When you first start investing, the two things that there’s no shortage of are questions and opinions. Everyone has a different method, different hints, tips, tricks, and advice that they swear by. Should you invest by yourself, or through a professional? Should you go all in on the meme stocks that are all over Reddit, promising massive growth immediately? What about cryptocurrency—is it finally the right time to buy or are we only halfway down the crevasse after the ground fell out under decentralized digital currencies in June?
No matter what, investing comes with risks. It’s up to the investor to determine what the right level of risk versus reward is right for them. So in that spirit, let’s talk about a couple of the main areas in which people can invest their money: real estate and the stock market.
What is real estate investing?
Pretty much anyone has had someone in their life—could be a friend, parent, boss, mentor, whoever—tell them that they should be investing in real estate. Now normally, what that means is purchasing a primary residence, rather than renting. For people who live in places like New York, Boston, D.C., or pretty much the entire state of California, there’s a certain amount of eye-rolling that accompanies that advice. A very “Yeah, sure, we’d love to invest in real estate, we’ll just come up with a million dollars cash up front to do that, I guess, sounds super achievable” energy. For people who live in smaller towns, cities, and other states that aren’t experiencing massive real estate bubbles, the idea of buying a first home is considerably more achievable.
However, buying a home isn’t the only thing that people mean when they talk about investing in real estate. Since the JOBS Act was passed in 2012, development companies have been able to source investment in projects through amendments like 506(c), which allow them to use things like social media to attract accredited investors to their projects in exchange for shares in the completed project—kind of like crowdfunding but for real estate projects.
There are also options like multifamily syndication—similar to 506(c), but with fewer barriers to investment, and that are open to non-accredited investors who are looking to diversify into real estate.
Now, real estate investing can be as varied as buying individual properties, acquiring properties to generate rental income, and purchasing equity shares in development projects both domestic and foreign. After all, investing just means acquiring an asset in hopes that its value will increase with time.
What does it mean to invest in stocks?
When you purchase stocks, you’re essentially purchasing a percentage of a company. Usually a miniscule percentage, but the value of that percentage is calculated based on the appraised value of the company as a whole. Everyone hears stories about companies like Apple, or Telsa, or Uber, who handed out stock options to early-stage employees before the companies exploded. For example, 40,000 shares of Telsa stock from when the company’s stock value was .99 cents/share would today be worth over $35 million.
Unfortunately, unless you’re some kind of prophet, wizard, or unethical time traveller, there’s no way to be certain whether or not a company is destined for that kind of meteoric growth. The vast majority of investments that people make in the stock market are through mutual funds—essentially a shared portfolio of investments run by banks or financial companies, which are designed for growth (containing largely higher-risk, higher-reward investments), or security (containing more stable securities that handle market adversity better). These funds are made up of a wide range of investments in multiple different companies, with the goal being that no one company’s volatility can overtly affect the fund as a whole. This kind of security makes them very attractive investments, particularly for portfolio managers, financial advisors, and financial planners.
Other options for trading in stocks include apps like Robinhood, WealthSimple, and Charles Shwab, which allow traders complete control over their portfolios, and can manage investments down to percentages of shares, rather than being restricted to whole shares like traditional investing. This means that, even though a single share of Tesla might cost $99, investors can purchase percentages of that share, allowing people to profit from the growth of established companies, even if they don’t have the income to profit off of.
How is investing in real estate different from investing in stocks?
So the principle of investing is the same, no matter what you’re investing in. The difference is largely in what your investment is acquiring. If you invest in the stock market, you are acquiring a minor share in a company, and as a result, your investment is tied to that company’s performance.
For example, maybe you invest in an underdog video communications company that’s established, but not widely regarded as an industry leader. Then a global pandemic hits, and all of a sudden everyone and their grandma are using the company’s technology, so much so that it’s fully lapping companies that have been at the top of the industry for years. The company’s valuation explodes, going from $67/share to over $550/share in 11 months. You’re over the moon. People talk about you like you’re a genius. “How did you know,” they ask. They ask you for investing advice. You’re riding high, and you’re never going back to the way things were before.
And then Isaac Newton’s famous words kick in—what goes up, must come down. Other companies start to improve their technologies and make up ground, taking back some of their market share. Combine that with the reopening of workplaces and society at large, and all of a sudden, the golden goose drops from $550 to $400, to $350, until not even two years later, it’s back at just over $100/share.
(It’s Zoom. We’re talking about Zoom.)
All this to say, investing in stocks isn’t gambling per se, unless you’re really risking it on some volatile stocks. But what you’re receiving in return is a bit ephemeral. You own a tiny bit of a company, that as long as that company exists and is doing well has the potential to increase in value, but that physically only exists on a piece of paper.
That’s where the real difference lies between real estate and stocks. When you buy real estate, you’re acquiring physical property, whether that’s a house, condo, or even just a plot of land, you are the owner of an asset that can be held and touched. A lot of people and companies that invest in real estate acquire properties for the purpose of generating passive rental income. In the past few years, the rental market has exploded in many cities, with the cost of rent rivalling the price of mortgages in many cases, meaning landlords who own multiple properties can generate passive rental income from multiple units monthly.
Another way that people can generate income through real estate investing involves “flipping” properties—essentially, purchasing properties at reduced values due to the original owner’s financial circumstances, the state of the building, or declining property values, and investing in the property in the hope of being able to resell it in the future for a profit. Many cities and states have laws to prevent people from flipping properties in unethical ways, but plenty of people upgrade, expand on, or build new homes and sell these investment properties for substantial profits.
Finally, accredited investors can now invest in development projects like condo or apartment buildings through amendments to SEC regulations like 506(c), which in a kind of roundabout way splits the difference between stocks and real estate. On the one hand, rather than purchasing a unit in a building, or shares in the development company itself, investors can purchase an equity share in the project itself, in exchange for a percentage of the sales of the building’s units or its annual rental income. In doing so, investors can actively help offset one of the most notable risks of investing in real estate—projects that run out of funds before they’re completed. Development projects are usually financed through institutions, but the longer a project goes, or if significant changes need to be made to plans, project costs can increase. One of the ways that developers can protect themselves against costs is to source additional investment capital to ensure that the project is able to complete construction to the stage where unit presales can begin and more revenue can be generated.
When it comes to multifamily syndication, essentially, people can invest in the development of an investment property (most likely purpose-built rentals or multi-unit buildings), in exchange for a share of the building’s profits, either through sale or generated rental income. Unlike with a 506(c), the majority of the project’s costs are covered by investors, which, since these aren’t necessarily accredited investors, generally means there will be more people investing smaller amounts. However, because of the way that multifamily syndication is structured, the onus is not on the investors to maintain the property in any way, or provide landlord duties, those responsibilities belong to the syndicator. The investor’s only responsibilities are putting money in and receiving their return on investment. However, depending on the stage of the project, that second part might take a little time. Investors typically aren’t paid out until the investment has reached its ‘maturity,’ (aka its debts have been at least mostly paid off and it is now generating profits. So for people who are okay waiting sometimes a few years to start seeing their investment start generating meaningful revenue, multifamily syndication can be a very attractive long-term investment option.
So ultimately, the biggest difference between investing in real estate vs investing in stocks is the level of security of holding a physical asset, rather than slightly more ephemeral shares in a company.
So, should you invest in real estate or stocks?
Like any investment, this is going to boil down to personal preference on the part of the investor. There are pros and cons to each, which I’ve tried to outline in the graphic below.
If an investor is looking for quick return on investments that are easily liquidatable (meaning they can be sold quickly and easily for cash), then stocks may be an attractive option. However, as the Zoom example illustrates, stocks which can offer high growth can also carry with them high risk.
Real estate markets tend to fluctuate less aggressively than the stock market does. For the most part, as investors upgrade their properties and make improvements, the value of those investments tends to reflect it. The physical nature of real estate also means that there is unlikely to be a situation in which that investment loses all of its value. While companies can go out of business, property always exists (and even if a property were to be burned down, or suffer other catastrophic damage, property insurance will help recoup the lost value of the property). Finally, unlike stocks, real estate is leverageable, which means that property owners can use the value of their properties as collateral in order to secure loans from financial institutions to pursue other opportunities.
Ultimately, both forms of investment carry risks, but real estate handles market volatility better, and can generate more reliable passive income. If you find yourself in a position to invest in real estate—in the words of our friends, parents, siblings and bosses—its rarely a bad idea.