Real Estate Vs. Stocks

The question of whether people should invest in real estate or stocks is a rather complex topic of market dynamics and volatility.  The decision should be based on future predictions determined by the fundamentals rather than past performance and short term media 'insight'.  With this in mind, it is most likely best to be diversified and include both real estate and stocks in your portfolio.  So now the real question is, what percentage should you allocate to real estate?

We must understand the basics of how the economy affects real estate and the stock market.  Although they are linked through an intricacy of financial stocks and REITs, they are ultimately independent and have their own unique characteristics. 

As we can see from the chart below, real estate was a very stable investment from 1980 to 2005, while the stock market (S&P 500) had exponential growth with extreme volatility in the later years.  From 1980 to 1989, the real estate market beat the stock market, but ultimately ended up behind. 

It can also be noted that the stock market greatly underperformed the real estate market from 2001 to 2003. 

Forbes.com

Taking Advantages of the Cycles

You must base your decision of how much capital you should allocate on real estate depending on your age and the current stage of the real estate business cycle.  If you are young and looking for risky investments, there is probably an opportunity for you during any business cycle.  However, if you are near retirement and are looking for a stable investment, you should probably stick to investing in real estate after a market adjustment for recession.  Considering real estate is generally much more stable than the stock market, it is probably wise to allocate more money to real estate as you get closer to retirement or are currently in retirement.  Real estate is often seen as a capital preservation vehicle. 

You can determine the current business cycle by watching economic reports and the analysis of real estate performance.  You should be looking to invest during a business cycle on the tail end of a recession or the beginning of an expansion. 

Please do not confuse the cycle of stocks with the cycle of real estate.  Although somewhat connected, they are not the same.

Interest Rates

In regards to commercial real estate, low interest rates make it easier for companies to expand by building more office and factories through borrowed funds from mortgage lenders.  This in return, makes investing in real estate more profitable.  High interest rates in contrast spark a lower amount of borrowing and real estate recession.  This makes investing in real estate less favorable.

Although interest rates should not be the only factor in your decision, it should have some influence on it.  Even if you are investing in commercial REIT's, where you are not directly affected by the interest rates, you will have a nice boost in performance with dropping interest rates. 

Although these principles are not solid through all markets, they are good general rules.

Conclusion

In conclusion, investing in real estate should be an on-going pursuit, but the amount of capital you allocate to real estate should be determined by your age, risk tolerance, and the current business cycle. 

Real estate is an excellent investment for people with a low tolerance for risk, nearing retirement, during a period of real estate business expansion.