A few days ago, a friend was visiting, and she remarked that I had the same real estate investing book on my shelf as she has on hers. Neither of us has ever invested in real estate, other than the houses we live in. (I don’t consider a primary residence an investment because my family and I need a place to live – but that, as they say, is a topic for another post.) She knows I that invest in stocks, and she asked why I had chosen stocks over real estate. Here’s the answer.
First, some context: When I was considering investing in real estate, it was the heady days of the unprecedented run-up of house prices of the previous decade. At that time, it seemed that any idiot could make tens, if not hundreds, of thousands of dollars by buying, and then re-selling in six months. People told stories about when there wasn’t a bidding war, bidding wars having become the rule, rather than the exception. The number of TV “personalities” who were making money hand over fist seemed to grow weekly. In short, real estate was the place to be for investors looking for a quick return. Obviously, the ever-increasing price (notice I didn’t use the word “value”) could not continue indefinitely; somebody was going to be left holding the bag. That timing-specific reason aside, here’s why I decided not to get involved in real estate investing:
- even a small house (or condo) is a huge investment into a single asset. If I had invested in real estate, I would have been all in, and that would have made it hard to sleep at night.
- a house is a complicated, interwoven whole, and problems that get neglected or worse, hidden, by the previous owner, can cost a buyer a lot of money not to improve the house, but to bring it back to what he thought he was getting in the first place. Sellers are highly motivated to hide shortcomings with their property, and this kind of behaviour is hardly unknown. An owner may be willing to live with certain compromises in the proper functioning of their house, but renters usually aren’t, which could mean significant additional expenses just after having bought the house – or at unpredictable times in the future.
- periods of vacancy can turn an investment into a money pit very quickly.
- mistakes can be expensive. Whether you buy in the wrong neighbourhood, make the wrong improvements to the property, or rent to the wrong tenant, mistakes can cost you a lot of money very quickly.
- interest rates rule your life. Rates have to go up some time, and when they do, re-mortgaging will be a slap in the face for current real estate investors; I hope they’re enjoying the current ride!
- through abuse or neglect, a tenant may cause thousands of dollars of damage. If an investor has several rental units, this risk is spread out, but if he just has one, he is placing a large part of his financial well-being in the hands of someone who has a lot less skin in the game.
Note: The book my friend saw on my shelf was Real Estate Investing In Canada by Don Campbell. Here’s a link to his blog.
If I had invested in real estate, I think I would have done OK. The market I’m in has stood up quite well over the past few years, and there is a net inflow to both my city and my province, so prices will probably stay strong for the foreseeable future. Even so, there would have definitely been some stomach-churning times over the past several years. I’m glad I decided to go into stocks instead. Here are some of the main reasons:
- much smaller initial investment. With stocks, you can dip your toe in the water, and then decide whether or not to keep going, and how quickly. Likewise, you can withdraw from the market to a degree, and at a time, of your choosing.
- diversification is much easier and cheaper to achieve. Buying small amounts in five companies sits better with me than buying all of one house. It just does.
- stocks come with a built-in management team. Obviously, companies make missteps from time to time, but large, well-entrenched ones don’t make a lot of mistakes. When they do, they are usually able to dig themselves out again. Senior management gets paid a lot of money to steer the ship, and they know a lot more about running their business than I do. (If I find I disagree, I can quickly and easily sell my shares; selling quickly isn’t so easy with a house.)
- income can be produced right away. By buying dividend paying stocks, I can generate a cash flow immediately, with a lot more modest initial investment.
- rising dividends provide a hedge against inflation, the same way rising rents can.
- dividends are taxed more favourably than rental income.
- the stock market allows for a variety of investing goals and strategies. Initially (and still true today) I was looking for a safe, steady-eddy source of income that would grow over time. Later, when I’m in a more stable financial situation, I may decide to take a few more risks in search of larger returns. As a stock investor, I can choose, and if I wish, change, my risk-reward profile for part or all of my portfolio relatively easily.
- dividend-paying stocks can be used as a safety net. In good times, dividends should be re-invested regularly. In bad times, I have the option of using that income to support myself, if necessary.
I’m sure that after reading these points, the stock market people are feeling pretty smug, and the real estate crowd is howling, but as I said, these are just my own reasons for choosing stocks over real estate investing. I’m not saying that I’ll never invest in real estate, but I’m quite happy that I made the decision that I did. Until my friend asked me about it, I have to admit that I hadn’t questioned the decision since I initially made it. That must be a good sign, right?