Real Estate (REITs) vs. Stocks
This article examines the differences between real estate (REITs) vs stocks.
A share of stock represents that you own a tiny percentage of a company. Its tiny because that one share is probably one of billions of shares.
The projected earnings that this company is expected to create is the primary thing that is represented in the price of its stock. You may also receive a bonus in the form of regular dividend payments.
Real estate is known as a “hard asset”, because ownership in real estate means you own all or part of a piece of land.
You may own this land directly, through a partnership, or through a Real Estate Investment Trust (“REIT”).
With stocks, you are betting that the value of the company will rise over time.
With real estate, you are betting the value of the land will rise over time.
In the meantime, you may earn dividends off each asset depending on how profitable they are.
What are stocks?
A stock is a form of currency. It represents an ownership share in a company. Let’s say a company issues 500 shares of stock and you buy 10 shares. You own 2% of the company.
However, companies can issue tens or millions, hundreds of millions, or even billions of shares, so each investor rarely owns more than a fraction of a percent of a company.
The price of the stock you own will rise and fall based upon other shareholders, and their desire to own or sell their stock. The biggest factor regarding a stock’s price is the growth of a company’s earnings. That’s what mostly determines what investors are willing to pay to own a piece of a company.
What are REITs?
REIT stands for “Real Estate Investment Trust”. These are special corporations created by the federal government that create vehicles for investment specifically in real estate.
There are many complicated reasons as to why the government created these vehicles, but they aren’t terribly relevant to investors.
What is relevant is that a REIT must pay out 90% of its net income to shareholders, each and every quarter, as a dividend. Net income in this case means all the money left over after all of the expenses have been paid.
Thus, the way a REIT makes money is to place some kind of cash-earning business onto the land, or rent the land out to a cash-generating business. Then the REIT will use that money to pay the mortgage, interest on the mortgage, insurance, property taxes, and pay for all the overhead and maintenance and upkeep of the property.
90% of whatever is left over is paid to shareholders.
What are the differences between REITs and stocks?
There are few structural and compositional differences between REITs vs stocks.
As mentioned, if you own stock in a company, you own a tiny piece of that company. That company may be involved in any kind of business. generally speaking, the value of that company is going to be tied to the projected earnings growth of the company from one year to the next, and over the long term.
Theoretically, the value of the company will be reflected in a constantly increasing stock price over the long term. The company may also choose to reward shareholders by paying out some of its excess cash is dividends. However, that is entirely optional.
REITs also issue shares for ownership. If you own shares of a REIT, you also own a tiny piece of the REIT. Unlike stocks, however, ownership in a REIT is ownership in both the land that the REIT owns, and earnings generated by whatever business operates on that land.
Over the long term, real estate has historically appreciated in value. Just like stocks will fluctuate in price, real estate does also. But in both cases, their value over the long term is going to increase.
Where a stock has the option whether or not to pay a dividend, REITs are required by law to pay out 90% of their income as a dividend.
The change in value of real estate tends to be slower than that of stocks. So over the long term, stocks are probably going to appreciate more then REITs will. REITs, however, have less volatility. Therefore the fluctuations in their price tend not to be as great as stocks.
Read more about investing in mutual funds vs. stocks
Advantages of Stocks
When it comes to investing in REITs vs. stocks, here are the advantages of stocks:
- Wider variety of businesses to invest in
- Higher potential reward over time
- Insulated from real estate losses
Here’s a video that gives additional information on investing in stocks.
Wider variety of businesses to invest in
The biggest advantage in purchasing REITs vs stocks, is that with stocks, you can invest in just about any industry on the face of the earth, whereas REITs are only invested in real estate.
In purchasing stocks from different sectors, you create diversification for your portfolio. Diversification is critical when it comes to creating any kind of long-term portfolio.
If you are only invested in one stock or one sector, then should something bad happen to that stock or sector, you will only experience losses.
However, if you have stocks representing many different sectors, you would expect some to go down and some to go up at any given moment in time. That diversification smoothes out risk.
It also gives you the opportunity to invest in a company or sector that you happen to know a lot about. As legendary investor Peter Lynch always said, “invest in what you know”. If you happen to be an expert in used cars, you’ll be better off investing in stocks involving used cars and you will and real estate.
Higher potential reward over time
Every type of investment has a different level of risk in a different possibility of reward, and that’s true of REITs vs. stocks. Generally speaking, the more risk that you take, the higher the reward is likely to be.
There are certain types of investments that are very risky by nature, and other types of investments that are more conservative by nature.
Historically stocks are more risky than real estate. Real estate is known as a hard asset meaning it’s something that you can actually put your hands on. It’s real. You can do something with that land.
A stock is more abstract. It represents a piece of ownership in a company. Just about anything can happen to a company, everything from great success to criminal fraud, anything from the stock going higher and higher forever and the stock going to zero.
With all of that risk comes the possibility of higher rewards over time. Historically, the stock market in individual stocks have appreciated over time. If you look at any 30 year rolling. Of the stock market, you will find that stocks have never returned less than 8%.
Real estate, however, is essentially forever. Even if the whole piece of property burns up in a fire, and takes all of the buildings that are on it with it, an insurance company is likely to pick up the bill. Even if it doesn’t, that piece of land is still there. It can be used for something.
Thus, over the long term it will always retain some value. Therefore, REITs carry less risk, but the long-term appreciation potential is going to be less than stocks.
Insulated from real estate losses
The other obvious advantage of investing in REITs vs stocks is that a stock portfolio won’t necessarily be exposed to real estate losses.
If you remember the mortgage crisis of 2008 and 2009, the value of real estate all across the country was obliterated. REITs were hammered. Stocks were, too, but for different reasons that were downstream from real estate.
Real estate can, and does, go through down cycles. Financial crisis was a black swan event, something that happens once in a generation. Normally, real estate down cycles occur but are not quite as devastating.
Nevertheless with stocks, you eliminate one area of risk to your portfolio.
Advantages of REITs
When it comes to investing in real estate (REITs) vs. stocks, here are the advantages of REITs:
- Geared for income and conservative investors
- Regular dividend payments
- Hard asset
Here’s a video that gives additional information on investing in REITs.
Geared for income and conservative investors
REITs are solid choices for income, conservative, and retired investors. As mentioned, REITs tend to have less volatility than stocks – certainly less than growth stocks – and that kind of investment tends to be of interest to conservative investors.
The dividend payments that REITs offer make income and retired investors happy, because they yield more than bonds do, and those investors also prefer less risk.
Regular dividend payments
REITs generally offer regular, and growing, dividend payments. Once a REIT goes public, it usually has a history behind it, and the managers know how much cash should be available at the end of each quarter. Thus, the dividend payments are stable.
Many REITs continue to improve over time, so they raise their dividends on an annual basis.
In hard times, REITs can and do reduce their dividends, but that is more the exception than the rule.
As mentioned above, investing in a hard asset has very little downside. Even in the worst possible situation, a REIT might go bankrupt.
Yet something still must happen to the land it sits on. If it has increased in value over time, there’s a chance that common shareholders might still retain some value in their shares, whereas with stocks, bankruptcy usually means shareholders get nothing.