Stock Market vs. Real Estate Investments

Here is a very powerful but simple explanation of why real estate investment is better than investments in the stock market or other financial instruments. For some reason, I have not heard this explanation back in University while doing both bachelor’s and an MBA degree and knowing this earlier, would made me rich.

When investing into real estate, one would usually get a mortgage, which is basically bank providing you with substantial leverage, something you would not be able to obtain even when trading on margin. For example, you could be investing $100,000 of your own money for downpayment, while getting another $400,000 in mortgage. When real estate grows at 5% a year, your property appreciates by $25,000 ($500K*5%). Looking from the perspective of your original investment of $100,000, you have just made 25% on your money, virtually on a risk free investment.

I doubt most individual investments would ever be investing in stock market on margin. Even if stock market growth was double the real estate market growth, you would still only make 10% on your money ( $100K * 10%).

Even if real estate grows at the rate of inflation of 3%, an investor still is gaining 15% on their money given leverage of 1 to 5. What if they are leveraged 1 to 10? Then the real gain is 10x.

There are years when real estate is growing at 20% a year. Someone who was leveraged at1 to 10, would be gaining 200% on their money on virtually a risk free investment! Find me another asset class that would do this. This explains what looks like an insane growth of real estate markets over the last few years in certain markets.

Of course, there is an issue of a real estate bubble, memories of the 2007/8 housing crash but I would argue that in the long term real estate would still grow, especially in the big urban markets, driven by the urban population growth, immigration, and money printing by the central banks.

Obviously, this logic would not work 100% of the time, some markets are significantly overpriced and could experience even long term real estate price declines (example of Japan comes to mind). An investor over-leveraged in a declining market, could erase their equity in their home. But the good news, there will not be a margin call, you could still own your house or rent it out, and pay it off over long periods of time with housing markets likely to recover – hence my premise of a virtually risk free real estate investment.

There are many other factors to consider such as taxes, maintenance costs, proximity to growing real estate markets, long term population trends but generally, for a regular person, living in a big urban center, this logic holds.