{"id":105139,"date":"2019-01-11T11:00:35","date_gmt":"2019-01-11T18:00:35","guid":{"rendered":"https:\/\/www.biggerpockets.com\/renewsblog\/?p=105139"},"modified":"2024-02-13T18:22:23","modified_gmt":"2024-02-14T01:22:23","slug":"core-concepts-in-real-estate-and-stock-investing","status":"publish","type":"post","link":"https:\/\/www.biggerpockets.com\/blog\/core-concepts-in-real-estate-and-stock-investing","title":{"rendered":"5 Core Concepts in Both Real Estate and Stock Investing\u2014and 5 Key Differences"},"content":{"rendered":"

I was delighted\u2014and a little surprised\u2014to read the findings of a sweeping economic study<\/a> analyzing the returns of real estate, stocks, bonds, and short-term bills<\/a> over the last 145 years.<\/p>\n

The study, a joint project between several American and German universities along with the German central bank, found that real estate offered both higher returns and lower risk than stocks. Not surprisingly, returns on bonds and bills lagged far behind both.<\/p>\n

I love stocks, don\u2019t get me wrong. In fact, the majority of my investing capital is in stocks.<\/p>\n

Over 145 years, developed economies\u2019 stocks returned an average of 6.89 percent per year. They returned even more in the U.S.: 8.4 percent. And if you look at the \u201cmodern era\u201d from 1980 to present, stocks averaged 10.7 percent per year.<\/p>\n

Across the many industrialized countries analyzed, real estate offered returns averaging 7.05 percent over the last 145 years, beating stocks\u2019 average returns. And perhaps even more importantly, real estate has proven far more stable with less volatility and risk.<\/p>\n

In fact, when you take a ratio of return over risk (the “Sharpe ratio<\/a>” in economics), real estate offered an impressively high 0.7 Sharpe ratio, compared to only 0.27 Sharpe ratio for stocks.<\/p>\n

It\u2019s worth mentioning that by \u201creal estate\u201d the study authors specifically mean rental properties, as they are measuring both rental income and appreciation. Similarly, they included both dividend income and appreciation for stocks.<\/p>\n

I get frustrated when I hear investors lionize either stocks or real estate alone and dismiss the other. After all, a successful portfolio is a diverse one!<\/p>\n

So here are five core concepts that apply to both stocks and real estate, along with five key differences, that all investors should understand.<\/p>\n

5 Overlapping Core Concepts<\/h2>\n

\u201cSimilarities\u201d is the wrong word for these; rather, here are investing concepts that apply to both real estate and stocks. They are not identical, but they are analogous.<\/p>\n

1. Annual Yield<\/h3>\n

In stocks, annual yield showcases the dividend income that a stock or fund pays out as a percentage of the stock price. For example, a $100 stock with a 2 percent yield pays $2 per share per year. (More accurately, that\u2019s what they have paid in the past, but as brokers are quick to point out, \u201cPast performance is not indicative of future results!\u201d)<\/p>\n

Yield says nothing about potential appreciation. That stock may rise by 10 percent over the next year or drop by 10 percent.<\/p>\n

Rental properties follow similar logic. Investors can forecast cashflow based on purchase price, rent, and expenses to come up with the property\u2019s expected annual yield.<\/p>\n

For example, a $100,000 property that rents for $1,200 and follows the 50% Rule<\/a> (ongoing expenses equaling 50 percent of the rent) can expect an annual yield of 7.2 percent. The math breaks down like this:<\/p>\n

$1,200 x 50% = $600\/month net income<\/p>\n

$600 x 12 = $7,200 annual income<\/p>\n

$7,200 \/ $100,000 price = 7.2% annual yield<\/p><\/blockquote>\n

Again, appreciation will move independently of yield after purchase; the property could appreciate by 5 percent or decline in value, just like a stock.<\/p>\n

Annual yield is what percentage of your purchase price you can expect back in the form of annual income.<\/p>\n

2. Expense Ratio<\/h3>\n

Investments usually come with expenses.<\/p>\n

When you buy a mutual fund or ETF, you\u2019ll notice a number indicating the expense ratio. That\u2019s how much the fund charges investors to oversee and administrate the fund. In the case of index funds, these are usually very low, such as 0.1 to 0.2 percent. For actively-managed funds, they are much higher, up to 2 percent or more.<\/p>\n

\"expense-ratio\"<\/p>\n

This expense ratio is the annual percentage that the fund charges you. If you buy $1,000 in a fund with a 1 percent expense ratio, the fund will charge you $10\/year in administrative expenses. (In the real world, that number will fluctuate along with the value of your holdings\u2014if your $1,000 investment rises to $1,100 next year, then next year they\u2019ll charge $11.)<\/p>\n

And if expense ratios for equities sound high, expenses for rental properties are much, much higher.<\/p>\n

As mentioned above, a common rule of thumb is to estimate costs at 50 percent of the monthly rent. These expenses include repairs, maintenance, vacancy rates, administrative fees, travel expenses, and more.<\/p>\n

3. Management Expenses<\/h3>\n

Real estate and stock portfolios also both need to be managed.\u00a0Managing stock portfolios means periodically rebalancing to maintain your desired asset allocation and, of course, strategically buying and selling stocks to meet your investing goals.<\/p>\n

Some investors outsource this management to a financial advisor for a fee, typically around 1 percent of all investments under management. Thus, if you have a portfolio worth $500,000, you could expect to pay around $5,000 per year in management fees.<\/p>\n

Rentals also require labor to manage\u2014and typically a lot more of it compared to stocks. Property managers usually charge 7 to 10 percent of rents to take on the day-to-day headaches of fielding tenant phone calls, overseeing repairs and maintenance, and so on. They often charge additional fees for placing new tenants<\/a> in the range of half a month\u2019s rent to a full month\u2019s rent.<\/p>\n

It\u2019s worth pausing to point out two key differences here:<\/p>\n