Real Estate vs. Stocks & ETFs: Which should you invest in?
Should you invest in real estate or in the stock market? 🤔 Both investment options can be really profitable for investors. That's why we compare the two investment possibilities in these article.
- Stocks and ETFs offer affordability, ease of setup, diversification, and liquidity.
- As disadvantages, stocks and ETFs also come with volatile prices, average returns, lack of control, and tax implications.
- Real estate investment offers preferred tax positions, higher returns on equity, the ability to use leverage to scale up investments.
- Required with real estate is a significant financial barrier to entry, time commitment, management responsibilities, etc.
Introduction: Real Estate Vs. Stocks & ETFs
One of the questions we are most commonly asked as financial advisors is ‘what should I invest in?’ People ask this all the time – stocks, real estate, crypto, gold? Although lately, people talk a lot less about crypto – and we all know why! Gold is also a more niche investment, so let’s talk about the big two that most people focus on – stock markets and real estate.
Understanding the differences between these two investment options is crucial to making informed decisions about where to put your money. That’s why we’ll be taking a closer look at both the stock market and real estate, comparing the advantages and disadvantages of each as an investment.
Advantages of Stocks and ETFs
First, let’s take a closer look at the advantages of investing in stocks and ETFs. These investment options offer numerous benefits, including:
- Affordability: We can get started with stock investing on the cheap. All we need is enough money to buy one share – mainly, this will be 100€ or less.
- Low effort and easy to set up: The advent of discount brokers means that we simply have to open an account with a cheap broker, and we can usually buy exchange-traded funds (ETFs) for zero commissions and trading fees, and only a small annual management fee for the ETF itself.
- Diversification: By using ETFs, we can gain access to the entire global stock market (or just a portion of it that we like) just by buying one security, for a very low fee. Buying a global or world index means that, through that ETF, we own a very small piece of thousands of stocks worldwide, for very little money.
- Liquidity: Providing we don’t invest in very small and illiquid stocks or ETFs, we should be able to sell our shares whenever the stock market is open – which is usually Monday to Friday, except for public holidays in most countries. This means we can flexibly increase or decrease our savings rate to put money into the market whenever it is convenient for us.
Disadvantages of Stocks and ETFs
Ok, well those are some pretty important advantages, but they don’t come at zero cost. There are some significant disadvantages to consider when investing in stocks and ETFs, including:
- Volatile prices: That liquidity we mentioned earlier has a drawback – while we can always sell our shares, the price we get can change quite a lot in a short period of time (check out what happened in March 2020 if you don’t believe us).
- Average returns: It’s very hard to beat the stock market. Because prices are so transparent and efficiently priced given the economic environment, and so fast to react to change, most of us will be best off just buying ETFs rather than spending the time to try and get above-average returns. This typically means a return of about 7% – although remember the point about volatility above. And it can be difficult for those of us who want higher returns to accept just getting the average!
- Lack of control: As a shareholder, we are passive investors, meaning we don’t have any control. We can’t decide how often to pay dividends – the company management does that. If we buy an ETF, we can’t decide exactly what companies go in it – the ETF management and the index provider will decide that. Companies can cut their dividends without asking our permission. This can all be frustrating. If the economy deteriorates, we won’t be able to protect our investment from losses.
- Taxes: As we mentioned above, shares may not be tax efficient. If we sell our shares, we will pay 25% capital gains tax above 1.000€ per year. We will also pay tax on our dividend payments. The only exception to this is if we hold the investment in our pension.
Advantages of real estate in Germany
But what about the alternative? Well let’s look at the advantages of real estate:
- Preferred tax position: Real estate investment in Germany can be very tax efficient. When buying a property, we will be able to deduct our closing costs from our tax bill. We can also deduct the interest payments on our mortgages as well as property management and renovation costs. This means we can substantially reduce our taxable income. We can even sell our property without paying any capital gains tax once we have held it for ten years. And unlike dividends, our tenant is legally required to pay rent, making the income from our property more or less guaranteed.
- Higher return on equity: Real estate investing works best with a mortgage. Since a mortgage is just debt secured on the property, this makes real estate a leveraged investment, meaning we invest less of our own money in order to get a return.
- Ability to use leverage to scale up our investment: We can use mortgages to increase our investment very fast. For example, if we buy a 100.000€ property with a 20.000€ downpayment and an 80.000€ mortgage, and it rises in value to 110.000€ while we pay off the mortgage to 70.000€ over five years, we now have 40.000€ of equity, a 100% return on our investment, excluding the rental income. We can now re-mortgage this property to 90.000€, take our 20.000€ of equity, buy another 100.000€ property, and repeat the process.
- Passive income: It is critical to understand that real estate is only passive income if we use a property manager to take care of the tenant relationship for us. Without a property manager, real estate is not a passive investment, it is more like a small business – and one where you can get an unfortunate call at 11 pm on Sunday.
Disadvantages of real estate in Germany
Sounds pretty good, right? Investing in real estate can offer some attractive benefits, but not so fast – real estate also has some disadvantages to consider:
- Financial barriers to entry: The first, and most obvious issue preventing us from seeking our fortune in real estate is that we need substantial sums of money to put up first. On a first property, this could be at least 5.000€ to 10.000€ on legal and administrative fees in addition to the downpayment. It may be possible to have these fees covered by your mortgage lender, but this can be very expensive as well.
- More leverage, more risk: The leverage that makes the returns available in the property so attractive is of course, a double-edged sword. At least initially, our property portfolio will be undiversified, and we have the full location risk. What if the area we have bought in suffers an increase in crime and becomes an undesirable area to live in? We also have vacancy risk if our tenant moves out – while still owing the bank our mortgage payments each month. These are all risks that can be mitigated with work, but they still exist, and this means that acquiring a high-quality investment property and a good mortgage deal is much more work than just buying a stock or ETF.
- Time investment: While real estate can be close to passive, there is no getting around the fact that some effort will be needed from your side. If nothing else, you will need to source reputable professionals who will help you find the right property, get a mortgage, manage the property, and file your tax declaration.
- Very limited liquidity: German bureaucracy being what it is, it will take a few months to sell your property even if everything goes well. This assumes you find a buyer quickly, that buyer easily gets a mortgage and many other things.
Conclusion: Which Should You Invest In?
In conclusion, choosing between investing in real estate or stocks and ETFs comes down to individual circumstances and preferences. Stocks and ETFs offer affordability, ease of setup, diversification, and liquidity, but also come with volatile prices, average returns, lack of control, and tax implications.
Real estate investment offers preferred tax positions, higher return on equity, the ability to use leverage to scale up investments, and passive income potential. However, it also requires significant financial barriers to entry, time commitment, management responsibilities, and risks associated with property ownership.
Ultimately, the decision to invest in real estate or stocks and ETFs should be based on personal goals, risk tolerance, financial situation, and investment objectives. A diversified portfolio that includes both real estate and stocks and ETFs can offer a balanced approach to investing. If you need help with setting up the right strategy for you, feel free to book a free meeting with us.