Do Stocks Outperform Real Estate?: Stocks, Bonds and Real Estate.

Part of The Ultimate Guide to Passive Real Estate Investing In Multifamily Via Syndication

Table of Contents

1. Do Stocks Outperform Real Estate?
2. Real Estate Volatility vs. Stock Market
3. Stocks, Bonds, and Real Estate
4. Commercial Real Estate vs. Stocks Historical Returns
5. So is Property a Better Investment than Stocks?
6. Frequently Asked Questions about Stocks, Bonds & Real Estate
7. Do Stocks Outperform Real Estate - Conclusion

Unlike bonds and stocks, what’s unique to real estate investing is the opportunity to mortgage a part of the purchase price to leverage the investment and take control of an asset worth considerably more than the cash you used to acquire. A slight rise in the value of a carefully and conservatively leveraged real estate investment can result in significant equity when compared to an unleveraged asset.

That said, stocks can produce infinite returns, and bonds offer the most security out of the three. 

So, where should one place their money? The stock market? Bonds? Or real estate? We’ll answer that and also investigate which investments outperform the others.

Do Stocks Outperform Real Estate?

Residential and commercial properties are the primary types of conventional real estate investments. Many want to know whether investing in real estate or playing the stock market is better.

Veteran stock investors will tell you to do the latter, while investors with a more conservative risk profile advise investing in real estate, such as rental properties. And often, stock investors heavily invest in commercial real estate to leverage the depreciation “paper losses” to shelter their income portfolio-wide. But which investment is more likely to turn a profit while minimizing losses?

The stock market has historically seen more significant growth than the property or housing market, making it a better investment for growing wealth quicker. However, real estate is safer than stocks since stocks are less stable than housing. It also has a strong intrinsic value in comparison to stocks.

Both real estate and stocks have historically made excellent investments. Therefore, your choice must be based on your objectives, risk tolerance, and knowledge of each asset type. However, most experts agree that real estate investments are safer for those looking to grow their wealth long-term.

Also, because property values and rentals typically rise in line with inflation, owning real estate is generally regarded as a strong hedge against it. Access to cash becomes more scarce as the economy gets more uncertain; therefore, investing in rental properties provides steady cash flow even during an economic downturn. Another reason to invest in real estate is the tax advantages you get that are not available to those investing in the stock market.

While profits from stocks are heavily taxed, investing in property allows you to lower your tax bill through various depreciation methods that you can take advantage of.

There’s also the 1031 exchange, where you can sell your commercial real estate property, defer the capital gains taxes, and roll over those pre-tax gains into a more considerable cash-flowing asset. 

Another reason real estate investments are better than stock investments is their illiquidity, unlike the stock market. We look at this in more detail in the next section.

Real Estate Volatility vs. Stock Market

Volatility in stocks is very high, unlike real estate, where it is low. Stocks are priced daily, making them subject to large swings in value as investors’ sentiment drives the market based on how they feel about the particular company or the market overall.

That means that if you’re fearful and don’t like the news that you just heard about the economic outlook from the chairman of the federal reserve, for example, you can sell your investment, along with hundreds of thousands of other retail investors, simultaneously driving down the price. Therefore it goes without saying that prices fluctuate as people’s emotions change.

On the other hand, real estate is illiquid; thus, this asset class is primed for long-term pricing stability. This time when investors feel fearful, it’s hard for them to sell fast or liquidate their assets, keeping values stable. All this makes real estate prices a stronger long-term winner with more certainty, along with all the tax advantages that come along with it.

Let’s now individually discuss investments in real estate, stocks, and bonds, another investment type often compared with investment properties for potential return on investment (ROI).

Stocks, Bonds, and Real Estate

Investors have various options nowadays, with conventional investments like equity funds coexisting with new asset classes like cryptocurrencies and non-fungible tokens (NFTs). However, the four primary categories of investments are still bonds, stocks, mutual funds, and real estate. We will be looking at three of them here.

Bonds are the most conservative choice among these three investment options because they offer a guaranteed return if held until maturity. The gains, however, are often smaller than those of real estate and stocks, which involve greater inherent risk. Real estate also has a more significant entry barrier, but investors can buy stocks for as little as a few dollars.

In short, all three investment vehicles or asset classes have pros and cons, and we will outline some of them below.

Stocks

Investing in stocks means purchasing an ownership interest in a company. The stock market’s overall performance has consistently outperformed the bond market and inflation over time. Windfall gains may also be distributed to owners in the form of dividends, increasing the stock’s value.

Pros

• Possibility of generating both significant short-term returns and consistent long-term returns.

• Stocks have a lot of liquidity. You can sell equities for their market value if you unexpectedly need money.

• Shareholders may influence the governance and policies of the corporation with a more significant stake, although this is extremely hard to do.

Cons

• Short-term volatility is very high. You could lose your entire investment overnight.

• Financials and business processes are highly complex.

• Small-stock holders typically have minimal influence over the company’s operational choices.

• There are no significant tax advantages.

Bonds

You are loaning to a company or government when you purchase a bond. They promise to pay you interest over a predetermined period in lieu of your loan. Because they are less volatile than stock investments and are guaranteed by the credit and full faith of the governmental or private issuer, bonds are frequently regarded as one of the safest investments.

Although they offer stability, bonds do have certain disadvantages. For instance, compared to equities, they often significantly offer smaller returns. Furthermore, the valuation of your bond will decrease as interest rates increase. But bonds can be an excellent investment strategy to diversify your holdings and lower your overall risk.

Pros

• Return on investment that is predictable and fixed.

• Straightforward risk ratings.

• Bonds with high ratings pose less risk to principal.

Cons

• Potential profits are typically meager.

• Bonds with low ratings can still be risky.

• Bond rates might fluctuate depending on current market interest rates.

Multifamily Commercial Real Estate

While several types of real estate investments exist, multifamily commercial real estate provides the strongest risk-adjusted return. 

Additionally, this specific asset in real estate is the long-term winner in the real estate tangible asset class that offers the best long-term gains vs. stocks. 

The demand for multifamily housing grew during and post-pandemic as multifamily outperformed other real estate asset classes and other investment instruments like stocks and bonds. This trend is expected to continue as the U.S. needs to build more new units to meet demand, largely due to high building costs.

Multifamily real estate offers excellent tax advantages to investors. Straight-line depreciation and bonus depreciation are tools that multifamily investors can leverage to offset a considerable amount of their taxable income from the property. Also, if you qualify for “real estate professional status,” this tax status would allow you to take your passive “paper losses” that you share in as a multifamily property owner and use that to shelter against some of your non-passive active income.

Pros

• Diversified Tenant Base

• Property Management Efficiency

• Ability to Scale

• Stronger Financing Options

• Tax Advantages

• Larger Tenant Base

• Strong and Stable Cash Flow

Cons

• Commercial real estate, in general, is illiquid. Meaning it’s not as simple to pull your cash out of the deal as it would be to sell a stock.

• Subject to interest rates and market pressures; also relatively localized.

We will now determine whether commercial real estate or stock investments are better by looking at their historical returns.

Commercial Real Estate vs. Stocks Historical Returns

Source: Marcus & Millichap, stock market vs commercial real estate returns from 2000-2022.

The chart above breaks down the historical return from the year 2000 to 2022 if you invested $1,000,000 in commercial real estate vs the stock market (S&P 500).

The CAGR (Compound Annual Growth Rate) for CRE was 7.8%, while the S&P 500 was 5.3%. This means that if you invested $1,000,000 in CRE in the year 2000, it would be worth about $5,600,000 in 2022, while your $1,000,000 stock/S&P 500 investment would be worth about $3,200,000 in 2022.

What’s even more significant above these outsized long-term gains for CRE is that it also offers strong cash flow and considerable tax advantages through the power of various forms of depreciation. Further shielding the cash flow distributions you would have paid over the last 22 years and further increasing your post-tax rate of return.

So, based on the information above, which is better: property or stock investment? We answer that next.

So is Property a Better Investment than Stocks?

A good investment portfolio should include both stocks and real estate. However, despite stocks having a high return potential, the volatility of increases the risk of investors losing their principal.

Real estate investing, especially in cash-flowing real estate like multifamily, is a much better long-term way of investing. These assets have strong intrinsic value, and they will appreciate significantly if you buy in the right markets with solid fundamentals. The cash flow pays you to sit there and wait to receive all that appreciation years later. 

Also, the tax advantages of multifamily are what truly separates it from stocks because even if, let’s say, my multifamily investment earned the same annual rate of return as my stock investment, I’ll keep more of it post-tax due to the power of depreciation.

Frequently Asked Questions about Stocks, Bonds & Real Estate

Do Stocks Outperform Real Estate - Conclusion

Stocks and real estate have their perks and drawbacks. Although you can achieve the highest returns in the shortest amount of time, stocks are also the most volatile investment compared to bonds and real estate. Bonds offer the most security but the lowest returns.

Real estate investing is the most ideal since it has strong intrinsic value and is a secured hard asset with strong tax advantages and above-average returns. 

Sources:

1. Federal Reserve.GOV, “Monetary Policy and the Corporate Bond Market“
2. Federal Reserve.GOV, “Assets by Wealth Percentile Group“
3. Marcus & Millichap, “Commercial Real Estate vs S&P 500“
4. Mill Gardens Apartments, “Apartments in Warner Robins GA“