Investment advisors are often asked, “Should I invest additional funds in real estate or stocks – which is better?” There’s no easy answer, and arguments can certainly be made for either. Each approach has its own unique advantages and disadvantages, so having a good understanding of both will help you decide which one is right for you. You may even find that it’s in your best interest to invest in not one or the other, but in both.
To help you decide, here’s a quick list of the main advantages of real estate and stock market investing:
Advantages of investing in the stock market
Stocks are much more liquid than real estate. They can be sold online instantly with the click of a button. Depending on the location, real estate could take weeks, months or even years to sell. With stocks, you can sell a portion of your portfolio while, with real estate, you would have to sell the entire investment.
A stock portfolio typically requires less work to manage than a real estate property. With stocks, you could enlist the help of an investment manager or choose to invest in a passive index fund that doesn’t require much decision making. With real estate, it takes time and work to find good tenants and you are responsible for fixing any issues with the property. Being a landlord may not appeal to those who don’t have the time, or would prefer to do something else with their time.
Smaller investment required
With stocks, you’re not limited to a single large investment. If you have some extra money to invest, for instance $20,000, this can easily be invested in the stock market. But $20,000 will likely not be enough for a down payment on a property. With real estate, you would need to have at least a 20% down payment if you wish to avoid the CMHC mortgage insurance requirement.
Lower transaction costs
Real estate commissions, property transfer taxes and legal fees can add up quite quickly with real estate transactions – especially with the current high cost of real estate. Buying and selling stocks through a discount broker costs typically around $10 per trade, and there are no-load mutual funds that do not charge any commissions.
It’s easier to diversify with a stock portfolio. Mutual funds or ETFs are good ways to diversify with minimal costs. It’s more difficult to diversify with real estate, unless you own multiple properties, which requires substantially more money. Diversification helps to reduce volatility and overall risk.
Advantages of investing in rental properties
As a property owner, you have total control and responsibility for the property. If you want to do a minor renovation because that will allow you to increase the rent, you can do so without anyone’s approval. Or you may wish to do a major renovation like redoing the kitchen or adding an extra bathroom because you think it will increase the resale value. You don’t have that control as a shareholder. You have to trust the management of the companies that you invest in.
If you take out a mortgage when you purchase real estate, you are using leverage. For instance, if you put down a 20% down payment, any increase in property value will be magnified fivefold. A 2% property increase will yield a 10% rate of return. Of course, the reverse is also true. If property prices were to drop, losses would also be magnified. You could also leverage with stocks, by using a margin account. The biggest risk of using margin is the potential for a margin call, where the financial institution may recall the loan if the value of the portfolio has dropped too much. With real estate, you will not be forced to sell if property prices start dropping.
With real estate, you don’t get the same day-to-day volatility that you get with the stock market. Real estate does have its ups and downs, but it tends to follow a more gradual curve. Stocks can experience significant daily swings from factors such as quarterly earnings reports, global or economic news, and investor sentiment. Since stock and mutual fund prices are so readily available, it’s easy to see when markets are dropping. It may be difficult for the average stock investor to stomach a 10 to 20% drop. With real estate, since there is no specific price list, you wouldn’t necessarily know if the value of your rental property has dropped 10 or 20%. Because of this, you’re more likely to stay the course and not panic when prices are falling.
In the case of rental properties, you can deduct operating expenses, such as mortgage interest, property taxes, property management fees, insurance, and repairs. All of these expenses can be deducted against the rental income. If your rental expenses exceed your rental income, you can deduct the rental loss against other sources of income. You also have an option to deduct Capital Cost Allowance (CCA), which allows you to claim depreciation, reducing your current tax obligation and deferring it to future tax years when your income may be lower. Rental income generates RRSP deduction room for those still eligible to contribute. Canadian stocks do provide preferential tax treatment on the Canadian dividends, but the tax deduction and potential tax deferral are a significant advantage of investing in real estate.
Real estate investors like the ability to use their physical piece of property. For those of you who may be considering downsizing in the future, moving into the rental property is always an option. With stocks, you won’t be able to use what you own. You only get statements showing that you own a particular stock or mutual fund. If the world were coming to an end, real estate investors can always take shelter in their property.
While this list can serve as a guideline to help you figure out which option seems intuitively better, you should look at your complete financial situation with your planner to figure out what the best investment solution is for you.