The GOAT – The Greatest Of All Time.
The debate that consumes much of sports talk shows and neighborhood playgrounds.
Is it LeBron James or Michael Jordan? Tom Brady or Joe Montana?
The impossible comparison, taking two players from different eras and trying to juxtapose them against one another to determine who is the GOAT.
Investors have a similar never-ending debate, what’s the investment GOAT? Stocks or Real Estate?
These two investment juggernauts – stocks and real estate – have fueled investors’ enthusiasm since the beginning of time. But what is the most optimal of the two investments?
Neither. Apples and oranges.
This question – the one they’ve been asking for ages – is the wrong question. It’s not stocks vs. real estate in a battle for excellence. Each investment is individualized and should be resourced when its characteristics best align with an investor’s objectives.
Today we will discuss the 6 key traits that make stocks and real estate distinctive. We will not dive into all the granular nuance but rather set the table for you on how one goes about comparing these two allocations.
So, off we go…
Liquidity is the most underrated trait, and it really doesn’t get enough airtime when we talk personal finance. Liquidity is simply one’s ability to convert an investment quickly and easily to cash.
Stocks are traded on an exchange, and billions of shares trade hands each day. Stocks of different sizes and risk profiles will have varying volumes of trades per day, but your household name stocks have a high liquidity level. With the push of a button on your online custodian, you can quickly and easily exchange your stocks for cash.
As of today, traditional real estate doesn’t have a similar frictionless platform. It is the process you are most familiar with – contacting an agent, placing the wood stake with the “for sale” sign on the front lawn, open houses, escrow periods, etc. If you want to sell your property, there will be a process, and it is unlikely that the timeline from the decision to cash in hand would look anything like the process of selling a stock.
Some might argue that this is a benefit – keeps you safe from making an emotional decision. Others might have a rebuttal that when an emergency presents itself, liquidity matters most. Again, not a debate of superiority but rather a highlight of differences.
Some real estate investors underappreciate the power of leverage. The average buyer will typically only come to the purchasing table with 20% of the transaction cost. Who’s the silent partner covering the majority (80%)? The bank. This is what we call a mortgage.
When one measures investment returns, even though only 20% was the down payment, the total exposure is what the returns will be measured on. Sure, the borrowing isn’t free, and this needs to be considered. Leverage can amplify gains and losses.
On the other hand, I don’t think you will get very far if you walk into the bank asking them to be the silent partner and provide you 80% of the cost on your next stock purchase. Yes, there is margin and other derivatives to create leverage, but it isn’t the same.
Will there be two sides to the debt debate? Of course, you will have your debt-shamers, and you will have your advocates. Debt, in and of itself, is not evil, but like anything, it can be perverted.
Yet another consideration when we are weighing these two investments against one another.
I often get asked why I don’t have any rental properties. Is it because I think they are a bad investment or that I have some valuation opinion on the real estate market? No and no. I am scared to death of being a landlord. My life is chaotic, I’ve got two kids in diapers, responsibilities at work, and my wife and I have to fight hard just to protect our weekly exercise routines.
I love the idea of owning rental properties. When something breaks, you will hear about it, and you will foot the bill. Yes, you can get a property manager, and yes, they will ease some of that burden, but at the end of the day, you are still the “CEO.” I am sure I will in the future, but I just can’t shoulder that responsibility right now.
I repeatedly tell clients that are buying their first rental property, “congratulations on the new business venture!” Why? Because the framing around this is so key – this is not like buying a stock or a bond where you take a passive role. You will be committed to running this business, and as the landlord, there is a multitude of business responsibilities that you will have.
This might be one of the features that I love most about stocks – I invest, someone else runs the business, and we both share in the profits.
In the world of stock investing, we are on the tail end of a custodian cost warfare. In the last handful of years, we’ve seen the major discount brokerage firms reduce their trading fees from $5 a trade to $3 a trade, to free. The act of buying this publicly-traded company or that company is now a no-cost endeavor.
Will this removal of a cost barrier create more transactions and turnover and lead to potential bad investment decisions? Maybe, but this is not within the scope of today’s discussion. What we do know is the cost of buying real estate is not free. You have agent commissions, title fees, escrow expenses, appraisal, etc.
Again, two very different investments.
How long does the average person stay in their home? 13 years. How long does the average person hold a stock? 5-8 months (h/t Ben Carlson).
Perhaps a reality of the difference in liquidity and transaction costs, or maybe just how daunting a task it is to move. Regardless, history reflects very different “average” holding periods for these two investments.
Our tax code is very accommodative to real estate investors. Everything from depreciation to like-kind (1031) exchanges to capital gain exclusions. These benefits are impactful and should be considered and factored in when assessing a real estate investment.
Transacting/investing in stocks doesn’t offer all the same tax bells and whistles. Sure, there are ways to be strategic about managing a stock portfolio, and there are some tax advantages to be had, but I would say the tax scale weighs in favor of real estate.
Now, as David Bahnsen often says, “you can’t let the tax tail wag the dog.” So, taxes are a factor but one of the multiple considerations that need to be assessed.
Different Tools For Different Jobs
We started out with the claim that it isn’t stocks vs. bonds. This is not a GOAT debate. Like an old boss used to tell me, “it’s not this or that, but rather this and that.”
Stocks and bonds behave differently, and their uniqueness allows you to assess which puzzle piece – stocks or real estate – will fit best for the hole you are trying to fill in your portfolio. Diversification isn’t just about risk and returns. It’s also about the items we discussed today: liquidity, leverage, responsibility, cost, holding periods, and taxes.
My advice is to avoid any article that claims stocks are better than real estate or vice versa. Just know they are apples and oranges. Partner with your financial advisor to go through the checklist we did today to decide what best solutions for you and your family.