Real Estate vs Stock Market

Real Estate, in my view, is probably a worse investment than the stock market.  The transaction fees are massive, the amount of work required is onerous, the amount of leverage required makes me nervous, appropriate diversification is hard for Thousandaires.  I don’t like any of these things.  There are surely benefits, for example the lack of diversification and amount of leverage allowed can make you rich very fast if you’re good or lucky.  The main benefit of real estate, in my view, is behavioral. I suspect that if an investor treated his stock investments, they’d no longer consider stock investing riskier than real estate and they’d make a great deal more money.  (No, I don’t mean that you should get an 80% loan on one stock and hold it for thirty years, don’t be an idiot.)  How could you treat your stock investing more like real estate investing? What are the behavioral advantages?

Huge transaction fees

This means that you don’t jump in and out of real-estate.  You buy some land or building and sit on it for years. In the stock market the average holding period of a stock is 5 days. Sure, some of this is downweighted by computerized trading, but you shouldn’t be trying to make money from a stock purchase after a month.

Long Buying Process

Buying a house takes about a month.  During this period you have a long due diligence process.  You inspect the property to make sure you’re getting what you’re supposed to be getting.  You appraise the property to make sure its worth what you intend to pay for it and you spend weeks doing this.

Rare Price Quotations

People get the impression that housing prices are really stable, simply because they only see the actual market value of their house twice, when they buy it and years later when they sell it.  If someone told you the exact value of your house every second of every day I suspect the illusion that house prices were stable would be utterly shattered.  Imagine this story if you will, your friend comes to you having very recently bought a house.  He says, “After only a month of owning my home the price has dropped $4,000!  A similar home in my neighborhood just sold for $4,000 less than I paid for mine.  This is a big investment for me, I couldn’t afford to lose that $4,000, and I certainly can’t afford to lose any more money!  I better sell my house today before I lose any more money.”  Clearly your friend has lost his mind, and you would know that you need to talk him out of doing anything drastic, sure maybe house values in his area will keep falling and he’ll lose all his money and hate you forever, but you still know the “right” thing to do in his situation.  For some reason when it comes to stocks, all that clear thinking goes out the window.

Treat Your Stocks Like Real Estate

If you bring the behavioral advantages real estate has over to the stock market, I’d bet that you’ll make more money with less work and stress.  The rules here are: never sell (because you pretend your transaction fees are huge), do careful research (a month on any stock before you decide to buy), and never look at the price (which doesn’t matter until you sell, which should be never).  If you do that, and mix those advantages with the advantages from stocks: simple diversification, very little work required to upkeep a stock (no one from Coke will call you at 3 AM expecting you to solve some problem with the business), and tax advantages (Much easier to own in tax shelters like IRAs + dividends and capital gains have a top tax rate of 15% rather than ~40% for rental income).

Real Enemy: Sloppy Thinking

Real estate can make you rich, plenty of people have also gone bankrupt in real estate because of the leverage present.  Lack of diversification sometimes causes a problem.  For example, your rental property can get flooded, most flood insurance policies don’t cover garden level units.  One bad tenant can wreck your investment.   You can mitigate these risks, but ultimately having the majority of your net worth tied to one investment seems like a recipe for a lot of variance (here variance means wild riches or financial catastrophe).  My biggest gripe with real-estate is my interaction with folks on the subject.  The numbers they estimate for income are inevitably rosy and important costs are often left out, the benefit of stock in a business is that someone has already done all the accounting for you to figure out if the business is profitable.

The other bit that drives me nuts is when discussing the risks the possibility that the price of the real-estate might fall, or that rents might fall is often treated as totally impossible. Looking at the last five years of price/rent appreciation and drawing a line through it is completely insufficient.  Prices include all known information generally.  People wouldn’t be selling if they thought that they were getting a bunch of appreciation in the near future.  The best response I’ve ever found to this sort of sloppy thinking is a lecture given by Robert Shiller entitled Irrational Exuberance – As Relevant As Ever:

If had I mic to drop…