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Real Estate or Stocks:
What to Invest In

Investment or Dwelling...
While owning a home can contribute to overall wealth and may be considered an investment, the home you live in is a crucial asset that can not be sold without significant implications. Unlike stocks, which can be sold without impacting your living situation, home equity can not be accessed without selling and moving, or taking out an additional mortgage. Therefore, it might be best for a home that is a residence to be considered a separate type of investment from other financial activities that may contribute to income in retirement. While investing in properties in addition to a home used to live in may be a good option for some, owning multiple properties may not be attainable for many.

Barriers to Buildings
For most households, making investments using debt may not be a sound financial decision. This may be a primary reason why stock ownership could be a better choice than owning properties other than your own home as an investment. Only around 30% of Americans have $100,000 or more in assets not including their home. With the average home price currently hovering around $500,000, purchasing an investment property without using debt may not be practical. In addition to the potential cost barriers of purchasing properties as investments, real estate ownership is a job within itself. Maintaining properties requires the investor to either have enough knowledge and time to carry out management duties on their own, or to have enough resources to hire professional property managers. Neither of these circumstances may apply to the average investor.

Although outright ownership of real estate for investment purposes may be impractical for many, equity investments such as real estate investment trusts (REITs) may provide an option for real estate investing for average investors. REIT funds can be purchased like stocks, allowing investors to allocate an appropriate amount without having to shell out what it costs to purchase an actual property or pile on debt. REITs also provide a way to avoid having to manage properties yourself or hire managers to do it for you. With REITs consisting of companies involved in real estate-related operations, they typically generate recurring cash flow through rent or mortgage payments. Also, REITs are required by law to pay 90% of their taxable income to shareholders through dividends. These features mean that REITs often pay attractive dividends and are usually associated with an income strategy.

Cash Flow
Although Income strategies, such as focusing on dividend or interest payments as a source of steady cash flow, can be an appropriate plan for some investors. However, with only around 30% of households having $100,000 in assets not including their home, an income-focused investment strategy may not be a suitable course for the average investor. For example, even $100,000 invested in a REIT with an exceptionally high annual dividend rate of 5% will only yield around $5,000 per year. While someone with a million dollars invested in the same fund will generate $50,000 per year. The differences in the cash generated between investment amounts may illustrate why an income strategy may not be the best option for many investors.

Growth Strategy…
For many investors, a growth strategy may be more appropriate than an income-focused strategy. Growth strategies focus on the appreciation in value of an investment over time, and while real estate values have risen historically, they may not provide the same opportunity for growth as stocks. For example, since 1990, average home prices have risen by about 230%. By comparison, the overall stock market has risen by more than 1,200% within that same time. Additionally, 10 of the largest REIT exchange traded funds as measured by assets under management have underperformed the overall stock market since their inception. The difference in rates of appreciation demonstrates why a growth strategy involving stocks may provide more of an opportunity than real estate to increase wealth over time for the average investor. Also, although the stock market is known for its ups and downs, the real estate market is not immune to turbulence. For example, during the Great Recession, average home values dipped by more than 20%, taking over 6 years to recover to previous levels. While those who are able to purchase real estate in addition to their home without loading up on too much debt, as well as those who can invest enough for an income-focused strategy to be appropriate may benefit from real estate-related investments, stocks may be a better choice for others.

September 20, 2023

Home value data from the Federal Reserve Bank of St. Louis.

Markets Demystified is published the first and third Wednesdays of each month, and explores how stock market investing can relate to personal finance.

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