Should You Invest In Stocks Or Real Estate (Or Both) – Dual Investment Strategies
Most people invest in real estate, perhaps quite logically since this is a very easy business model to understand. Equity (stocks) is perceived as riskier and thus less desirable as an investment. The aim of this article is to give some pros and cons with both asset classes (I’m considering direct investments – not mutual funds). There is no “best” investment as this boils down to preferences and goals. However, these two asset classes might complement each other because, as I wrote in the last article about diversification, you can own several asset classes and theoretically increase returns while lowering the volatility of your whole portfolio.
Below is what I consider relevant issues to contemplate before you invest:
Price appreciation:
Where can you expect the most capital gains? This question is tough to answer, but the research I have seen indicates that stocks have performed better than real estate over long cycles (unleveraged), for example this research. That makes sense. Except for the land, why should an apartment or house appreciate in value? It’s a perishable good that literally ends up as rubbish if it’s not properly maintained. The only two reasons why it tends to increase are because of the opportunity cost of building a new house and the value of the land. When the cost of building new real estate increases, the alternative is to buy a cheaper and older apartment (and this increases its value). Because of this, real estate tends to increase at a rate in line with inflation. The value in a building is the cost of its materials and labor, plus a tiny profit margin. Costs and labor are of course the main components driving inflation.
If we include leverage the answer obviously changes. While very few use leverage in the stock market, it’s the opposite in the real estate market: Leverage is very common.
A Norwegian student named Johan Skorge Skaaret wrote a very interesting master dissertation (in Norwegian) about the real estate prices in Norway from 1899 to 2011. His conclusions are that real estate over this period as a whole has produced low returns:
The chart includes real estate prices in 4 of the 5 biggest cities in Norway adjusted for inflation. I suspect most investors believe that the price surge since the early 1990s is normal, when it most likely isn’t.
Two Norwegian students wrote an interesting master dissertation (in Norwegian) about real estate and stocks as an investment between 1996 and 2013. Their conclusions can be summarized in this table:
| Period | Real estate annual returns </ |