Real Estate vs. Stock Market: Which is a Better Investment?

Real Estate vs. Stock Market: Which is a Better Investment?

When looking at the best ways to generate potential returns for your investment portfolio, there is much debate on whether the stock market or real estate investments offer the best opportunity.

The Best Long-Term Investment: Gallup Results (U.S.)

In Gallup’s annual Economy and Personal Finance poll, respondents were asked to select the best long-term investment from among five investment groupings. Over the last two years, gold led the pack as best investment in 2012 as well as 2011 — soaring above stocks and real estate. Now, as the real estate market shows signs of improving, sentiment has changed, moving up the scale in favourability.

Gallup Poll

Although real estate has made a return in favour in terms of Americans’ perceived best investment, this month, I’d like to share my thoughts around this long standing question and suggest that it’s really not a question of Real Estate or Stocks… it’s about real estate AND stocks.

Each investment options provide a range of benefits. Regardless of your asset class, returns are determined by different factors that generate different benefits. It’s important that you investigate and consider investing in both real estate and the stock market for different reasons.

As I have mentioned in other newsletters, every investor has different needs and objectives.  The first step in weathering the ups and downs of the current and future market cycles is to understand your investing goals and objectives.  As H. Stanley Judd, author of “Think Rich” once said: “A good plan is like a road map: it shows the final destination and usually the best way to get there.”

Let’s look at these benefits in more detail and what to consider before you invest.

Real Estate

As part of diversified portfolio of all asset types, real estate provides key benefits.  These include:

Leveraging Other People’s Money

Leveraging allows you to use other people’s money instead of your own money to purchase real estate.  Conventional financing from banks can provide you funding up to 80% of the property’s value.

According to financial educator, Talbot Stevens, real estate can be an intelligent investment choice. In a recent interview, Stevens acknowledged: “Real estate investing is like a mini-business that doesn’t have a lot of complexity to it. For the average person, real estate can be a good strategy.”

Strategic Investment Realty encourages our clients to be wise about using leverage and understand the risks of overleveraging. Borrowing against an asset can be a great way to increase your portfolio returns, but it does carry some risks.  Real estate investors must be able to:

  • Manage changes in the interest rate to comfortably pay down the debt.  In a worst case scenario, selling your investment may be your only option.

Timing and competition for similar investment properties are important considerations of this scenario. Bear in mind, selling your asset will crystalize your gain or loss depending on market demand and conditions.

  •  Earn more than you’re charged for borrowing to make an investment
  • Find the right tenants to maintain your investment, as they will be the ones that pay off your mortgage through monthly rents.

Asset Appreciation

Changes in the particular real estate market conditions (demand and supply) impact the value of your real estate investments.  Over time, appreciation of your real estate investments can boost your net worth.

Although you as an individual can’t control the market on a large scale, you can respond to changes in the market to affect your property’s desirability.  Simply put, you can affect your asset value and the income it can generate.

If, for example, you have an older investment property, you can upgrade or improve the property’s exterior and interior to appeal to a different market of renters.  This allows you to attract the right kind of tenants and get additional rental income and be a step ahead of your competitors.

When comparing real estate to stocks, many people highlight the benefits of stock dividends. In a way, real estate rental income can also be viewed as a dividend.  Like some stocks that provide dividends, real estate provides you monthly income (via your rent) in addition to any increase in value to realize gains over the long term investment.

 Tax Reduction and Inflation Protection

In the quest for tax reduction and deferral, real estate is often left unnoticed.  However, investing in real estate provides some important tax considerations.  According to an article from the Financial Post, it can be considered a “secret” tax shelter.

How do real estate investments impact your taxes?  Here are some tax benefits:

  • Rental income is taxable and rental expenses, including mortgage or line of credit interest, are tax-deductible.
  • Often, if a property has highly leveraged financing, it may operate at a loss for tax purposes creating a tax deduction against all other sources of income and therefore, a tax refund, but it must pass a test that there is a reasonable expectation of net income in a reasonable timeframe.
  • If an investment runs at positive cash flow for tax purposes, depreciation can be claimed to offset some or all of the taxable income inclusion.

I always recommend discussing the impact of real estate investing with your accountant or tax professional to determine how your personal situation may be impacted from any of the items above.

Real Estate Market Conditions

As I mentioned earlier, the market conditions will play a major role in determining the price people are prepared to pay in order to purchase real estate.  This means that if you are able to look at supply and demand to determine if there is an oversupply of product, you may have an opportunity to buy properties at prices below market value.  This is especially apparent with motivated vendors. You can always negotiate the final price based on market and the property condition conditions.

It means that as an imperfect market – there are opportunities to invest and leverage timing to improve your returns.

As an owner of a unit in a multi-family real estate investment you can affect how your property can operate in various market conditions: getting involved in the decision making process is the best option to impact change.  Each decision is voted for approval via elected directors of a governing board, which is responsible for any major decisions.  This process can take time, so having a proactive governing board is a very powerful asset to your property.

The Impact of Speed and Direction

If we were to look at real estate and stocks, we could use a boat analogy to illustrate the differences.

I like to think of real estate a tanker – the market is slower to turn – both in direction and speed. It takes a while to get going, stop or change direction. Often, investors use a buy and hold philosophy, so they are not in any rush to turn around and resell the investment.

On the other hand, the stock market can be described as a speed boat. It can turn direction on a dime and can have significant swings in values in a short amount of time. You need to consider the timing of your trades and the impact of buying and selling in the short term, to support your portfolio goals. This is especially in times of volatility in the equities market.

Stocks and Mutual Funds

Over time, investing in stocks is a potentially profitable method of increasing your wealth. If you do your research, you may find that stocks and other equities can be an important component of a diversified investment portfolio to meet your long-term investing goals.

Leverage

Like real estate, investors have the opportunity to borrow money to purchase stock.  Unlike real estate, where the value and income of the property are considered by the lenders, borrowing funds for stocks will be based on and the amount determined by your existing financial position which includes your current assets, liabilities, equities or personal covenants. When borrowing against your stocks, which is also known as “buying on margin” there is a limit to the amount or percentage you can borrow and usually it is not more than 50% of the value of the existing stocks. When buying on margin you need to address how you are going to pay off the debt.

In the right market, a small percentage change in the value of a particular stock can effect in a very large change in the value of the investment.

As an investor, you have the potential to buy stock at one price, and in ten years the price may double, so you benefit from that increase.  However, when you invest in real estate, you can get the additional benefit in your tenants actually paying off the debt while also gaining appreciation.

Generate an Income

Although not all stocks offer dividends, investing in certain stocks may provide an income from your stock portfolio. If you are receiving a cash dividend you can reinvest your dividends in that particular investment, another investment or take the cash.

Stockholder Voting

As a stockholder, you have voting rights that allow you to elect certain directors and participate on a small scale to set direction. Although you can vote, the share price is the share price.  You as an individual investor can’t negotiate for a different price per share.

With real estate, you can improve your investment by giving it an upgrade. You can’t affect the price of the stock like you can in real estate.

Liquidity and Volatility

Unlike real estate, changes in stock price and direction can happen instantly.  In 2009, when the economy shifted, we saw the effects of how share price can turn.  On January 14, Nortel witnessed a 79% share price drop on the Toronto Stock Exchange as it sought out bankruptcy protection.

In the end, it was not enough to save the company and thus serves as a cautionary tale of the importance of research. It’s important to be prepared for changes and swings in stock prices.

Market Conditions

Overall equity market conditions can have a large effect on your stock value.  As we saw in 2008 and 2009, many investors experienced the massive impact of several different factors converging at one time.  Some people maintained their stocks, others sold, while other investors purchased stocks and depending on when and what action they took, determined their outcome.

In the real estate world, massive housing price corrections were due to lending policies with several factors converging at one time.

Nassim Nicholas Taleb, a Nobel Prize winning Economist, has a metaphor that describes these seemingly out of the blue surprise “perfect-storm” conditions.  The black swan theory describes an event that:

  • Has a major effect
  • Is a surprise to the observer
  • And after the fact is rationalized the benefit of hindsight.

Speed and Timing

Things move fast in the stock market. As we have seen in the past, your stocks can increase or decrease overnight.  For investors, this allows you to modify your course and make adjustments as conditions change. When this happens you may have to respond quickly if you haven’t built an investment plan for these changes.

I always recommend that you have a plan with objectives before you start to invest. Buy rationally and see what other investors are doing.  If you are unfamiliar with investing in either asset class then it is best to work with someone who is an expert in this field.

Contrarian Investing

Contrarian investing can be a successful strategy.  If other investors are buying, contrarian investing suggests that you sell or hold your investment. But is it is far more involved than just doing the opposite of what others are doing. I have learned a great deal about investing in the equities market from Steven Jon Kaplan at www.truecontrarian.com. And one of the lessons I have learned is: nobody gets it right every time and so managing risk and investing within your risk tolerances is a vital part of this process.

Risk Management

The Volatility Index can offer insight into implied investor volatility over the next 30 days. The Chicago Board Options Exchange Market Volatility Index, is often referred to as the fear index or the fear gauge, as it represents one measure of the market’s expectation of stock market volatility.

A Balanced Portfolio Approach

In the end, a balanced diversified investment portfolio can help generate income and support your long term investing returns.  Your age and propensity for risk can help determine the right mix of investments for your portfolio.  Most importantly, work with a team of professionals to help set up the best fit for you so that your investments perform and you can sleep at night.

Resources and Reading


Rental Property Insurance - What does Your Insurance Cover?



Understanding and Mitigating Your Risks – Rental Property Insurance and the New Limitation Act.

Propety Insurance

This month I’d like to share my thoughts on how you can better manage risk once you’ve made a purchase and what to consider for insurance coverage, and lastly provide an update on the Limitation Act.

For real estate investors, understanding and managing risk is an important part of selecting the right investment.  We consider each opportunity carefully, determining how the investment fits into our portfolio.  We deliberate on the economic fundamentals of the region, then investigate the unit and property to determine it’s the right fit.

Many investors however, assume that once the paperwork is approved and the title has been conveyed, the process is complete.  If you opt into a Rental Association Program (RAP), you expect to receive a monthly statement while the property is maintained by a professional property management group.

Insurance Policy

We all know that sometimes accidents happen.  As a real estate investor, having the right insurance coverage allows you to sleep a little better at night, knowing that you have your assets covered.

Leaky dishwashers, clogged drains, overflowing bathtubs or sinks can not only damage your unit, but if it’s located on the upper flow, it can do thousands of dollars of damage to the units below. Although the strata or condo insurance would cover the damage to the suite, it can significantly impact the deductible on the strata corporation.

Also, a simple trip or fall by a tenant’s guest may lead to injury and legal action.  If someone has a fall and requires long term medical attention, do you understand the amount of your 3rd party liability coverage and the value of the coverage?

The insurance landscape is constantly changing, with multi-family properties facing both increasing deductibles and premiums for insurance. In some cases, if there is not adequate coverage, the board could consider approaching the investor to contribute for the deductible.

As a real estate investor, I decided to take it a step further.  I approached Property Managers and asked them a series of questions.  In the end, I had a decision tree that I thought may help you understand the process and the level of coverage. Here it is:

 

Insurance-decision-tree

If you’re unsure about your coverage, ask this key question to your Property Manager:

IF I’M IN THE R.A.P. OR RENTAL POOL, AM I RESPONSIBLE FOR THE DEDUCTIBLE OWED TO THE STRATA/CONDOMINIUM CORPORATION?

They will be able to provide the answers as to how the rental association program policies relates to the insurance questions.

So what can you do to limit your exposure?

  • Understand your coverage.  If you are in a Rental pooling type program where there is a blanket policy, then review the RAP policies to understand the amount of coverage and what would happen in a “worst case scenario”.
  • Assess your risk. Read the Master Insurance Policy to determine your deductible amount.
  • Ask questions.  Email your Property Manager so you are well informed and prepared to take the necessary action.
  • If you do find yourself financially exposed for the deductible, please consult with your insurance broker as you can simply add a rider policy to your existing insurance policy.

As you can see, understanding and managing risk for your real estate investments doesn’t end when the sale is complete.  Informed decisions are better decisions.  Take the time to understand your coverage so you can rest easy knowing that your assets are covered.

At Strategic Investment Realty, we are in the process of creating a grid document that will provide the answer to the above key questions.

Now, let’s look at the New Limitation Act for BC coming into effect June 1, 2013 …

The New Limitation Act in BC
The new Limitation Act, which comes into effect June 1, 2013, impacts the time period in which BC strata corporations must act in order to proceed with legal action.

Under the new Limitation Act, a strata corporation has two years after the day on which the claim was discovered.  The current Act offers a default limitation of six years.

Legal action from a strata corporation may include:

  • Fines and levies
  • Charge-backs
  • Interest
  • Collection of strata fees

past dueSo, for example, let’s say there is an owner who has outstanding fees and interest.  Currently, a letter of understanding is sent out to ensure funds are recovered from the owner.  After the new Limitation Act comes into effect, if fines are owed for longer than two years, they may not be recoverable.

With this in mind, council members should seek legal advice as soon as possible when:

  • facing the likelihood of initiating any legal action
  • evaluating any accounts or legal proceedings that exist prior to June 2013

Of course, if you have any concerns about a potential claim, discuss the matter with your lawyer sooner rather than later.

I have included a couple of links to review the details of the new Limitation Act link 1  and Limitation Act link 2 for BC.

If you have comments, questions, or want to see more information on these topics, please feel free to call or email me.
Cynthia Aasen | cynthia@strategicinvestmentrealty.com | 604 764 5647