How to Compare Equity and Real Estate as Investment Options?

Introduction

When it comes to wealth creation, predominantly, there are two options available: equity (shares or stocks) and real estate (finished and raw).

Although there are many other avenues that people like to consider e.g. precious metals, forex, commodities, art, paintings, and some new ones as well, including cryptocurrencies and NFTs (non-fungible tokens). By and large, these are speculative products and you make money only when someone pays you more than what you bought them for, which may or may not happen. In between, you are left to fend for yourself.

So, as a rule of thumb, at least 80% of your investment portfolio should consist of equities and real estate. This is apart from any investments in debt (fixed income). Debt is useful for parking any money needed in the next 3-5 years. It can protect your money against inflation only if the profits are reinvested.

Is There No Speculation in Equity and Real Estate?

A question that might arise here is: Is there no speculation in equities and real estate? Yes, it is possible to speculate in equities as well as in real estate, and it is quite widely practiced as well, but you can also invest in them. In all other assets mentioned earlier, however, you can only speculate.

If, whether in equities or in real estate, you are trying to capture short-term price fluctuations and are not interested to unearth and own the underlying value, you are, ipso facto, speculating.

After all, What’s Wrong with Speculation!

Another question that might be asked is: What’s wrong with speculation? There is nothing wrong or right with investment or speculation. In fact, the framing of the question is wrong. A correctly framed question would be, what to expect from investment or speculation?

If you know what to expect from speculation and still decide to speculate, it is perfectly fine. But if you speculate and expect what should be expected from investment, you may be disappointed. In the same way, if you invest and expect what should be expected from speculation, you may also be disappointed.

Equity vs Real Estate

With speculation out of our way, now let’s discuss how to compare equity and real estate as investment options.

Real Estate

You can invest either in raw real estate or a finished product. A residential or a commercial plot can be bought and then be sold or rented out after construction/ value addition. You can also invest in a finished product: a house, office building or a shop, etc. Your business plan is regular rental yield and long-term capital gain. Another variant is agricultural land. While you own it, you may either cultivate it yourself or give it on rent.

Real Estate Investment Trust (REIT) is another avenue of investment. These are finished and operational real estate projects listed on the stock exchange. This model is similar to equity investment.

Characteristics

Real estate is a scarce resource.
Development and upgradation in land status results in a substantial jump in its price.
Except REITs, real estate assets are physically owned. One can see and touch them. You have control over their operation, unlike equities.
Real estate has a strong linkage with one’s social status, especially in developing countries.

Pros

Very safe investment.
Stable earnings.
Capital gain can easily beat inflation overtime and can give worthwhile profit.
As frequent buying and selling is not feasible, it is easy to hold properties for a long time.

Cons

Real estate is a cyclical sector which means that the sector can grow rapidly for 2-3 years, followed by a 4-5 years period of very slow growth or even stagnation.
The assets incur a regular maintainance cost which has to be subtracted from the rental earning.
The data in real estate sector which is needed for analyzing historical trends and making future projections is not very well maintained . For example, for a particular property, the data regarding its price, rental yield, state of maintenance etc is not available. On the contrary, for every company in the stock market a very elaborate data regarding its earnings, expenses, debt, price history and many other parameters is available for its entire life cycle.
Real estate investments offer relatively less flexibility. For example, the units (house or shop etc) have a much higher price when compared with equity units (shares). Therefore, if you have even slightly less money than the price of the asset, you cannot buy it. In the same way, when you own a real estate asset and you need a smaller amount of money, the asset cannot be liquidated to fulfill that need. You don’t face this problem when you invest in equities.
Investments should be viewed as your business. An important quality of a good business is that it should be able to absorb the cash it generates, in order to scale itself up. Real estate assets do not score very high on this count. For example, if you want to buy another property from the rental yield of already owned properties, it will take considerable time. On the contrary, in can be done in equities almost immediately and effortlessly.
Your portfolio is highly concentrated in one sector i.e. real estate and even in a small geography which violates the basic principle of financial safety i.e. diversification.

Equity

You can buy shares directly from the secondary market. You may also own them right from initial public offerings which are sold in the primary market. If you don’t want to spend time and effort in research and selection of shares, you can also invest through mutual funds who will do the same for you for a management fee. By buying the shares, you become a part-owner in that business and you have a share in its earnings and profits. You will get dividends as well as capital gain if you have made the correct choice.

Characterictics

There is a wide variety of businesses listed in the market and every business has different characteristics. The whole market is divided into various sectors. Some businesses are in growth phase, some have stable earnings, some are cyclical and some are not even worth considering. It will be correct to say that stock market is a buffet of businesses.
What should be expected from an investment depends on the type of the business.
Another characteristic of the equity investing is the style and philosophy of the investor e.g. value investing, growth investing etc.
Although the businesses you invest in exist physically, your ownership is virtual through a document. You have no control over how the business operates unless you are a majority share-holder.

Pros

Equity investment is hassle free. It is vey simple in the sense that you only need a smart phone and internet to get connected to the market and buy shares.
You can find businesses from a wide variety according to your temperament, needs and expectations.
Equity investing is extremely flexible. You can invest small amounts as well as bigger amounts. If you need cash, you can quickly liquidate a portion of your portfolio and fulfill your need.
Another flexibility parameter on which equities score very high is that the effort needed to manage a small portfolio, in terms of money invested, is almost the same as needed to manage a fairly large portfolio. Equity investing is also free of HR challenges.
Equity investments are very good at absorbing the cash they generate. You can reinvest the dividends effortlessly.
Very elaborate and detailed historical data is available for analysis and decision making.
Equity portfolio can be well diversified across many parameters. For example, you may own a number of stocks from a variety of sectors, you may have few growth and value stocks, few small-cap, mid-cap and large-cap companies and some high dividend yield companies. You can also buy the same stock in small chunks on different days giving you time diversification. This luxury is not available in real estate investment.

Cons

Investing in shares directly can be quite risky if you don’t learn it deliberately. You have to know what is the business model, how the company makes money, how is the management, how are company’s accounting practices, how strong the brand is and much more. You should also have a fair idea about how to analyze the balance sheet, profit and loss statement and cash flow statement etc.
Developing your own investment style takes time.
Stock market volatility poses an emotional challenge to the investor. He has to control his greed and fear.
Since you can buy and sell just with the click of a button, it is very tempting. Hence, holding for a long period becomes difficult.

If you want to know more about how you should invest in the stock market, please click here.

Conclusion

Both equity and real estate investing are viable options for wealth creation. Both have their advantages and disadvantages. You have to work on and develop your own style and thought process. You may either invest in one or have a mix of the two. Try to develop a long-term view, as wealth creation takes time.

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My other articles, you may find useful are:

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Investment vs Speculation

A Brief History of Money

Why I Started a Blog on Personal Finance

Anatomy of Financial Risk

Debt, Equity, and Real Estate: An Overview

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