How To Choose Between Real Estate And The Stock Market

Real estate vs stock market

One of my best friends happens to be a wildly successful real estate investor. Picking up the baton of a family business, he built up a neat little empire of apartment buildings and commercial properties – all by the age of 40.

He also happens to hate the stock market.

To him, it just doesn’t make sense. It’s volatile, illogical, and far from a place he would choose to store – and grow – his family silver.

I, on the other hand, have long been on the opposite end of the spectrum. Quite happy to put my money in stocks but slightly reluctant on the topic of real estate.

Apples And Oranges?

It might not seem that way at first, but the stock market is far more predictable. History shows that over long periods of time, the stock market returns about 8% in nominal terms.

And contrary to what most people think, it is near impossible to lose money in the stock market, assuming you have a long-term horizon and don’t do anything silly.

stock market investing - 15 year annual

Real estate isn’t like that. Bad deals and excess leverage can easily wipe out your returns and leave you in the hole.

However, real estate also offers far higher upside. On the right deal, the powerful combination of price appreciation, mortgage paydown, and judicious use of leverage can drive your returns well into double digits.

Then there’s diversification. Index funds provide instant, low-cost access to a globally diversified pool of thousands of equities.

Real estate, on the other hand, will leave you exposed to a small geographical area until you build up a larger portfolio of properties. Even then, you will likely be 100% exposed to one city or country.

In some cases (i.e. the UK), the government can also step in and impose regulations that lower the attractiveness of property as an asset class.

It’s worthwhile going through the comments on this post to get a handle on some of the challenges faced by UK property investors.

Finally, real estate also has far higher transaction costs and much lower liquidity.

You can get rid of your equities in a millisecond (though that isn’t always a good thing!). Exiting your properties can take years.

Getting Comfortable

The bottom line is that real estate and the stock market are two very different animals, with starkly different investment profiles.

As such, they are bound to attract different kinds of investors in the first place.

Some people are much better suited to buying virtual slices of ownership in large corporations while for others, nothing will ever beat good old brick and mortar.

Our upbringing also plays a massive role here.

My friend’s family was never into stocks – but they sure were into property. In fact, they started house hacking (see Lesson #2) before the term was even invented.

My family, on the other hand, was never big on real estate. However, stocks became part of dinner table conversations as soon as my parents started making enough money to invest.

There’s no need to let your legacy define your investment strategy. But it is worthwhile taking an honest look at your personal circumstances and preferences to decide which asset class is right for you.

Top 5 Reasons To Choose The Stock Market

Here are some good reasons to choose the stock market as your primary investment vehicle.

1. You have little free time

Despite what people would like you to believe, sourcing real estate deals and managing properties is very time-consuming.

It takes a lot of bandwidth to research, screen, and monitor areas of interest. And when the right property does come up, you want to move quickly.

It doesn’t matter that it’s midnight and you’ve had a long day at work followed by a tough evening with the kids. If there’s a good property on the market, you need to crack open that spreadsheet, run the numbers, and chuck in an offer.

Your tenant doesn’t care that you are on holiday. If something breaks, they want it fixed asap. If they want to move, they won’t plan it around your schedule, leaving you to find a replacement.

You can hire a property manager to help with these things. But even then, you can never disengage completely. Not keeping tabs on property managers rarely ends well.

2. You don’t like complexity

In addition to being time-consuming, property can also be complex and messy. Dealing with tenants, regulations, evictions, renovations, banks – I could extend this list to run pages and pages.

Don’t get me wrong – these aren’t enjoyable pursuits to begin with.

But if your heart sinks when you imagine yourself doing these things, real estate probably isn’t right for you.

3. You are in a high tax bracket

This one is easy. The higher the tax bracket, the more of a tax break you get on contributions into your tax-deferred vehicles like workplace pensions or 401(k) plans in the US.

As you can see from the table below, the higher the tax bracket, the higher the effective returns on your workplace pension investments.

Effective return on workplace pension investments (assuming an 8% nominal return and 75% employer match):

A higher rate (i.e. 40%) taxpayer today who will be a basic rate (20%) taxpayer in retirement can expect to generate c.13.8% on her workplace pension contributions.

It can be very challenging to find a property investment that exceeds that return threshold.

4. You get a great employer match

See above. Similar to taxes, a generous employer match does wonders to juice your returns. Why bother with the hassle of real estate if your employer can do all the heavy lifting for you?

Effective return on workplace pension investments (assuming an 8% nominal return and a 20% tax bracket in retirement):

5. You are not retiring early

One of the challenges presented by early retirement is the need to “bridge the gap” to the time when you can access your pension. Here in the UK, it means making a conscious trade-off between a pension and an ISA.

The problem with ISAs is that your investments don’t get the same oomph they do in workplace pension plans. You will likely be capped at ~8%, the long-term nominal return on equities.

Property, on the other hand, can offer those incremental returns – and provide interim liquidity before you start drawing on your pension.

But if for whatever reason (i.e. you started late or are just plain enjoying your job) early retirement is not on the cards, it may be worthwhile sticking to the stock market.

Top 5 Reasons To Choose Real Estate

Then there are those of us for whom real estate can be a far better match.

1. You enjoy the process

This is the #1 prerequisite that trumps all others. If you don’t enjoy researching specific areas, visiting properties, running numbers, and negotiating offers, you simply won’t enjoy real estate investing.

Ultimately, this will impact your returns – and not in a good way.

There’s absolutely nothing wrong with disliking real estate investing. But it’s worthwhile being honest with yourself before you go too far down the rabbit hole and damage your finances.

Then there’s the social aspect.

Let’s put it this way: being a people person won’t make you a great real estate investor. That being said, the vast majority of successful property investors tend to have a strong social skill set.

If you dread picking up the phone to a tenant or dealing with contractors, sit this one out.

2. You have hit your allowances

Tax breaks and employer matches are great – until you’ve hit the threshold. There’s a reasonable number of people here in the UK who will at some point get hit by a pension taper or the LTA.

At this point, the economics of real estate become much more favourable vs. investing in a vehicle like the ISA.

In addition to #1, this is one of the biggest reasons I’ve gone into real estate. Between the taper and the LTA concerns, my annual pension contributions now run just a couple thousand per year.

If you are in the same boat, the economics of property investment become much more attractive.

3. No access to employer plans

There are many people who simply don’t have access to an employer plan with full bells and whistles. Unless you are able to set up your own corporation, a self-invested personal pension won’t go as far as a workplace plan.

On a comparative basis, being in this situation makes the real estate option far more attractive.

4. You want to retire early

Real estate isn’t a prerequisite to retiring early, but it can really help.

And if you want to stay busy in retirement, having a portfolio of properties gives you ample room to tinker with renovations, extensions, subdivisions, and all the other things that can give you an extra return on your investment.

5. You think the stock market is overvalued

This is a big one.

A concern with the current equity market valuation levels is a pervasive theme coming through in both the comments section of this blog as well as the real-life conversations I have as part of my day job.

It’s a complicated topic and today’s post isn’t the place to explore it.  The bottom line is that if you have a strong view that equities are overpriced and are looking for yield, you have few alternatives outside of real estate.

This isn’t to say that real estate couldn’t experience a correction, especially if interest rates revert to historical levels. But at the end of the day, you simply have to take a view on the relative value of the investable asset classes at your disposal.

Best Of Both Worlds

Of course, it doesn’t have to be mutually exclusive. On the contrary, investing in both property and the stock market may be the best strategy.

First of all, there is very weak correlation between the two asset classes. In corporate finance, diversification is the only free lunch. Might as well get it.

Secondly, it makes a ton of sense to max out those tax-deferred vehicles – and use real estate as a way to bridge the gap to retirement.

Ultimately, what matters most is choosing an asset allocation strategy that’s right for you. The points above can serve as a helpful framework for answering that question.

Happy investing!

About Banker On Fire

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Banker On FIRE is an M&A (mergers and acquisitions) investment banker. I am passionate about capital markets, behavioural economics, financial independence, and living the best life possible.

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9 thoughts on “How To Choose Between Real Estate And The Stock Market”

  1. This definitely confirms my feeling that I should concentrate on pensions and Isas with maybe 2 to 4 properties in my partners name where the tax isn’t so much of an issue

    Having a decent amount of income from somewhere other than my job is definitely attractive though with property but with vanilla btl it’s going to take a fair few to be meaningful

    1. Banker On FIRE

      At the end of the day, you don’t want to diversify for the sake of it.

      That being said (and if the numbers make sense), I’d rather have my eggs in both the stock market and property.

      It’s good to be able to do financial planning at the household level.

  2. We have both real estate and paper assets and are majority real estate b/c the market seems to increasingly defy reason. But our biggest focus right now is our own business b/c the pandemic has put pressure on all sectors — business/ jobs; real estate; and paper investments. Our business efforts are what we have most control over so we’re doubling down there and massaging the rest till the uncertainty passes (or at least becomes less uncertain).

    1. Banker On FIRE

      Indeed. I’m a big (long-term) believer in the stock market but diversifying beyond it is one of the key reasons I’ve gone into real estate.

      If you don’t mind sharing, what kind of business are you guys running? Am always fascinated by entrepreneurial stories.

      1. I started a career coaching/ corporate training/ HR consulting business over 12 years ago and continue these types of projects to this day. Husband has an IT background so runs the website associated with this, and we are creating products from my services. We also just launched a printables shop on Etsy with items relating to financial independence and personal development.

        1. Banker On FIRE

          That sounds great, thanks for sharing! Sounds like a very synergistic setup with your husband too, though I am sure the various activities keep both of you quite busy.

          Hope the businesses hold up well in the current environment. If anything, demand for career coaching should go up!

  3. Amazing article as usual!

    Personally I prefer the stock market, the instant liquidity and set and forget style of investing allows someone like me to focus more on generating a higher income while enjoying solid capital growth!

    Long term though, I think real estate should from a part of my portfolio!

    Best wishes

    1. Banker On FIRE

      Thanks Josh.

      To me, the best way to get into real estate is to own your primary residence (though for a variety of reasons I don’t tick that box myself). As your net worth grows, and assuming the local market conditions are right, you can then start adding additional properties.

  4. Pingback: Eight Lessons From Building A Seven-Figure Real Estate Portfolio (And Adding $1M A Year) - Physician on FIRE

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