Transaction tax

Real estate or stock market?


With the Tri-City real estate market about as hot as it has ever been, why would an investor want to consider investing in the stock market?

Let’s compare and contrast some of the common characteristics of investing, whether in real estate or the stock market, and see if the proposition to invest in the stock market is just as compelling.

For comparison, let’s also assume that this is not a personal residence but the acquisition of additional real estate.

Leverage

One of the virtues of real estate investing is the ability to raise money through a down payment and bank financing for the rest. A buyer can take $ 30,000 from him and end up buying a property valued at $ 150,000.

If the real estate market only goes up 5%, then the buyer’s $ 30,000 in equity has just increased to $ 37,500 (or a 25% equity gain). However, she also gets into debt by optimizing her money at 5 to 1.

A person can also leverage his money in the stock market by means of the “margin”. It is effectively the same as leveraging money to buy real estate. Instead of borrowing money from a bank, the individual usually borrows from a brokerage firm to buy stocks.

Diversification

A real estate investment is generally added to the personal residence of the investor.

Usually the two properties are in the same geographic location. A well-recognized investment rule is the prudent investor rule, which is codified in the laws of virtually every state in one form or another.

The rule is based on modern portfolio theory and has an explicit requirement for investment diversification.

The prudence for the real estate investor in this situation is to consider diversification: is it satisfied by the acquisition of another residential property? Or could the additional investment in operating companies (via the stock exchange) lead to better diversification?

Conversely, the same could be said if the investor did not own any real estate but had a large retirement account invested in the stock market.

Transaction costs

Normally real estate has a high transaction cost.

When a person sells a stock, the cost of selling the stock is very low or even free with some brokers.

But selling real estate is different.

Typically, the real estate seller hires a real estate agent who charges around 6% of the total value of the real estate. On top of that, the seller pays the usual closing costs, the cost of title insurance, and the real estate excise tax (around 1.78% here locally).

In total, the transaction cost on the sale of real estate can reach 10%. In addition, the real estate investor must take into account the cost of property management.

Liquidity

If liquidity were a specter, then buying real estate would lean towards more illiquid. If you want to sell it, and even if you have an immediate buyer, it takes time.

Once a tenant moves out, it can take two to three weeks to prepare the list of properties.

Then, once listed on the Multiple Listing Service (MLS), it can take anywhere from a day to several months to find a buyer. Once the buyer is found, it can take another 30 days to prepare the contract documents, obtain title insurance, perform inspections and complete the transaction with a closing agent.

In contrast, a stock or mutual fund can be sold instantly and the proceeds deposited into the investor’s account within 1 to 3 days.

Volatility

Although either asset class experiences price volatility, stocks are considered more volatile than real estate.

Tax considerations

If the investor uses real estate as an income-generating property, then he or she must depreciate the property and deduct this and all expenses from the income of the property.

Investing in stocks and mutual funds does not have a similar characteristic to that of the individual investor. Of course, the company in which the investor invests can use tax deductions in his favor and the investor benefits indirectly.

So, real estate can offer big tax breaks to those who wish to shelter their income. But, note that when selling the property, the investor has to recoup the depreciation at a rate of around 25%. Beyond that, real estate and stocks are taxed at similar capital gains rates.

Passive income

Many people enjoy investing in real estate because it provides a passive income stream.

As mentioned above, rental properties are not entirely passive – there is the necessary management, which has become more complicated for landlords in Washington recently with the new Landlord Tenant Act.

The stock market provides passive income. If you buy a stock of ABC Inc., you probably couldn’t work for ABC even if you wanted to (well, most of us can’t).

Instead, you are a passive investor whose only role is to vote in annual board elections or other corporate mega-issues, while participating in the success – or failure of the business. .

Investing in real estate or the wider stock market can be financially rewarding. Consider each person’s characteristics to determine what works best for you – and don’t forget to branch out.

Beau Ruff, Chartered Counsel, is the Director of Planning at Cornerstone Wealth Strategies,
a full service independent investment management and financial planning firm located in Kennewick.


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