Thursday, March 12, 2015

Should you invest in Stocks or Real Estate?

We are sure, when it comes to investments; people always prefer real estate to stocks. One reason, people think real-estate returns are far better when compared to stocks. Another reason, you own an asset which you can visit, show off to your family and friends. If it is a house or flat, it is a matter of pride.

            But whether real-estate investments are fool-proof and safe? Or at least they are less riskier than stocks? Does it mean, risk averse investors prefer real-estate investments and risk lovers go for stocks? We are sure; you would have seen a friend or a relative visiting the court for a property dispute. The disputes would be less or almost nil when you buy a flat from a reputed builder. Again, how much you end up paying as interest for the loan is a big question. Here is what Albert Einstein says about compound interest, "Compound interest is the eighth wonder of the world. He, who understands it, earns it ... he who doesn't ... pays it."

          So people who are paying interest are the ones that are paying it. And who earns it? People who invest in equity related schemes or in any real estate property with their own money earns it. But can we buy a real estate property by paying upfront the total money? No, most of us cannot. But can we buy stocks with few thousands? Yes, we can.

Disadvantages of investing in stocks

·        Huge Volatility

·        Intangible

Disadvantages of investing in real estate

·        High transaction costs and commissions

·        Huge margin required

·        Returns are lesser than stock investments

·        Cannot diversify with limited funds

·        Chances of litigation are more

·      Maintenance costs like fencing if it is a plot, Renovation, painting, landscaping if it is a flat

·        Have to pay property tax

·        You end up paying twice the amount of the property if you take a loan

Let us see the advantages of owning a stock

·        Liquid

·        Better return than Real Estate

·        Low Transaction Costs

·        More variety (diversification)

·        Less investment required to own

·     Long term (anything more than a year) capital gains tax is zero (Meaning, just hold any stock more than a year, your capital gains tax is zero

·        Chances of litigation are less

Let us see the advantages of investing in real estate

·        Tangible

·        Interest payment can be deducted from taxable income

·        Less volatile

Seems like it is more advantageous to invest in stocks than in real-estate, isn’t it?  Here is what Samuel Langhorne Clemens aka Mark Twain has to say about real-estate investment, “Buy land, they’re not making it anymore.”

So is this the logic for people to invest in properties than into stocks? Well, let us dig deeper to find whether investing in real estate or stock yields a better return.

Check out this graph (Historical returns of S&P 500 index versus Housing Price Index)

This chart doesn’t include the dividends you could make by investing in stocks. If that is included, then the returns from stocks could be even more. And if you take a loan for your real-estate investment, you could probably end up paying more as way of interest.

Mumbai is the hot real-estate market in India. Mumbai cannot expand unlike Bangalore as it is an Island. Poor souls, they have to reclaim the sea to expand the city. Whereas a city like Bangalore is expanding in all directions. A standup Comic friend of us once joked,” Bangalore’s new airport is in Hyderabad.” In the year 1980, a sq.ft of land in the Dalal Street area of Mumbai was selling at INR 100 and it sells around INR 27000 today. That works out to an annualized return of 20.51% over 35 years. Similarly a property purchased in Carter Road in Mumbai in 1970s would have given an annualized return of 19% over 45 years.

Had you invested in Sensex when it was trading at 100 in 1979, you would have made an annualized return of 17% (today Sensex is trading at 29000). You must be smart; you noticed that the returns from Sensex was lesser than the real estate investment examples we discussed. Add another 1.5%  as dividend yield for Sensex, it would now match the returns on these prime properties.

Points to ponder

Many stocks that form a part of the index (Sensex) have given an annualized return of more than 30% since they got listed. If you invest wisely, you can expect an annualized return of more than 20% from stocks.

These prime properties are not for the regular Joes like us. We cannot afford to own a piece of land in those areas (Disclaimer – “We” refers to the Middle class and the lower middle class). But can we own a piece of Sensex for few thousand rupees? Welcome to the world of Bulls and Bears where every day is an exciting one!