real estate offers inflation-adjusted cash flows to investors through the rental income that it can generate. Real estate investors can be active or passive. They can invest, own, and manage the property themselves or they can participate passively through syndicators or REITs to create a passive income stream.
Besides the cash flows, real estate also offers important tax benefits and tax write-offs. Depreciation can reduce the total taxable income, and so can deductions like mortgage interest payments. Other popular tax benefits enjoyed by real estate investors are tax-deferred exchanges like the 1031 exchange. It allows investors to defer the payment of capital gains tax if the proceeds from the sale of a property are re-invested in a similar property.
Real estate offers portfolio diversification as it is viewed as having a low correlation with other popular asset classes like stocks and bonds. And lastly, real estate offers tangible asset ownership, something you can visit, see, improve upon, and sell to generate long-term value.
Getting Started with Real Estate Investment
If your interest in real estate as an investable asset class has gone up after reading this post, then we encourage you to dive in deeper and learn some more. The first step would be to assess your risk tolerance and explore how real estate can fit into your financial plan.
There are multiple ways of investing in real estate. Skyline Point Capital offers various types of real estate investment opportunities. You would want to choose the right one based on your various goals and risk profile.
One thing that a professional investment firm like Skyline Point Capital offers is its expertise in identifying opportunities, closing transactions, and managing assets. The firm also offers regular updates and support to all its investors.
If you would like to delve deeper and evaluate our services, then feel free to schedule a free consultation with us. Alternatively, you can simply give us a call and find out more.
Conclusion
Real estate investments can be quite rewarding and satisfying if they are done the right way. We hope that you found this article educational and that you now have a better idea about the risks and rewards that real estate investments offer.
