Most of us have been told that we should work hard, climb the corporate ladder, and invest in the stock market along the way to maximize our financial growth. Most high-income earners subscribe to this method their whole careers, only to find out that fees chipped away at their net worth and volatility created massive swings and stress for them.
Other savvy investors look to real estate. They believe amassing a portfolio of rentals will give them passive income, appreciation, tax advantages, and more. They’re right. However, it also tends to give them a second job.
If you’re like most professionals, you probably want to either focus on being a high performer in your career, or you want to spend time with your family or doing something that brings you joy. Not taking on a second job.
Let’s take a close look at investing in stocks versus real estate. We’ll cover five reasons you may want to diversify away from stocks and into real estate, how commercial real estate investments mitigate risk, and why the stock market can be much riskier than real estate.
As with any investment, there’s an element of risk. Just as you could have been hit by a bus this morning, unexpected things come up in life, in the stock market, and in real estate.
The key is not to look for investments that are risk-free (that doesn’t exist), but to understand the risks thoroughly, determine your threshold for risk, and ensure that you’re doing everything you can to mitigate risk.
While the following reasons are why we prefer diversification through real estate, I find that these are common concerns and risks for nearly every investor I speak with regarding growing their investments.
Sure, we’d all like to believe that a stock portfolio would generate returns at a steady 7 – 10% over the course of our lifetime, but that’s just not the case. It is true that the market has increased over time at that rate, but that may not be the situation when you go to withdraw that income.
For instance, you are ready to start using your investment income and quit your job. Suddenly, the market drops 50% overnight. Your $1.5M portfolio just became $750k. Sure, the market rebounds, but looking at that number will likely inspire you to work another few years until that correction.
Stock market volatility can crush your goals depending on the timing.
In real estate investments, even when the value drops, the underlying income usually remains the same and often increases over the long-term. In other words, you can still receive the same cash flow. You may have to postpone the sale of the asset, but could continue to enjoy that cash flow.
Often as investors, we can get emotional when we see stock market fluctuations. Stock market investors often panic during a downturn and sell their stocks. Then they get back in the market too late after the market values return.
“Doing well with money has little to do with how smart you are and a lot to do with how you behave. And behavior is hard to teach, even to really smart people,” writes Morgan Housel in his book The Psychology of Money.
The truth is that we all believe that we aren’t the type of person who will become fearful and sell off our investment portfolio during a downturn. But the data doesn’t support that. Most people succumb to fear and sell. Others are forced to wait years until their portfolio recovers.
Because you can’t trade real estate the way you can with stocks, it removes more of the emotion from the equation of buying and selling quickly. Real estate investing is a get-rich-slow game that naturally removes much of the emotional decision-making just because decisions can’t be made as fast as in stock market trading. This can lead to much better long-term returns.
I’ve tried my hand at individual stock investing and mutual funds and found it impossible to assess the “value” of any stock I would purchase. Perhaps a stock’s P/E (price/earnings) ratio was at a historic low, so it might look like a good buy. Then it reaches a newer low because that industry isn’t looked upon as favorably.
Or, I’ve invested in high P/E stocks that only trade that way because the investor sentiment says that the company is going to generate higher sales and profits many years into the future.
This is often called the Greater Fool Theory, which looks like, “I’ll buy a stock today for $10 and hope another fool buys it from me later for $20.” In other words, the actual value of the investment is overinflated and there is another fool out there who is willing to buy an overvalued stock.
The underlying principle here is that it can be extremely difficult to evaluate the value of your investment in the stock market, especially if you are looking to spend less time on your investments – not more.
When you acquire real estate investments, whether it be a personal single-family rental or an ownership share of a syndication, you know that it has real value that won’t drop to zero. There is a physical asset that is securing your investment and there are tenants in place that are paying the rent to occupy those spaces.
This is truly the magic bullet of real estate investing.
Could you imagine contacting a representative at Fidelity and asking them if you could put 25% down to buy $400K worth of stock and they can hold the stock as collateral? Of course, we know that’s ridiculous and a brokerage would never let you do that.
Sure, you can buy stocks on margin, but if the value goes down too far, you have to put up more money to cover the decline in value.
So why would a bank let you borrow money to purchase real estate and not make you put up more money if the value of the real estate decreased? What it tells me is that real estate is intrinsically more valuable than stocks.
The beauty of being able to borrow money shines through with appreciation and the historic gains made from the sale of hard assets (hint: that’s you).
Say you put down $50K to purchase a $200K home, by borrowing $150K from the bank. When you buy it, you really only own 25% of the house. If the house value increases to $300K, who gets the $100K in profit? You do of course, but with only a $50K investment. And when you own it, your tenant is paying down your mortgage for you.
In real estate syndications, we also secure a commercial loan from banks. Every one of our Limited Partner investors (that’s you) benefits from this leverage.
Many investors are taught to have a target amount to save in their retirement accounts. This is known as their Financial Independence Number, or FI number. This number is some sort of guess as to how much money they’ll need to live on in retirement, which can be a really difficult number to estimate.
Then they have to guess how long they think they’ll live to figure out how much they can withdraw from their account. On top of that, if you don’t rebalance your stock portfolio (think stocks vs bonds), then you could end up having to live on a lot less depending upon the timing of your retirement.
When properly invested in real estate, you can enter retirement with a portfolio of cash-flowing properties. You’re less worried about a stock market crash coming at a time when you planned to draw down on your retirement savings.
Cash flow could fluctuate along with changing markets and business plans that involve significant capital improvements or rehabs, and we always recommend planning your income accordingly. Generally, it can be easier to build wealth based on cash flow in real estate than on a large balance in a stock market retirement account.
If you’re on the fence between active and passive real estate investments, the experience you gain from owning small rentals is irreplaceable. However, personally owning rental properties is not a prerequisite to commercial real estate syndications.
Either way, investing in real estate is a great way to diversify your portfolio and mitigate risk. It gives you an opportunity to have a positive impact in the world through each investment,
Here at Rooster Equity, we provide multiple ways to leverage the power of real estate syndications in your investment portfolio so you can take advantage of real estate’s cash flow, equity, appreciation, and tax benefits.
If you’re accredited and looking to deploy capital, we invite you to sign up for our Investor Club to get access to our current or upcoming opportunities.