Why Real Estate Is Better Than Stocks and Bonds
Note: this is Chapter 2 of an entire guide on Why Real Estate Investing?
With commission-free trading and mobile applications becoming the new trend in investing, there has been a heavy emphasis on trading in the stock market. However, real estate is still an American favorite. Your parents will probably tell you "buy a home as an investment!" In fact there's more money in real estate than in the stock market — an estimated $50 trillion dollars in 2020 versus $31 trillion in the stock market.
The stock market offers a number of benefits including, but not limited to, ease of access and high liquidity. And we believe that equities (like stocks) are part of a larger investment portfolio allocation.
But why real estate?
Real estate offers a historically low volatility market, an automatic inflation-hedge, and a completely separate market from stocks and bonds.
Volatility
We've all heard the advice...
Invest in the S&P500 and you'll become a millionaire!
As ETF's and Mutual Funds have become the most popular investment vehicles for wide scale diversification, the stock market has entirely become more correlated. There is a heavy concentration of money in ETFs and Mutual Funds, which makes the consolidation of the stock market much greater since only a few investment management companies are able to make market-wide decisions.
To back this up, over that past 25 years, we've seen the stock market lose nearly half of its publicly traded companies (from ~8000 to about ~4000) according to World Bank.
Moreover, since the recent movement towards democratizing stock investing led by commission-free brokerages, there is more inexperienced investors in the market today. We believe this is a double-edged sword. On one hand, it is great that more people are getting to investing early on, but on the other hand, large numbers of inexperienced traders can cause drastic price changes.
We've seen the widescale effects already — the S&P500 has recently been seeing large daily movements of over 3%.
Therefore, if your entire investment portfolio consisted of only stocks and bonds, your investments are now subject to much more risk than previous generations.
Automatic Inflation Hedge
Here's what an inflation hedge is:
In short, an inflation hedge is an investment that protects your money from inflation.
For example, many people keep part of their portfolio in gold or other precious metals. This is because as inflation rises (and the dollar loses value), gold tends to get more expensive which protects you from losing value.
While stocks and bonds technically can inflation hedge, this is typically dependent on the specific stock or bond as they appreciate and depreciate in value.
What makes residential real estate different is that it typically grows at the same rate as a country's gross domestic product (GDP). This is because as the GDP grows (read: economy grows), the demand for the limited supply of land tends to increase at the same rate eventually leading to higher real estate prices.
Furthermore, real estate has an intrinsic value — the building and land is worth some money even if there is a downturn in the economy.
This means that real estate tends to maintain its purchasing power of capital overtime or exceeds it, which may protect you from losses due to inflation.
Public versus Private Markets
Stocks and bonds trade on the public market. This means that:
It is easy to buy and sell quickly (high liquidity)
Pricing is set by the market with very little leeway for changes in prices
Transaction costs are extremely low
There is nearly an infinite amount of buyers and sellers
Real estate on the other hand trades on the private market. This means that:
It is difficult to sell and buy (low liquidity)
Prices can vary unpredictably at a given moment
High transaction costs
Depending on market conditions, there may be no buyers or no sellers
At first glance, it may seem like the public market is better in every aspect. However, there is upside to buying investments in the private market like real estate.
Having low liquidity allows the prices to stay more stable and experience less volatility on average as most buyers and sellers will hold real estate for longer periods of time to reduce transaction costs.
Moreover, varying prices allows more experienced investors to capture potentially above-market gains and returns that would not be possible in a public market. For example, a more experienced real estate investor may be able to negotiate for lower transaction fees and buy a house at below-average market prices.
Basically, private markets reward experienced and long term investors.
So what? Only invest in real estate?
We may be biased, but we believe that real estate is part of a healthy investment portfolio. As discussed in the previous chapter on Benefits of Investing in Real Estate and this chapter, there are a number of reasons to invest in real estate specifically.
But don't just take our word for it! David Swensen, the Chief Investment Officer of the Yale Endowment, has recommended about 20% of an entire investment portfolio should be invested in alternatives like real estate. This has also become a leading investment strategy by investment providers like Blackrock and Blackstone in an effort to lower volatility and increase potential gains.
What's missing from many new investor's portfolios is an alternative class investment like real estate. To recap, real estate can decrease volatility, protect assets, and increase diversification in an outside market.