STOCK MARKET VS REAL ESTATE
Which investment offers better returns: the stock market or real estate? Initially, the stock market (S&P 500 index) appears more lucrative, boasting a 45-year average annual return of 11.83%, compared to real estate's 9.03%. However, the real return on investment is more nuanced. Uncovering the true return requires considering the hidden costs and variables not captured in these returns. Further analysis may yield surprising results for equity investors.
11.83%
9.03%
S&P 500 Return
NPI Return
Market Volatility
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Many investors in the stock market, whether through personal brokerage accounts or company retirement plans, may underestimate the market's volatility. Despite averaging an annual return of 11.83% over the past 45 years, this does not guarantee consistent growth each year. Market performance varies widely, with some years seeing higher returns and others lower.
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Over the same 45-year period, the stock market has exhibited an average standard deviation of 15-20% per year. In simpler terms, this means that for any given year, an investor can be 95% confident that the market return will fall between -18.17% and 41.83%. Such fluctuations introduce significant uncertainty into the stock market, with a 30% chance of experiencing losses in any given year.
Fees
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Investing in the stock market, especially through a retirement account, comes with various fees that erode your investment returns each year. These fees compensate fund managers and cover administrative expenses, among others. From management to service fees, the cumulative effect of these fees can be significant, amounting to a minimum of 1-2% of your annual investment gains.
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Consider this: a seemingly attractive 11.83% return on your investments would diminish to only 9.83% after accounting for fees alone. Over time, these seemingly small percentage cost can have a substantial impact on your long-term wealth accumulation. That 1-2% loss each year cannot be compounded upon for the rest of your investment!
Taxes
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Do not forget taxes! Depending on household income levels, investors may face capital gains tax rates of 15-20% when selling their stock portfolio. Investors can leverage tax-advantaged accounts like Roth IRAs and Roth 401(k)s, which invest post-tax dollars and eliminate capital gains tax. However, investments held in other non-tax-advantaged accounts are subject to unavoidable capital gains tax.
Inflation
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The silent killer! Despite the Federal Reserve's 2% inflation mandate, the average inflation rate over the last 10 years has exceeded expectations, averaging 2.8%, with six years surpassing the 2% mark (Bureau of Labor Statistics). While inflation can signal economic strength, it poses a significant challenge for investors by eroding investment returns.
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The seemingly attractive 11.83% average annual return does not tell the whole story—it is a nominal return that does not account for the impact of inflation. Even with only 2% inflation, that 11.83% return effectively feels like 9.83% and highlights how inflation quietly diminishes investment returns. And if inflation exceeds expectations, as it has recently, investors face even lower real returns!
Liquidity
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While previous sections have highlighted problems challenges in the stock market, it is important to acknowledge one significant advantage that real estate does not have: liquidity. With abundant public information available about companies and a robust network of buyers and sellers, trading stocks is fast, easy, and cost-effective. Investors can quickly adjust their positions without losing substantial value on their invested capital.
REAL ESTATE ADVANTAGES
Reduced Volatility
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Multifamily real estate offers a significant advantage with its lower risk profile. During times of economic turmoil, such as the Great Financial Crisis, when the stock market experienced a 50% decline in value and delinquency rates on single-family loans soared above 11% (Federal Reserve), the multifamily market remained resilient. Delinquency rates stayed below 4%, and vacancy rates didn't surpass 8% (Department of Housing and Urban Development).
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Even amidst a global recession, multifamily investments demonstrated remarkable resilience, underscoring their reduced risk exposure as stability as an investment vehicle. This makes multifamily real estate an attractive option for investors seeking stability and consistent returns.
Less Fees
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Real estate investing, particularly through syndication, offers the advantage of lower fees compared to stock market accounts, helping to preserve investor returns. Typically, investors encounter an average one-time acquisition fee of 2-3%, which compensates the deal sponsor for sourcing and capitalizing the deal. Importantly, this fee is not deducted from the annual return on the investment.
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Moreover, investors generally only need to anticipate paying an average asset management fee of 1-2% . This fee structure significantly benefits investors by ensuring that their returns remain largely unaffected by excessive fees. Compared to stock market accounts, even the worst-case fee scenario in real estate tends to be more favorable.
Depreciation
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Do not forget depreciation! Real estate investing offers significant tax advantages through depreciation. Property owners can leverage both normal and accelerated depreciation of the asset, along with losses from capital expenditures (capex), to offset their personal income. Because it is a non-cash expense, depreciation creates tangible tax savings to return on investment and traditional income.
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This tax-saving mechanism is a distinct advantage of real estate investing. Unlike stocks, real estate investments enable investors to capitalize on depreciation, making it a valuable tool for tax optimization and wealth preservation.
Inflation Hedge
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Real estate serves as a significant hedge against inflation. As inflation drives up prices, real estate investments tend to adjust accordingly, protecting investor returns. Unlike the stock market, where inflation erodes purchasing power, real estate returns are structured to account for inflationary pressures.
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The attractive 9.03% average annual return in real estate actually reflects its real value, with inflation already factored in through increased rents. Even in less favorable markets, rental price growth tends to mirror inflation, ensuring that real estate investments maintain their value over time.
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This aspect is particularly significant for investors as it helps mitigate concerns about diminishing returns when inflation exceeds expectations. By providing a reliable hedge against inflation, real estate emerges as a resilient and stable investment avenue.
Illiquidity
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In finance, the saying goes, "There is no such thing as a free lunch!" Despite the numerous benefits of real estate investment, one might wonder why it's not the go-to choice for everyone. The primary deterrent lies in its lack of liquidity, a characteristic that distinguishes it from the stock market.
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Unlike stocks, buying or selling a property is a time-consuming and costly process. Brokers' fees, along with financing expenses, add up, making transactions in real estate challenging to execute swiftly. In real estate, there's no affordable 'undo' button, necessitating a high level of confidence before making a purchase. However, this inherent illiquidity also fosters opportunities for creativity in deal-making, potentially leading to better returns.
CONCLUSION
So, which investment vehicle reigns supreme? Considering volatility, fees, taxes, and inflation, real estate emerges as the superior option, boasting an approximate 8% real average annual return compared to the stock market's 7%. Case closed! It is time to harness the power of real estate for accumulating wealth.
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At Hackman Holdings, we embrace the power of real estate as a wealth-building tool and a means to make a meaningful impact. We are committed to partnering with investors to navigate the intricacies of real estate investing and achieve financial goals that matter. Join us today on the journey to financial prosperity and purposeful wealth creation.
7%
8%
S&P 500 Return
NPI Return