Considering an investment in real estate begs the obvious question: What are the risks, and how do they compare to other investment opportunities? Whether you are new to investing or looking to diversify as much as possible and want to weigh all your options, understanding how real estate performs against other options such as CDs or stocks can be helpful. Let’s walk through the distinctions between investing in real estate and other investments, with an eye on risk and opportunity.
Real Estate Vs Stocks
Stocks are the ultimate gamble— they come with potential for enormous returns and the potential for disaster. Yields can be realized through dividends and the sale of the stock if the price rises. Payouts on dividends can disappear as quickly as the value of a stock, however, as companies have the right to start, stop, or decrease dividends to shareholders, as needed, and the value of a stock can drop as quickly as it can rise.
One option to mitigate risk when investing in stocks of course is through investment in a mutual fund, which allows you to spread out investment capital across multiple entities. Generally speaking, returns on stock investments average out at about 7 to 10 percent. When dealing with top-shelf options, such as Coca-Cola or the Disney Company, you can see 5-year stock price total returns as high as 30 percent. All in, however, neither stocks nor mutual funds deliver real assets or the stability and control you can get with real estate.
Real Estate Vs Bonds and CDs
Bonds, in essence, are loans to a corporate, municipal or governmental entity. As such, they are a fixed income instrument, and the only income you will see is through the interest paid back on that loan. Given that these financial instruments are made out to large, established entities, they are considered some of the most stable investment options out there. Downsides include how easily these investments are impacted by inflation. The interest payments on bonds are fixed; as rates rise during inflation, the price of a bond falls as new higher-coupon bonds are issued. The original lower-yield bond has less value in the marketplace, in short.
A CD, or Certificate of Deposit, functions as a time deposit, and was historically one of the most reliable ways to save money and get a bit of growth. Though less popular today, CDs still provide safer investment by holding your money for a specific period of time at a fixed interest rate. As such, CDs are extremely stable but involve a waiting game as they can take 5 to 10 years to mature. During that time, you have no opportunity to access the funds or see any income. With real estate, as a contrast, there is much more liquidity and opportunity to tap into equity, when necessary.
Taxes are a second consideration. Investing in bonds or CDs offers few if any tax breaks. What’s more, investors may have to pay capital gains taxes or income taxes on interest earned from these notes. Tax deductions on real estate investments, on the other hand, are diverse and sizable. When the right tax breaks can successfully take you down to a lower income bracket and decrease your tax liability, sacrificing this feature can be a significant disadvantage.
Real Estate Vs Gold
A traditional counterbalance to other investments, gold serves as a bulwark in times of financial distress, tending to rise in value as the economy shows strain. For example, after a short spike in the beginning of 2020, gold prices skyrocketed post-March 2020 as the COVID crisis spread. Additionally, gold is the one investment option that offers the “real” asset tangibility of real estate. It is, however, a waiting game with no opportunity to earn revenue as you wait for the value of your gold to rise. The gold market is subject to volatility and speculation, too, as with any market.
The Risks with Real Estate
As with any investment, there are risks to consider with real estate. Bad locations, difficult tenants and high vacancies can all cause problems for an investment. When you do your due diligence on the front end, however, carefully vetting a property and its tenants, these risks can be mitigated. When balanced against the cash flow potential and the fact that the value of a property asset can never be zero, real estate becomes one of the more appealing options in many portfolios.
Real Estate Vs Other Investments in Summary
Stocks offer the chance of enormous returns, CDs and bonds offer stability, and gold offers a safe haven. Real estate, however, offers a tangible asset, opportunity to access equity throughout the life of your investment, and cash flow. While diversifying your portfolio with a variety of investments is important, leaving real estate out of that portfolio translates into a lot of missed opportunities.