If you ask a real estate broker whether real estate or stocks are the better investment, nine times out of ten you’ll hear “real estate”. But if you ask the same question to a stockbroker, they’ll tell you “stocks” nine times out of ten. And by the same token if you ask a barber if you need a haircut, you better expect the chair’s already being dusted off for you.
The truth is both stocks and real estate can be great investments, or poor investments, depending on your idea of value. I like to think that as long as you’re building equity in some type of cash flowing investment purchased at a good price, everything will turn out just fine if you hold it long enough. That said, I do think real estate investors generally have a better grasp on investing than the average buyer of stocks. That’s not to say I necessarily favour one asset over the other, but I do believe one group of investors has a psychological leg up over the other.
No real estate investor buys rental properties with the expectation they are going to sell them in three to six months. Yes, there are flippers out there operating on the margins, but the majority of real estate investors have multi-year or multi-decade holding periods. In contrast, the average holding period of a stock investor is about five days. The beauty of holding cashflowing assets over long time frames is that the longer you hold them, the higher the probability of gain. Naturally, one of the most important reasons real estate investors experience good long term returns is because they tend to hold on to assets for a long time. And most stock investors don’t realize higher long term gains because they don’t hold on long enough to earn them.
The real estate investor has a natural advantage when it comes to valuation. There should be only two times you get a value on your real estate property: when you buy it, and when you sell it. Unlike the stock market, there are no quoted prices in between the transaction dates. Now imagine if real estate investors had a sign on their front lawn with the daily quoted value of their property. Some days it would be up, and other days it would be down. That kind of daily update would likely encourage far more speculation and trading activity due to the mere availability of quoted prices. Stock market investors, on the other hand, can get their stocks quoted by the second. It’s no wonder then, that they feel the urge to trade. At best, investors can get distracted by the constant stream of quotes, while at worst they might actually start believing those quotes represent real economic worth. If you enjoy not reading stock quotes over the weekend, give it a try during the week. You will be happier for it.
Finally, real estate investors have a natural preference for free cashflow. I’ve never met a real estate investor who didn’t buy a property without first considering how much rent it would generate. And if that rent did not cover the total operating costs, there would be obvious cause for concern. In other words, real estate investing focuses not just on the value of the building or structure, but the value of the free cash flow that the building generates over time. In contrast, many stock investors miss the cashflow aspect altogether. To be clear, I don’t mean cashflow in the sense of dividends, but instead refer to free cashflow in the accounting sense, the total of all cash generated from a company’s operations minus its capital and maintenance expenses. While in the real estate world a property with negative rent would be avoided like the plague, few seem to notice companies with negative free cashflow until it’s too late. If stock investors spent more time ensuring they were buying not just a good asset, but a cashflowing asset, they would see higher average returns over time.
In all, stock investors tend forget the pieces of paper they trade represent shares of real companies with real products, real expenses, and real earnings. It’s tougher to forget that with the tangibility of real estate. But if stock investors treated their stocks the same way they treated real estate, we’d have far more successful investors in Canada. No matter what you read or who’s doing the answering, remember that one is no better than the other – it’s just a matter of perspective.
Ben Kizemchuk is a Portfolio Manager & Investment Advisor with Altus Securities Inc. in Toronto. He offers financial planning and investment management for high net worth Canadian investors. Ben focuses on high quality investments, the Growth and Income Portfolios, low risk investing, and reducing tax.