Why Real Estate is a Better Investment then the Stock Market

I know upon writing this many stock market gurus will bash real estate as they always have. And in light of the current market conditions, I thought it would be a good time to explain why real estate is a better investment then the Stock Market.

Real Estate vs. the Stock Market- A Primer on the Differences

Difference #1 - Capital Gains

For most of us paying tax is simply a part of life. That old saying "there are only 2 sure things in life ...death and taxes" is true. Paying LESS TAX is what all educated investors need to study. Investment real estate offers one of the best tax shelters there is when compared to the stock market.

As noted earlier, we all have to pay tax, but why not pay less. If you properly set up your real estate investment holdings as a business, then you will only pay 50% capital gains tax on your profit. For example if you made $1000.00 in the stock market, you will pay 100% of the tax on that money. So if your tax bracket is lets say 35%, then you have to pay $350.00 in tax. Your net profit now becomes $650.00 AFTER TAX.

In investment real estate, if you earned a $1000.00 profit, you will only be taxed on 50% of the profit which works out to $500.00. The tax you pay ( using the same 35% tax rate) will only be $175.00. Making your net profit $825.00 AFTER TAX.

In time owning investment real estate can lead to a vast amount of money saved in tax  And of course, you do not have to realize your profit till you dispose of the property. Which means that if possible, you do not have to sell until your personal tax rate is at its lowest, saving even more money.

Difference #2- Value

The stock market is valued on company balance sheets, assets, P/E ratios and other wonderful terms that could spin your head around.  All these terms at one point or another help in understanding how valuable a stock is. (*Quick Note...for those that do not know what a stock is... it's a piece of paper that says you own a "share" or a piece of the company in one form or another. For the purpose of this article we will not get into the types of share ownership here)

However digging deeper into the foundation of basic economics and the meaning of value, a value placed on something is only what someone is willing to pay for it. In other words EVERYTHING is worthless UNTIL someone pays you for it.  Let me clarify. You buy an antique dresser because you are an antique dealer and you "know" its value or what someone ELSE is willing to pay you for it. In other words you could say to yourself, "wow this dresser is worth at least $500.00.The guy only wants $250.00 for it...I'm buying it" You say $500.00 because you understand the craftsmanship, the name of the manufacturer and so on.  But digging deeper into the true meaning of value, you say $500.00 because YOU BELIEVE THAT SOMEONE ELSE WILL PAY YOU $500.00 for it. I say this because in reality the dresser is nothing more then wood pieced together with nails and glue.

Let me give you a more pertinent answer. You own a small factory that makes widget42. Last week you and your accountant completed your year end financial statements and it showed that you had a net asset of 100k in your company. Your company was worth 100k.  Your company owns machinery, inventory, Accounts receivable etc... . However today it was announced that widget42 causes cancer.  When you get into the office you discover that all your orders have been cancelled and there is a lawsuit pending.  You immediately call up your one of your suppliers and say "hey I'm going bankrupt, the machine you sold me last year I will sell back to you. Last week my accountant said it was worth 25k" (based on fancy depreciation modeling that only accountants and Tax people understand). He says sorry I'll give you .10 cents on the dollar for it. He makes other calls. They all say the same thing. What happened? Just last week you had a company worth 100k now you are lucky if it's worth 10k. What happened to the value?

Well we can certainly analyze the effects of news and market forces which stock market gurus can discuss in endless drivel and commentaries.  But let's get to the point. He lost money because the value that his sophisticated accountant gave him just last week was in reality just a piece of paper. The real value in his whole company is what someone is willing to pay you for it. You can throw all the calculated numbers you want at something and base value on all kinds of things, but until you sell it and the money is in your hands, then everything you own is in reality ....worthless. Now I know that sounds all doom and gloom, but we are all in the same boat. All of us own things and all of us have value based on what we can SELL them for (yes it's simplistic but it works!!) 

So big deal, I own a piece of real estate that is worthless. And I own a stock certificate that is worthless. What's the point?  Value in stock is worthless until you sell it. Therefore the same can be said about real estate. Value in your home is worthless until you can sell it. But there is a difference. A stock certificate is a piece of paper.  A value was placed on that paper because of what you paid for it based on market conditions of value.  Real estate, well it's physical. Yes value can be placed on it by the same market conditions that value stock, and here is the difference. It's real. You can touch land. You can physically still use it. Even if it is worthless, you can still walk on it. (well I guess you could walk on a piece of paper too, but it's just not the same....). You can grow something on it, even if it's worthless. You can sleep on it even if it's worthless.  Get my point? A stock certificate is a piece of paper that is worthless until someone pays you for it. Real Estate is worthless until someone pays you for it, BUT it still has use!! Even if land has no value, it still has use. A stock certificate has NO use if it's worthless.

Difference #3- Leverage & Margin Accounts

Margin Accounts - Going Long

Everyone talks about leverage in real estate. Which in simple terms means that you can take 25k and leverage it into owning a 100k home?  That is, you put down 25k and you can own a home worth 100k.

You can sort of do the same in the stock market. Margin accounts are accounts that allow you to "borrow" money against the value of a stock, much like borrowing money to buy a home.  Going "long" on a stock means you want to own it and in most cases you can borrow between 50-90% of the value of the stock to purchase it.  That is, you can pay for 50 shares and in a margin account you can really "own" 100 shares.  Similar to real estate.  But there is a difference. If a share you just bought drops in value while in the margin account, you have to "cover" the difference.  You have to come up with more money to balance out your margin account. But in real estate, if the value on a home drops after you bought it, the bank does not ask you to cover the losses.  You will only absorb the loss if are forced to sell it. So margin accounts do allow for leverage, and if there is a loss, you have to come up with more money. In real estate, if there is a loss you only realize it if you are forced to sell it. If you keep it and keep paying the mortgage payments you can still use it. Real Estate losses are only realized upon the sale of it. Not during its ownership.

But let's use this same example and presuppose the share values go up. In this case you will have "extra" money in your margin account. You will now have excess funds that you can either spend, leave alone or re-invest it. In real estate we have the same opportunities. If the value goes up after you purchase a home, you can re-finance it ( get a new mortgage on a property you already own) and take the money "out" that way to spend, reinvest, or save it, But note there are costs involved to refinancing. Be sure to work out all refinance costs before proceeding.

Margin Accounts -Shorting

Now let's use the same example of a margin account but this time we don't want to really "own" a stock like we do when we go in a "long" position. We want to short sell it. Short selling means that we don't really want to own it because we calculate that the value will drop. After all why would we want to own something if we think the value will drop... right?. So in the stock market we can short sell a stock in "hopes" that it goes down. If it does, we make money. If it doesn't ( i.e. it goes up), we lose all our money PLUS the difference in your margin account. Very much like gambling. In fact this kind of investing I would call speculation or educated gambling, but that is another story.

We can do the same in real estate....sort of. We never really want a property to go down in value but the same speculative techniques where we "hope" the value will change like in the stock market can still apply in real estate. We all know that we can buy a property with no money down (This article is not going to explain how, that's for another time). With a no money down purchase you would buy in hope that the value goes up. If it does then we made money, but if it goes down, then we never really lost money for two reasons. One, we never money down in the first place to buy it and secondly we do not have to come up with the money right away to cover our losses like in a margin account. We only absorb losses in real estate when we have to sell it.  And if it is a rental property, it doesn't matter what the value, as long as it produces cash flow, you will only realize a profit (or loss) when you sell it.

Difference #4- Market Fluctuations and Change

In many ways the stock market and real estate are both consider asset classes. That is, they both have value. However real estate is considered to be de-coupled from the stock market. The stock market can affect real estate values and vice versa, but in very different ways. 

First off, by the speed of the affect. In the stock market a news item can immediately send the markets up or down. It happens within minutes. In real estate a news items can take weeks, months or sometimes years to have an affect on real estate value.

Secondly the type of changes have different affects. A rail link that comes into a new community will have a ripple affect on real estate values in the surrounding neighborhood. But that same rail link has little or no real affect on the stock market as a whole. Yes the value of the specific Rail Company may go up, but that may depend on other factors as well.

Which brings us to our third point; the stock market affects real estate and real estate affects the stock market....BUT...in very different ways.  What that means is that if the stock market as a whole drops in value, our home values may drop...or they may not. It depends on many other outside economic factors (too many to explain here).  If however the values of real estate drop as whole, then yes it will affect the stock market in a dramatic way (case in point-sub prime meltdown).

 In Summary

 I, like you have lost money in the stock market at one time or another. I, like you (maybe) have lost money in real estate.  And that is the first point of discussion. I lost money in both. But I have found the real estate market to be a safe haven compared to the stock market. I have identified similarities in both markets and have come up with the following conclusions:

1-Tax - The capital gains paid on investment real estate is 50% vs 100% of a stocks capital gain ( taxed at whatever your personal marginal tax rate is)

2-Value- Stock value is worthless and useless / Real Estate value is worthless but still has use.

3-Leverage -You can leverage both real estate and the stock market, but in stocks you have to cover your losses immediately in your margin account. In real estate you can "hang on" and wait to sell at a later date.

4-Margin - You can short sell in stocks and you can buy no money down in real estate, but again any losses that occur in stocks must be compensated for immediately. In real estate, time is on your side.

5-Speed of change - Change occurs in the stock market quickly. Real estate is a week to months; again time is on your side to make decisions.

We have to put our money somewhere, and real estate is out on top in the long run. The practical use of real estate and the application of time is always on real estates side.

I agree that you can lose money in both. But real estate change, in many aspects is foreseeable. If you are educated on the local and national economy you can, to a degree, estimate real estate values more so then the stock market. Change in the stock market can be immediate and unforeseen.

To educate yourself on real estate visit www.educatenotspeculate.com

Mana Investments ( www.manainvestments.com) can walk you through all the complexities of investing in real estate for the first time. We have developed tried and true options to help you find, buy, and manage your investments. We focus on Barrie, Orillia, Collingwood, Innisfil and Midland because from our economic research we believe that these towns have good growth potential over the next 10-15 years.  We firmly believe and TEACH that real estate is about education....not speculation. For information on upcoming seminars please visit www.educatenotspeculate.com             

For more info: (705)-812-1033

Email: mark(at) manainvestments com

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