Should I buy a Rental Property or Invest in Stocks?
Are you confused about whether to invest in a rental property or stocks? Real estate can pay off, but claiming that it is a better investment than investing money in the stock market is naïve. While both choices have advantages and disadvantages, buying a rental property is highly suggested for investors for various reasons. Let us go through the benefits of investing in rental property vs stocks.
Rental Property Vs Stocks
Many people who have traditionally invested in real estate do not trust or care to understand the realm of the stock market, while most stock investors are wary of real estate.
As a result, there are many different views on the stock market vs. rental property, making it difficult for beginners to make a straightforward and fair comparison. It’s not a “either/or” situation, and both options are equally valid. The best way to choose is primarily a matter of:
- Personal inclinations
- Risk tolerance
- Return objectives
- Current valuations
Thus in this article, we will compare and contrast real estate and stocks to help you know which investment method is best for you.
Why Should You Buy Rental Property?
To make an informed decision, let us take a look at the benefits rental property brings that stocks do not.
Cash flow is well-known for accounting for a higher portion of a rental property’s total return. Tenants pay rent every month and depending on the properties’ purchase price. This income may represent an unleveraged return of 5-10 percent.
The cash flow yields can vary greatly depending on the property’s quality and location. Still, most investors will seek out rentals with above-average yields (or capitalization rates) to have enough liquidity to cover their mortgage, maintenance and build cash reserves for vacancies while still earning a reasonable return. But that’s not all. Properties also appreciate over time.
Stocks, on average, provide relatively little in cash flow (or dividends) to shareholders and rely on capital appreciation for the majority of their returns.
Better Management Control
One of the most compelling reasons consumers invest in rental properties is the ability to live in, touch, and feel them. It’s tangible. They intend to renovate these homes to boost their worth and rentals. To put it another way, they want complete control over their investment.
With stocks, you’ll have to rely more on intermediaries and management teams to run the business on a day-to-day basis. It generates a “primary agent” risk, which many people are hesitant to take.
It all depends on your personal preference:
- Earn passive income, but you’ll have to rely more on other parties.
- You will control your finances, but you will be required to do more managerial duties.
If you have the passion and expertise, you’ll probably do better with the second option.
Building Wealth through Leverage
It is easier to secure a long-term fixed-rate mortgage with a low interest rate to fund most of the rental operation. Rental investors frequently use this strategy to optimize returns, and it can involve up to 4-to-1 leverage. It can lead to excessive risk-taking; but, even with a more appropriate 2-to-1 leverage.
If you can finance your rental property at 2-to-1 leverage, pay a 3-4 percent mortgage rate, and acquire a 7-10 percent yielding property with a 3 percent annual appreciation potential, you will have annual returns that considerably beat the stock market indexes. The average annual returns in this situation would be closer to 15 percent.
Stock investors can also use margin to leverage their stock investments, but this is a much riskier strategy because,
- Margin debt does not have the same favourable terms as mortgages
- Stocks are not as consistent as rentals
- The underlying companies are already relying on debt to fund their operations.
It’s difficult to deny that rental properties are more tax-efficient than stock investments when it comes to taxes. Rental investors can depreciate their properties from the first year onwards, lowering their revenue with a non-cash charge. They can also deduct all other property-related expenses from their income, including interest. The amount of taxes a rental investor pays will vary depending on the circumstances, but many investors can earn cash flow thoroughly tax-free.
Stock investors will not benefit from depreciation and may face a higher tax burden, but they can take advantage of tax-deferred accounts.
Purchasing a Rental Property vs. Stocks: What’s the Risk?
Risk is highly subjective, and how one assesses it will differ from one investor to another. According to stock investors, rental properties need a lot of effort, tenants may damage the property, rents may go unpaid, and you may even be sued.
On the other hand, Rental investors will warn you that stocks are exceedingly volatile, that you have little influence over them, and speculators dictate that market performance.
Both of these are essentially right, and it all simply comes down to the investor’s personal preference. However, from a risk standpoint, rental investors have two substantial benefits versus stock investors:
- Rental revenue is reasonably steady and reliable. Because it is vital to have a roof over your head, rental investors are likely to profit even during the recession.
- Rental properties are particularly effective inflation hedges. As replacement costs rise, the property’s value is connected to inflation, and the tenant’s rent is increased upward.
Stocks can also deliver these benefits, though usually to a lower degree or in a less direct manner. So you know now that you should buy a rental property instead of investing in stocks.
We at Sigma Properties advise you to take this decision exclusively based on your risk tolerance and the expected return on your investment over the next ten years. Not everyone is suited to rental investment. They necessitate more significant effort and accountability, as well as being less liquid. However, there is no doubt that more entrepreneurial investors who are prepared to put in the work have an ultimate chance of earning more superior returns.
2021 is one of the few times in history when the conditions for holding both stocks and real estate at the same time have never been more vigorous. The real estate sector in 2021 will flourish because of the after-effects of the pandemic, so if you own properties, you’ll be in a great position to own an asset that will always be in demand for many years to come.