Why the stock market can be a better investment than real estate

Isn't real estate a better investment than the stock market?

After all, the perception is that real estate "appreciates steadily," while the stock market is volatile.

Furthermore,

real estate seems like a tangible investment, one an investor can "see, feel, and touch," which only adds to the perception that real estate will hold its value in the long run.

Well-chosen real estate properties, properly maintained, can deliver long-term appreciation for investors. Yet saying they are preferable to a well-diversified asset allocation portfolio for most investors is shaky, if not erroneous.

Calling real estate less volatile than the stock market is, at least partially, an illusion. What contributes to the perception of enhanced volatility in the stock market is the fact that stock movements are reported on daily (often in sensationalized fashion), while there is no comparable visibility of price movements in the real estate market.

Similarly, the perception that there are higher returns to be had in real estate is just that: a perception.

Equities and real estate report similar overall historical performance dating back to at least the early 1970s. Bonds have traditionally offered lower returns than either one, but they make up for this by being both highly liquid and less volatile.

When real estate investors do not benefit from price appreciation due to changes in demand from strengthening demographics, they find that their investment has far fewer drivers of growth.

It’s reasonable to expect some price appreciation, but much or all of it is attributable to general price inflation. This type of appreciation helps an investor keep pace with inflation, but it cannot be counted as true growth.

Also, changing demographics can hurt long-term growth as easily as they can help; unexpectedly slow population growth — or an excess of properties for sale — can depress appreciation below the level of inflation.

And when it comes to renting real estate properties, there are no guarantees.

There are also risks: gaps between tenancies, or unexpected major repairs, as well as the uncalculated cost of the time and effort required by the investor to manage and oversee the property.

Then there is liquidity risk, as real estate cannot always be quickly converted into cash.

By contrast, a diversified asset allocation portfolio typically offers risk-adjusted returns that are comparable to those associated with real estate.

The dynamics of the price appreciation associated with stocks is similar to that of real estate — it is as difficult to predict which stocks will benefit from increased demand for their shares as it is to predict which real estate markets will benefit.

But stocks have an advantage in that it is much easier to diversify among them, which reduces the chances of choosing the wrong investment.

Jamal Mahmood is a Certified Financial Planner and Chartered Financial Consultant with the wealth management firm Access Wealth Planning in Roseland, N.J.
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