Comparing Stocks and Real Estate, Which is Riskier?
by Christopher Levarek
“The stock market is a device for transferring money from the impatient to the patient.”
- Warren Buffett
For the majority of people, stocks is the default choice for investment and retirement. Some choose to invest into the stock market with Fidelity or Vanguard or even Robinhood while others invest on auto-pilot through index and mutual funds in a 401k.
But why stocks? What is it that provides the comfort of investing into other company’s a person knows very little about? Is it the familiarity with a company brand, gut feeling, an insider’s secret or simply checking the box for investment/retirement?
Perhaps it is the nostalgic memories of watching Michael Douglas play Gordon Gecko in the 1987 movie “Wall Street”, or the adrenaline ride displayed in the much later produced “Wolf on Wall Street” in 2013 with Leonardo DiCaprio that inspire action?
In any case, in this article we examine the risk profile of stocks versus real estate and how the two measure up against one another.
Risk is Inherent
We need to understand that in any investment risk exists. There is no such thing as no risk in investing when it comes to any asset type or investment. However, the key is to understand the risk as well as your comfort level or acceptable risk and make an effort to mitigate that risk.
Risk #1 - The Fundamentals - Consumer Demand
Stocks
At it’s base, when people are investing into the stock market, they are investing into a company. These companies produce products and services for people to use. Apple iPhone, Ford cars, Carnival cruises are products or services of the company.
If the product does well, the company does well. If the product goes out of style, the company better find another product or the company goes out of style. It is always difficult to predict with certainty the length of time those products or companies will remain in popularity.
If we look at VHS or Kodak for example, these companies and products were at the top of the market. Quite rapidly however, due to technology, the consumer demand shifted and these companies declined bringing the investors along for the ride.
Multifamily Real Estate
If we look at an investment into real estate, specifically multifamily, we can see the consumer demand is for a Basic Need. According to Maslow’s hierarchy of needs pyramid(yep, we went there), we all need first food, water, warmth and rest. As a real estate investor, we are providing the basic need of shelter or rest.
This is a fundamental need and one which does not diminish or go away and thus the risk in loss of consumer demand is non-existent at it’s core.
Risk # 2 - Downturns or Market Turns
Stocks
Many avoid investing in stocks altogether to avoid those large recessions and the stories of losing it all. The Great Depression, the Tech Dot-com Bubble pop, the Sub-Prime Mortgage crisis are all some that discourage investing.
Pulling capital out during a recession can be costly and leaving investments in accepting short-term loss for the hope of long-term gains doesn’t always turn out for the better.
Multifamily Real Estate
Recessions are a normal part of real estate and thus have become an integral part of investing into the asset, specifically multifamily.
When times are good, people move up to luxury A class apartments or large single family homes. When times are not so good, people move down to more affordable living standards in B or C class apartments, multifamily.
So during a recession, demand actually increases for apartments and multifamily in general thus decreasing the risk profile even during a downturn.
Risk # 3 - Competition Can Disrupt
Stocks
Have you ever heard of Sony’s Betamax? This was an actual competitor to VHS, the old video tape cassette we all use to watch movies on. Did you know that Sony was first to market, but VHS by JVC provided a product that could record movies for 2 hours longer and, in brief, ultimately made Betamax non-existent. The great tape war between the two companies lasted from 1975 to 1987 with VHS emerging the ultimate victor.
So why did VHS succeed where Betamax failed? Well they simply found an edge on a very similar product and predicted consumer trends or behaviors. Yet, investors into Betamax had no idea this would occur and many had no warning on the development or operations of Sony.
Multifamily Real Estate
Building real estate takes time and space. Indeed, there is limited space on this earth and building new apartments takes years. This limits the influx of competition to existing apartment complex owners. Additionally, when most new apartments are built, they are brand new and typically A class or luxury apartments. Naturally at present and for many years, there has been and is a constant shortage of affordable housing or B or C class apartments.
Since the demand does not lessen, the increase or newly emerging built apartments do not compete with existing B or C class apartments that are well managed. Affordable housing is in high demand and so competition forcing high vacancy on a nearby apartment is low.
Risk # 4 - Transparency and Control
Stocks
Investing into stocks can be the opposite of transparent. Once you’ve invested, it is quite typical that you have very little eyes into the operations or performance of the company. Although this can be ok when the market is trending up, it is another story entirely when the market is trending down.
Additionally a stock investor also has 0 control of the stock or company. They’ve gotten onboard and are simply a passenger along for the ride. Buckle up!
Multifamily Real Estate
In a multifamily real estate syndication, an investor should know who the deal sponsor is and be able to reach out to ask questions directly.
A good syndication investment should have protections in place to mitigate risk with capital reserves for unexpected expenses, insurance on the property and a team of qualified professionals with experience in previous deals.
All of this should be transparent and easy to see for an investor performing due diligence on the investment. Updates on the property performance and financials should be sent monthly or quarterly providing insight on the operations of the syndication and the business plan.
In Final
Understanding the risks in an investment is a great place to start. Often we get caught up in the scenario where everything goes right but what if everything goes wrong? How do you mitigate that risk?
Hopefully your answer is not is not to “sit on the sidelines” as this is within itself a risk! Not taking any action to further your goals and prepare for retirement is even more riskier then investing into stocks or real estate. Inflation is not doing anyone favors to capital left idle in a savings account or in cash.
There is not any right way to invest, however the key is to mitigate risk and invest in something. We just happen to like multifamily real estate over stocks for the reasons above. The choice is however yours. Just take action.
Invest Smart!