Why is Real estate considered riskier than stocks?

Question

Can't find out why real estate is considered riskier than stocks. Is it only because of liquidity risk?  Trying to buy second vacation home, so need to sell off stocks.  Am I jumping from the frying pan into the fire?  Am 64yo, so am pretty risk averse. Any suggestions greatly appreciated.

Ned Carey · Answer

@Bill Johnson  Welcome to BP,

Real Estate is Risky

Many will disagree with me but real estate is one of the riskiest investment available.  That is not what you hear but it is the truth.

In real estate you can not only easily lose all your investment, you can lose more than you invest. With something like some quirky law suit over lead paint or an environmental hazard you can lose MUCH more that you invest.

I know, most of my best deals have come from other failed investors.

Now here is the secret of real estate risk.

Your risk is proportional to your knowledge. I feel my investments are very low risk. That is because I know;  the market values, market rents, the wholesale value to another investor, the cost of repairs, the local area and it's prospects for appreciation or going the other direction,  etc. etc.  Very importantly I know the hidden costs of real estate. These are costs most investors grossly underestimate. I am not guessing, I know my numbers cold.

OK I may not be 100% correct all the time but I am not speculating. I know my numbers and what makes a good deal. I wouldn't do 3/4 of the deals most investors do.

Read something by Warren Buffett or Sam Zell. The number one thing they talk about is risk and how they asses it.

I am not trying to scare you. I am trying to make sure you are prepared. Good luck. We are here to help.

Scott Mac · Answer

Hi Bill,

Brain surgery is riskier for a Heart Surgeon than it is for a Brain Surgeon.

As Tony Soprano would say; "Capiche?"

A fish knows his own pond the best.

Good Luck!

Steve Vaughan · Answer

Whether RE is riskier than stocks or not depends on what you're selling and what you're buying and why.  Broad index funds are different than penny stocks or leveraged inverse funds.  Multi family is different than houses or a home you'll live in or just enjoy.

RE held for productive use is different than a 2nd or vacation home.  The reasons for owning stocks vs a vacation home are completely different.

I fully expect your financial return from a vacation home to be much less than index funds in the market.  Your joy return? Maybe more depending on the maintenance and repair requirements. Stocks will never flood, freeze or need a paint job.   Apples and oranges here.

Ned Carey · Answer

@Frank Jiang wrote        Buying a stabilized multifamily unit in a nice area is, in fact, safe  .   .   .   I believe multi family risk to be extremely high right now. All the factors that drive prices up in this category have swung in one direction - the direction of higher prices. When the pendulum swings back on any one or multiple of these it could cause dramatic losses in the  Multi-family category.

These factors include high occupancy, extremely low interest rates, and extremely low cap rates. What happens to occupancy when Millennials decide they Do want to own homes? What happens when short term loans get called due to interest rate hikes?

Ned Carey · Answer

@Shafi Noss it is my belief that most people do not understand risk. One of our members @Jon Holdman put one aspect of it very well. High risk is not high reward it is high potential reward.

You clearly understand the math of risk much better than me. I go by simple rules like the above and "all things revert to the mean"

Russell Brazil · Answer

Real estate alone on its face is generally considered less risky than stocks when we are talking pure riak premiums.

real eatate however is commonly purchased with leverage, and leverage by definition increases your risk whether its on real estate or stocks.  Real estate also will commonly have tenants, which increases your risk. Its important to note, not all investors will actually place tenants in a property. So thats important to understand in any risk premium analysis.

Further, real eatate on its own has a whole spectrum of risk just like stocks do.

Darius Ogloza · Answer

Trevor, tell that to a squeezed short seller!

Kris L. · Answer

@Trevor Imlay

If you invest in stock on margin you sure can.

Shafi Noss · Answer

Hi @Bill Johnson, extrapolating on @Ned Carey and @Russell Brazil's points about risk spectrums and knowledge, it's helpful to know exactly what risk is. A good way to tie it down to reality is to think of risk as the standard deviation in return. In other words return is how much you'll make in the long run and risk is how much you can count on getting those returns in a particular year. (There are other distributions like leptokurtic and long-tail but let's stick with a bell curve).

For example the S&P 500 over the last 10 years, according to Morningstar, has had Return: 11.64% and SD: 13.42%. Source: https://www.morningstar.com/indexes/spi/spx/risk

How does real estate compare? The first step is to choose an asset class, and then a specific deal within that asset class.

There are many assets, single family rentals, single family flips, small multifamily rentals and flips, large multifamily syndications, self storage, office, retail, new construction. Each will have their own returns and risk. New construction, which is an asset class I work in can have wildly high returns, but a large standard deviation. Whereas many institutions will buy stabilized multifamily properties with low returns, but very reliable ones. The rest are in the middle. So new construction might have Returns: 40% and SD: 15% while stabilized multifamily has Returns 6% and SD 0.3%. (Don't quote me on this, it's just an example)

There's also deal level risk, and I believe this is what Ned was talking about in his first post. An experienced investor like Ned can see patterns in the market, team members, and geography to see the success of a project from a distance. An investor who doesn't know the geography is flipping a coin on whether she's buying in a good area, Ned might already know which areas are desirable for tenants, and will just pick those. So he's reduced the randomness, and therefore the risk. Inexperienced investors can reduce randomness by partnering with experienced one's though they'll probably get lower returns.

In your case, since you're past retirement age and risk-averse, you may want to choose a return rate then find a real estate asset class that has lower variance than the stock market and then find a deal and operator to partner with who can give you the risk level you're looking for.

Frank Jiang · Answer

Real estate is not inherently riskier than stocks.  Buying a stabilized multifamily unit in a nice area is, in fact, safer than buying an individual high deviation stock such as Tesla or speculation stocks.

The fact that real estate is leveraged actually does not make it any riskier than stocks imo, because the equity you see in stocks in the stock market are themselves already leveraged.  What company out there doesn't use leverage?

The reason real estate can be more dangerous than stocks is that there are a lot more opportunities for you as the investor to make glaring mistakes.  There is less hand-holding.  When you invest in a company, a person with theoretically excellent pedigree is getting paid an exorbitant amount to make sure that the company is not overleveraged, that the company has liquidity, that the company is deploying its capital appropriately, and that its operations are running smoothly.  You get to own all of these aspects as a real estate investor and you are thereby appropriately compensated for that additional risk.

Why is Real estate considered riskier than stocks?

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