About a month ago, I had the opportunity to hop onto the real estate bandwagon. It was a terrific deal, had low entry barriers and speculators had high expectations of the area where the project was located.
But I passed on the opportunity. (I hate passing on opportunities, especially when it is laced with the promise of financial freedom.)
Not because it was a bad deal, but it was a mixture of risk averseness, timing and lack of conviction on my part.
Well, it got me thinking. For someone on Forbes's Billionaire List who made his/her wealth through stocks, I can name you one who achieved the same through real estate.
But we're not talking about who makes the most wealth here, that's not the point. We're talking about financial freedom - that's what White Collar Freedom is all about.
So, Stocks or Real Estate?
The case FOR real estate:
- You make a profit through capital gain and rental yield. When a property increases in price and you sell at a higher price than your cost, you make a capital gain. When you charge a rental that is higher than your monthly mortgage payment, you earn additional monthly income. What's there not to like?
- The ability to leverage with structured risk, as opposed to margin trading on stocks.
- Deals & other sweeteners by developers. Over here where I am located, there are various deals and offers that can get you a 95% loan - which essentially means that your initial outlay is a mere 5% (or sometimes even lesser). Other sweeteners include guaranteed rental payments for the first 2 years. However, this differs from country to country.
- Low initial outlay for potentially massive gains. Your outlay may only be $20,000 (5% of a $400,000 property) but if the value of the property increases to $500,000, you earn $100,000. That's a 500% return on investment!
Also, where I'm located, you only start paying your mortgage when the property is ready for occupancy. So if the project takes 2 years to complete, you pay nothing (besides down payment) for the first 2 years, which gives you:
- More time to save up for a buffer. More financial buffer means you have more holding power when the rental market is soft. In simpler terms, it means you can sleep better at night.
- Ability to refinance and bankroll another property with the difference. Do read up about refinancing.
The case AGAINST real estate:
- You are assuming that property prices will always go up. It is also optimistic to think that you'll always have a tenant. But that's why you need a financial buffer (read point 5 above).
- The risk of abandonment. Project developers may abandon the project due to financing issues or other reasons and you may lose your down payment. (This applies to unbuilt projects only)
- Maintenance, insurance and legal documentations. There is certainly more hassle when it comes to real estate - stacks of legal documentations to secure your property, applying for financing, etc. Don't forget furnishing and maintenance of property units, as well as the collection of rental from tenants (however, this can be overcome by appointing a property manager at a fee, thus reducing your net income yield)
- Lack of liquidity. Unlike stocks, you can't sell your property as and when you like. When times are good, you pay your monthly mortgage payments. When times are bad and your property is vacant, you still pay your monthly mortgage payments. If your financial buffer can't withstand a rough period, you run the risk of foreclosure and unlimited liability. (Worst case scenario = bankruptcy)
- Physical survey and location study. The thing about real estate is that there is more work involved in the preliminary stage which requires you to travel to the location physically and understand the surrounding area and growth potential.
The case FOR stocks:
- You make a profit through capital gain and dividends. Similar to real estate, you actually own a percentage of an actual business which you can sell off at a higher value if the price goes up. Companies with stable track records also pay out dividends that increase every year.
- Low entry barriers. Stocks in the US are sold per unit while other international stocks are sold per lot (e.g. 1000 units). Generally, it is easy to open a brokerage account and start investing with $1000 as a start.
- More strategies to choose from. If you're aggressive, you'll go for a growth model (purely on the idea of buying low & selling high). If you're passive, you can dollar-cost-average on Index Funds and Exchange Traded Funds (ETF). If you want a slower but steady growth strategy, you have dividend investing (only buying companies that pay increasing dividends for the past 10 years).
- Limited liability. When you invest in stocks, you are using money that you already have. Therefore, you can only lose what you put out on the table.
- High on the liquidity scale. Unlike real estate, if you need to cash out for whatever reason(s), you just have to hit a button on your computer and you get your cash in 1-2 days.
- Easily available data and documentation. More data helps you to make a decision. Financial reports, ratios, management information, industry studies, etc.
- Ease of transaction. With online brokerages these days, all you have to do is to hit a few buttons on your keyboard and a transaction is made.
- You generally don't lose if you don't sell - requires little holding power. If you invest in high quality stocks, it doesn't matter if the price fluctuates, you have a choice to sell ONLY when the price is high. On the contrary, if the price of your real estate decreases and if you have no tenant, you continue to pay the monthly mortgages.
The case AGAINST stocks:
- There is more temptation to time the market. Speculation is as good as gambling. If you're speculating, you might as well go for a game of roulettes.
- Lack of leverage. With the exception of margin trading, investing using your own money means that there is no potential for huge gains like real estate. You're considered a skilled investor if you make 6-7% net returns per year (read: Bloomberg). However, with a dividend growth strategy, the magic of compounding works for you and this can accelerate the wealth building process significantly.
The conclusion is fairly obvious to me.
If you have a a point of entry into real estate and you have holding power, real estate investing will build your wealth relatively faster than stocks.
But if you're just starting out and have no holding power, buying high quality stocks that pay out good dividends beats putting your money in a savings account, any time of the day.