The Irrefutable Advantage Real Estate Investors Have Over Stock Investors

by | BiggerPockets.com

“Stocks have generally returned ~7-9% a year compared to 2-4% for real estate over the past 60 years.” —The Financial Samurai

That, of course, is only one part of the story. Real estate is often seen as an “in between investment” whose returns fall between stocks and bonds in both volatility and return. But while I would be mistaken to not note that stocks have some advantages (such as liquidity), real estate is, in my humble opinion, a far better way to go if you want to be an active investor. If you want to be a passive investor, both stocks and real estate have their place. And for a retirement account or diversification purposes, I think owning some stocks and bonds is a perfectly good idea.

But for the active investor, real estate wins by a landslide. I’ve discussed many of the advantages of real estate before, but here I will focus on just one, the granddaddy of investment advantages: buying at a discount or “beating the market.”

That “Great” Stock Pick

The idea of that killer stock pick is so ingrained in our society that it has all but been parodied and meme-d to death. Seinfeld had a whole episode about it, and as usual, the plot highlights the randomness of it all. Jerry loses most of his money before the stock rebounds and the undeserving George wins a big payday.

Scott Trench illustrates that stock-picking is a fool’s errand by discussing how, generally speaking, when it comes to stocks, “the competition is out of your league.” Trench tells us about a friend of his who:

“…manages a pretty sizable fund at a well respected firm in New York City. He spends perhaps 80-100 hours per week studying his industry (technology stocks) and has done this for over a decade. He reads annual reports, market news, and press releases from his Bloomberg terminal, and studies investor decks the moment they become available.”

And because of this, he “…has beaten the market by about 1-2% per year.”

Are you really going to do any better?

In fact, if Scott’s friend has beaten the market, he would be an exceptional aberration. Here’s what Nobel Prize winner Daniel Kahneman had to say on the topic in Thinking, Fast and Slow:

“Some years ago I had an unusual opportunity to examine the illusion of financial skill up close. I had been invited to speak to a group of investment advisers in a firm that provided financial advice and other services to very wealthy clients. I asked for some data to prepare my presentation and was granted a small treasure: a spreadsheet summarizing the investment outcomes of some twenty-five anonymous wealth advisers, for each of eight consecutive years. Each adviser’s score for each year was… [the]main determinant of his end-year bonus. It was a simple matter to rank the advisers by their performance in each year and to determine whether there was persistent differences in skill among them and whether the same advisers consistently achieved better returns for their clients year after year.

“To answer the question, I computed correlation coefficients between the rankings in each pair of years: year 1 with year 2, year 1 with year 3, and so on up through year 7 with year 8. That yielded 28 correlation coefficients, one for each pair of years. I knew the theory and was prepared to find weak evidence of persistence of skill. Still, I was surprised to find that the average of the 28 correlations was .01. In other words, zero. The consistent  correlations that would indicate differences in skill were not to be found. The results resembled what you would expect from a dice-rolling contest, not a game of skill” (Kahneman 215).

Yet humans, being what we are, always think we can beat the unbeatable. Nassim Nicholas Taleb, author of The Black Swan refers to this as “the illusion of control” and says stock analysts “have proved to be worse than nothing.”

credit-report-loan

Related: Why I’d Choose to Invest in Real Estate Over Stocks Any Day of the Week

Mutual Funds Versus Index Funds

Benjamin Graham—the father of value investing—would not have been surprised by these results. Graham notes that hedge funds are usually a worse investment than index funds (which just run on autopilot investing in a basket of stocks based on preset rules instead of being closely overseen by a manager) because of all the fees that come with hedge funds. In the updated version of his famous investing book The Intelligent Investor, the commentary notes the percentage of hedge funds that beat the Vanguard 500 Index Fund when fees are taken into account over different timespans. Here are the results:

  • One Year: 48.9 percent
  • Three Years: 59.5 percent
  • Five Years: 51.4 percent
  • Ten Years: 31.2 percent
  • Fifteen Years: 28.1 percent
  • Twenty Years: 14.9 percent

Graham concludes:

“Because of their fat costs and bad behavior, most funds fail to earn their keep. No wonder high returns are nearly as perishable as unrefrigerated fish. What’s more, as time passes, the drag of their excessive expenses leaves most funds farther and farther behind” (Graham 248).

Fees or no fees, you would expect the best hedge fund managers (who are paid millions and millions a year) to be able to consistently beat the market. You would expect wrong.

By the way, Benjamin Graham was Warren Buffet’s mentor. In 2008, Warren Buffet made a million dollar bet with the money management firm Protege Partners. Protege Partners could pick five “funds of funds” to go against Buffett. Buffett picked the Vanguard 500 Index Fund (which invests in the S&P 500). With only about a year to go in the 10-year bet, Buffett is crushing Protege Partners. After eight years, Buffett had a return of 65.67 percent. Protege Partners was wallowing at 21.87 percent (in large part due to their fees).

Buffett concluded that, “There’s been far, far, far more money made by people in Wall Street through salesmanship abilities than through investment abilities.”

This dynamic has lead some economists and financial analysts to develop what is called the Efficient Market Hypothesis, which states that it “is impossible to beat the market” because all the financial information is available and therefore the share prices will “always incorporate and reflect all information.” Thus, the share price is always right, more or less, and you can’t beat the market.

Related: 5 Ways Real Estate Wins Big Where Stocks Fall Short

There’s certainly some truth to this. There are so many analysts looking at these companies financials that nothing is going to go under the radar anymore. Much of it, though, I think is gobbledygook. During the tech bubble of the late ’90s, price-to-earnings ratios on some of the (often insane) companies that eventually went bust approached 100 (the average for the S&P 500 has been about 14). Does this represent an “efficient market”?

Instead, what I think the evidence points to is something closer to a simple inability to consistently predict the future with complicated things such as stocks. Regardless, the evidence is in, and it is overwhelming. If you can beat the stock market at all, it’s only by a tiny percentage. In other words, you are not going to be buying with any equity. You might as well give monkeys some darts and have them throw them at the stock pages in the newspaper.

On that subject, I should note that they effectively did this. “A March study by London’s Cass Business School found that among 10 million randomly created indexes, each with 1,000 U.S. stocks in equal weights (that is, monkey portfolios), nearly all of them beat a cap-weighted index from 1968 through 2011.”

apartment-value

And Real Estate?

The real estate market is much more local than the stock market. Every house, apartment, or office only has one buyer, whereas every stock is bought and sold by thousands. When an investor gets in touch with a motivated seller that owns a fixer they want nothing to do with, an opportunity to “beat the market” and buy with equity presents itself.

The mere fact the flippers exist and can continuously make money by buying low (then fixing up) and selling high proves the point. Have you ever even heard of someone “flipping a stock?” Perhaps arbitrage (usually done with currencies) would qualify, but that’s really a whole different matter.

Whether the stock market is efficient or just unknowable is somewhat immaterial. You can’t expect to consistently beat it. On the other hand, the real estate market is without question inefficient. Yes, this only applies to active investors, but it creates an enormous opportunity. And if you can gain enough equity to flip a house and make a profit, you can make enough to buy and hold and with equity right from the get go. Of all the advantages real estate offers, in my opinion, this is the biggest. Who cares if the annual return for real estate is less than stocks when you immediately start off with a 20 to 30 percent return? And, of course, you can compound that annual return by using leverage while insulating yourself from risk by buying with equity. This, of course, is the basis of the BRRRR strategy.

In summation, the key advantage of real estate is that unlike stock investors, real estate investors can and do consistently beat the market.

Investors: What do you think? Does anything beat real estate for the active investor?

Weigh in below!

About Author

Andrew Syrios

Andrew Syrios is a real estate investor in Kansas City and a partner in Stewardship Properties along with his brother and father. Their company owns just over 500 units in four states.

14 Comments

  1. John C.

    Thanks, Andrew. No matter how many times I’ve read this argument, I’ve always learned something new. You, too, brought another perspective to this debate.

    However, since I’m not an active stock investor, I’m confused by this:

    “percentage of hedge funds that beat the Vanguard 500 Index Fund when fees are taken into account over different timespans. Here are the results:
    One Year: 48.9 percent
    Three Years: 59.5 percent
    Five Years: 51.4 percent
    Ten Years: 31.2 percent
    Fifteen Years: 28.1 percent
    Twenty Years: 14.9 percent

    Doesn’t that mean that hedge funds handily beat the SP 500? especially if you take into account how their fees ate up the quite a bit of ROI?

  2. Thomas Phelan

    There are over 45,000,000 IRAs in America today collectively worth over Six Trillion dollars.

    And who has dominated those trillions of IRA dollars over the decades?

    Wall Street with a 95% share.

    Real estate limps along with a pathetic 3% – 5% (REITS not included as real estate, rather a Wall Street product).

    “How can this be?” Should be your immediate question especially if you are a Realtor®.

    But the truth is most Realtors® never ask this question. The sad truth is most Realtors® aren’t even aware of the disparity to come up with this question.

    Most people, if asked about Wall Street’s minions would acknowledge that their Stock Broker or Financial Planner is a specialist in his/her field. The same people would probably agree that their Stock Broker or Financial Planner is an expert in his/her field, e.g. Financial Products.

    Why such an ingrained belief? Because Wall Street has spent zillions of dollars over decades convincing people that they lack the knowledge, the expertise, the savvy to personally invest and that Wall Street’s minions and no one else are the ones to turn to for investment advice. What a Realtor® needs to understand is that Wall Street will NEVER recommend real estate.

    Also, Wall Street have never and likely never will, tout to the public that, “Oh, by the way, do you know your IRA can buy real estate?”.

    Most people, if asked about their Realtor® and whether or not he/she was an expert in “Investment Real estate” would say “No” or “I don’t know because my Realtor® has never approached me about investment real estate”.

    And therein lies the dilemma, how on earth can Realtors® ever chip away at the 95% dominance over six trillion dollars by Wall Street if the public isn’t aware that a local Realtor® is knowledgeable about investment real estate that could serve as a great alternative or compliment to a stock market portfolio?

    How can Realtors® bring to the American public the fact that they too can help with a person’s retirement with or without the help of an IRA?

    Don’t hold your breath hoping that one of the major real estate brokerage companies will step forward and assume the task and the costs involved to roll out a national campaign that its Realtors® are capable of presenting investment real estate. It isn’t going to happen.

    Ah, but there is an organization with over 1,000,000 Members and a treasure chest full of money that could launch such a national campaign and its name in NAR (National Association Of Realtors®).

    So why hasn’t NAR done so? This is the exact question I asked a former NAR President at a real estate conference a few years ago.

    The past NAR President fully understood my proposal, that NAR become aggressively involved in educating the public that its member Realtors® are capable of offering real estate investment properties to the public. Mind you I am not talking about the world of commercial real estate with its Malls and towering Office buildings, rather I am referring to a simple Duplex, Triplex or maybe Fourplex.

    I was excited to hear his answer because this is the first time I had the opportunity to pose such a question and face-to-face with NAR’s top leader. Candidly, his eyes started to glaze over and he replied, “Honestly I don’t know why NAR hasn’t done something”. Further conversation revealed the fact that he had no real grasp that an IRA could buy real estate and that IRAs collectively held six trillion dollars.

    He promised me he would look into it and introduce me to some key players. He never got back to me.

    Okay, enough of my sad story but I will not end this reply on a sad note.

    Rather, I ask that you allocate 100% focus on the next few paragraphs of how, if I were NAR, I would structure a National Campaign that would educate the public that a Realtor® can be a valuable asset to the American public and not just by selling homes.

    A series of National TV commercials would be the Forum.

    The Commercial

    A young couple proudly stands in front of a new home. Their Realtor® shakes hands and gives them the keys while congratulating them. The Realtor® adds: “Once you have settled in I would like to talk to you about how real estate can also play a part in your retirement plan.”

    Dissolve into the same couple and Realtor®, all a little bit older, standing in front of a Duplex. The Realtor® congratulates them and hands them the keys while saying: “Once you have your Duplex a few years we can talk about 1031 exchanging up to more units”.

    Dissolve into the same couple with a dog and two children and Realtor®, again all a little bit older, standing in front of a Duplex. The Realtor® congratulates them and hands them the keys while saying: “Once you have your Fourplex a few years we can talk about 1031 exchanging up to more units”.

    Dissolve into the same couple with an older dog and two children and Realtor®, again all a little bit older, standing in front of an eight-unit apartment house. The Realtor® congratulates them and hands them the keys while saying: “Once you have your eight units a few years we can talk about 1031 exchanging up to more units”.

    Dissolve into the same couple now with grey hair standing in front of a sixteen-unit apartment. The dog and children gone and their Realtor® congratulates them and hands them the keys while saying: “Rather amazing isn’t it, you began with a Duplex and by 1031 Exchanging you never paid taxes when trading up and never had to come up with one additional dime. Now you have a sixteen-unit apartment house that will produce thousands of dollars of monthly cash flow for the rest of your lives.”

    Wow! To me that is a concept worth trying rather than sitting on the sidelines as NAR has done since the creation of the IRA in the 1970s.

    Have a better idea? Let’s hear it including how we can get NAR to get off its duff and educate the people that its Member Realtors® are not one dimensional and can make investment real estate suggestions.

    If you are a Realtor® I ask two questions:

    “What in your IRA? Is it real estate?”

    “When is the last time you suggested to a client that her/she should consider real estate investments for his/her IRA?”.

  3. Erik Whiting

    Good points, all around.

    I will say this: it takes a lot more work (i.e. “active”) investing to make money in real estate, and it’s a lot easier to lose your shirt if you don’t know what you’re doing. The leverage which compounds returns is a doubled edged sword that puts you into a world of hurt if used incorrectly and/or bad timing hits. In 2006-2007, I talked to a lot of newbie investors who were loading up on property because “prices always go up!”….only to get crushed in 2008-2009. In the stock market, if you buy $20,000 of Enron and the company tanks….well, you’re out $20,000. Your spouse may box your ears, but that’s it. In contrast, if you put down $20,000 on a $200,000 property and get primary and secondary (seller carry) mortgages and the deal goes sour, you still owe $180,000 which may force you into bankruptcy. I have no sympathy for those folks when that happens. Investors choose to accept the risk and the consequences when trying to use leverage. So there should be no whining if a portfolio tanks and their private life suffers. The investor would be just as quick to claim credit if the deal went well. Gotta be willing to accept both outcomes, sometimes even with the success or failure isn’t due to your own actions. The market is fickle in it’s timing.

    In short, I think this article does a good job looking at the goals for investing. If a fairly stable, steady return over 20 years with minimal involvement is the most important: then stick with diversified stock mutual fund indexes. If you want to play hard-ball…real estate is definitely better for returns, but you will WORK for it.

    • Andrew Syrios

      I would generally agree that the stock market is a fine investment for a passive investor, particularly index funds. Although there are options in real estate that are good for passive investors too. But for active investors of any sort, I think the evidence shows real estate is superior.

    • How do you lose $200K on a $200K house? The house went into a sinkhole?

      With a stock you can lose 100%, with a property, it would be extremely rare and terrible timing to lose as much as 40 or 50%.

  4. Irrefutable…..strong word! I’m now approaching 70 and I can say this with conviction…..investing is an arc of experiences during one’s lifetime. And if there ever was proof of confirmation bias, investing is at the top of the list!

    Most of the investor ‘advice’ from non professionals, friends and acquaintances that I’ve experienced usually always comes from their beginning with an investment approach learned by the elders of a person’s family. If grampa was a utility stock and municipal bond guy…that’s what gets handed down as the right way to invest. If two uncles were well off by doing remodel flips…guess what…..that’s were the adventurous from that family start off.

    Now, there’s a law that doesn’t get much print, but it’s a law just like gravity: “Experience is what you get when you don’t get what you want”, also known as ‘there isn’t one right way to do anything’.

    And that law, my friends, will have more to do with how you go forward with your investing prowess than any thing else, …….. unless you get stuck in your own confirmation bias.

  5. Most investors know how over valued stocks can be manipulated- and like it or not- the stock market is still the biggest Casino in the world. I like assets that I can physically hold. I know of more success stories related to Real state holdings vrs- stock portfolios. To each his own.

  6. How many stocks have positive cash flow with a 20% down payment? Not that you can buy a stock with 20% down and get tax deductible interest and get an interest rate around 4-5%.

    So there you have it. You simply can’t buy a million dollars worth of stock with $200K in your pocket, but you can buy a million dollar house or multiplex and start making money each month from cash flow.

    That being said, a stock portfolio off to the side once you have several properties is nice to have.

  7. Jonathan Twombly

    Andrew, it’s also good to draw a distinction between investment in commercial real estate, which provides cash flow, and just homes, which typically don’t (unless they are investment properties). A few years ago, in the wake of the Great Recession, JP Morgan Asset Management put together a great 35-year study that supports your argument and blows away the idea that stocks are better than commercial real estate at least. Especially in the downturns, commercial real estate outperforms stocks by 16%. Check out the article here. I am sure you will enjoy.

    https://am.jpmorgan.com/blobcontent/131/169/1383169203231_11_559.pdf

  8. Douglas Pond

    Nice read! Please note that all markets by definition are efficient. There are only inefficient prices in the market and for the reasons you mention, real estate can in some situations have more inefficient prices than other markets.

  9. Except at extreme tops, when the MLS starts to work like a stock ticker and everything sells in hours, the real estate market will always be less efficient than the stock market. There just aren’t any motivated sellers in the stock market, because it’s so liquid. But there will always be motivated sellers in real estate, due to financing. Financing or condition issues let people put themselves into huge messes that we investors can fix.

    I found it interesting that everyone has focused only on ROI as a percentage of total value. No one has mentioned all the deals we can do that have nothing to do with appreciation. For instance, all the lease option or owner financing deals you can do just by taking over someone’s payments. No qualifying, and sometimes with nothing down. Resell it on a contract for 20-50K down, and make 300, 400, or whatever per month for a long time. The cash on cash returns on those strategies are infinite. Try doing anything like this with stocks!

Leave A Reply

Pair a profile with your post!

Create a Free Account

Or,


Log In Here