Land! It's the only thing they're not making any more of.
It's rare to launch a financial article by paraphrasing Mark Twain, but always satisfying. And let's not beat around the (increasingly scarce) bush, he was right. Real estate is a fixed-sum investment. Any given city, state or country only has so many acres to sell and when they're gone, well… they can't actually go away. That's the other nice thing about land. It very rarely vanishes. Traders can sell it, buy it and carve it up into salable pieces, but it doesn't go away.
Unlike, of course, stocks. When it comes to securities in general, take everything we just said and reverse it. We have no good Mark Twain quotes for stock holding. Institutions can summon up shares by incorporating and make them vanish when they shut down. Arguably the main consistency between the two assets is that shares of stock represent a percentage of something fixed and finite. You can create smaller and smaller percentages of ownership, but a company can only sell up to 100 percent of itself.
Real estate and stocks are, by a wide margin, the two most common assets for the retail investor. Here's what you need to understand about each.
Real Estate Investing
Investing in real estate means buying ownership in "real property," a legal term meaning land or buildings. It is as opposed to "personal property" which refers to most other forms of physical, tangible assets. (Readers should take note that some sources refer to real estate as simply tangible, physical property. This is incorrect.)
There are several ways to invest in real estate. The most common venue for individuals is to purchase a single-family home or, for people who live in cities, a condominium in a building. For many people, their residence is their single greatest asset, one which will hopefully appreciate over time.
Other forms of real estate investing include:
• REITs (Real Estate Investment Trusts), collective funds through which people can invest in real estate by purchasing shares of the trust;
• Joint/joint and several ownership, which involves buying a piece of property along with one or more other people as co-owners;
• Rental properties, through which you buy a piece of property and rent it to tenants as a revenue source;
• Direct revenue, when you buy a piece of property and use it yourself to generate revenue, such as a storefront, a tourist destination or a mining operation;
• Property flipping, when you buy a piece of property in order to increase its value then re-sell it.
Real estate is generally categorized as either commercial or residential property. Residential is when the owner lives on the property and uses it mostly or exclusively as their primary residence. The property is commercial if the owner uses it mostly or exclusively to generate revenue. For example, you can take a tenant into your spare bedroom without declassifying a residential property. However, even if you move into an apartment in your 47-unit building, the law will still consider it commercial property because you rent space in it to other people for money.
Generally any time you purchase real estate you have made an investment. Even if you don't intend to ever sell the property its market value will change over time and you always have the option to sell if you so choose.
Real Estate vs. Stocks: Real Estate Pros
• Potential stability - Real estate is, generally speaking, considered a more stable asset than shares of stock with more potential for long term growth.
• Tax advantages - The tax code has several dedicated deductions for both commercial and residential real estate, including the ability to write off losses or depreciation on commercial property.
• Utility - You can use a piece of property. Whether you buy a house to live in or a beachfront cottage to rent, you can get practical use out of a piece of property while holding it.
• Familiarity - Retail investors are generally more familiar with the real estate and the issues that can influence the value of a piece of property, and they can personally visit and have the property inspected before buying it.
• Tangible asset - As a physical asset, real estate leaves you with something even if the market value of this investment diminishes. This can be seen as a hedge against losses, inflation or debt, as this is an asset that can't simply vanish.
Real Estate vs. Stocks: Real Estate Cons
• Unforeseen volatility - Given its reputation as a stable source of value, real estate losses can surprise unprepared investors.
• Cascading losses - Real estate prices in a region tend to influence each other. When one piece of property loses value it will tend to drag down neighboring values as well.
• Illiquidity - Real estate is much harder to sell than a stock. It can take a long time to find a buyer, and you have to do so in an active bidding market (this means that you don't know the price you'll get until after you sell it).
• Trading costs - Buying and selling real estate is expensive. You should expect to spend thousands of dollars in a transaction.
• Leverage - Most individuals buy real estate with debt (typically a mortgage) due to its expense. This can create problems if the property loses value.
• Costs over time - Holding a piece of real estate is expensive. Doing so means paying property taxes, mortgages, maintenance fees and any costs involved with upgrading the property.
• Inflation - It is common for real estate prices to track closely with inflation. As a result, many properties tend to gain little value relative to the value of money over time.
Investing in stocks means buying ownership in a piece of corporate equity. Each share of stock in a company entails a certain percentage of literal ownership. If a company releases 100 shares of stock then owning that share means that you literally own 1% of every asset, real, financial or otherwise, in the company. (In reality, a single share of stock is more likely to represent a ten-millionth of a percent of the company, but it's still ownership.)
Although the New York Stock Exchange is the largest and, arguably, most well-known place to trade stocks in the world, investors trade stocks on many different markets. These include the London Stock Exchange, the NASDAQ and the Japan Exchange Group. These are centralized markets that manage trades, publish prices and generally regulate their markets.
There are many ways to invest in stocks. The two most common are:
• Individual shares - Investors can directly purchase shares of a single company. This almost always happens on what is known as the "secondary market," which means buying shares from another investor rather than directly from the company itself.
• Funds - Investors can, in the alternative, purchase shares of a fund such as a mutual fund. These are financial assets that buy a group of stocks and package them into a general fund (as the name suggests). They then issue a return based on the average performance of all the stocks in the fund.
The performance of stock markets overall is measured by metrics such as the Down Jones Industrial Average and the S&P 500. These reflect the overall strength of the stock market based on specific measures (typically a bundle of representative stocks) and don't directly reflect the performance of any specific investment.
Real Estate vs. Stocks: Stock Pros
• Liquidity - Stocks are generally very easy to sell. Unlike real estate, you don't have to find a buyer or engage in a bidding process. The centralized markets bring buyers and sellers together and publish the current prices of stocks in near-real time.
• Profit potential - A single, highly profitable stock can make you rich. Their value can soar and, if you invested wisely (or fortunately) can cause comparable profits. Beyond this edge case scenario, though, stocks generally tend to be significantly more profitable than real estate in both the short and the long run.
• Dividends - Many companies pay a portion of their profits to shareholders in the form of dividends. This can generate passive income, and can be potentially quite valuable over time.
• Cash purchase - It costs much less to buy shares of stock than to purchase even a small piece of real estate. As a result, you can enter this market more easily and typical investors don't need to use debt in order to do so.
• Tax advantages - It is much easier to use stocks for tax-advantaged purposes like retirement and higher education savings accounts. Doing this with real estate takes specialized planning, when possible at all.
Real Estate vs. Stocks: Stock Cons
• Volatility - Stocks can generally be more volatile than real estate, swinging wildly in a short time. As a particular result of this, when stocks lose their value they can do so more quickly than real estate.
• Intangible asset - When stocks lose value they can do so more quickly and thoroughly than real estate. This can include the stock collapsing entirely and leaving the investor with functionally nothing to show for their investment.
• Specialized knowledge - Investing in stocks, particularly investing in shares directly rather than through a fund, requires specialized knowledge of the market and the underlying companies in order to do it well. This is unusual for an ordinary investor.
• Lack of utility - A share of stock has no other value. Unlike a personal residence, storefront or vacation home, you can get no other use out of a stock than to own it and hope it accrues value.
• No control - You can take some measures to improve the value of a piece of real estate, however limited. It is possible through investment and hard work to raise a piece of property's value. This is not possible with a stock.
It's never too late - or too early - to plan and invest for the retirement you deserve. Get more information and a free trial subscription to TheStreet's Retirement Daily to learn more about saving for and living in retirement. Got questions about money, retirement and/or investments? Email Robert.Powell@TheStreet.com.