At the time of writing, the Fed Chair and the Federal Open Markets Committee (FOMC) raised interest rates this month from 2.50% to 3.25% (0.75% increase) to ease inflation and other interest rates. A rate hike will affect revolving credit card debts, car loans, and some student loans. And what does this mean for stocks and real estate?
When the FOMC increases the interest rates, borrowing money becomes more expensive for public companies in the stock market. This limits their capacity to borrow money to fund projects and execute business plans that increase their earnings. Generally, a rising interest rate negatively affects stock market prices. Real estate investments, on the other hand, will have less net income due to a higher interest expense that needs to be paid every month. What should an investor do?
In this post, we’re going to compare the risks, returns, and the unique factors for each.
Key Points:
• This is a personal choice dependent on the investor’s current financial situation, risk tolerance, time horizon, liquidity requirements, and goals.
• Comparing stocks and real estate is akin to comparing apples to oranges. Returns are calculated differently and factors that affect each asset are different as well.
• The general stock market is strongly affected by national and even global events
• Real estate is heavily influenced by local markets and indirectly affected by national events
Stock Market Casino
48% of the US population owns stocks. Although the wealthiest 10% owns 80% of the stocks. This has been the traditional vehicle for building retirement funds. I heavily pursued investment management during my MBA. I was selected to be 1 of 17 fortunate students in my MBA to manage a student-run stock portfolio called the Cougar Investment Fund through the University of Houston. We would thoroughly analyze a stock by looking through a company’s annual report, quarterly SEC filings (called the 10-k), accounting statements, market factors, and any relevant news we could find. We would then consolidate all this information and derive a 10-yr cashflow projection. It would often take me 8 hours to sometimes a couple of days to establish a stock price to determine if we buy, sell or hold this stock. This step of the process was tedious, to say the least. We would then monitor each stock in our portfolio and any movement outside a +5% to -5% requires an investigation and a report. I vividly remember sending out a report stating that there was nothing that fundamentally changed the stock, and it was merely a social media from a handful of individuals.
I quickly witnessed how the stock market operates in two moods – fear and greed, and yes, both are emotions. A wise person once said that most of the things in this world are driven by money, power, and control – whoever has money has power and control, or whoever has power and control has access to money. I’ve witnessed first-hand how these emotions sway stock, which has nothing to do with a company’s real value. With my foundation being an engineer, which is heavily proof or evidence-based, I cannot confidently pitch an investment to a potential investor if I do not have a good grasp of the factors affecting the stock price, nor do I have control over it.
Lastly, stock market returns are diminishing if you look at it on a longer-term horizon. Since its inception in 1928, the S&P500 has returned 11.88%. Although, if you take the last 20 years only, the average is down to 9.87%. Factor in inflation, and you get a lesser return.
From intangible to tangible
Needless to say, I decided to look into other asset classes. When you break down the asset classes held by millionaires, 90% of them own real estate. As homeowners, the natural tendency was to own single-family home rentals (SFR). Although, the cash flow every month is nice, it will require additional time and effort on our end to manage the property. This will quickly compound as we add more SFRs under our belt. This was not the optimal model for us as we want to scale quickly and use our time in the most efficient way possible. We discovered the power of apartment syndications through a family friend who sold most of their SFRs and invested in multifamily. Investing in real estate through syndications gives you the benefits of owning the property such as:
1. Cash Flow
2. Equity Appreciation
3. Federal Tax Benefits
4. Leverage – other people’s time, money, and experience
If you go the passive route, you can capitalize on all these benefits and let your sponsorship team do the heavy-lifting for you. This is essentially, making money while you sleep.
Unlike stocks where returns are based on a company’s earnings, multifamily returns are based on income mainly from rent and other income opportunities. So as long as the property is receiving rent payments from tenants and is enough to cover all the debt obligations, the property will cash flow positively and its value will continue to appreciate.
Probably the most favorable factor is the ability to visit the property itself and get to know the people managing the asset, which is called your sponsorship team. Over several years while you hold the asset, you can witness its transformation both through physical renovations and improvements in the income statement.
Historical returns for real estate have proven to be resilient in different market cycles even during inflationary periods.
Source: www.REIT.com
Table 1. Compares the average annual returns of the S&P 500 vs REITs over different periods of time from 1972 to 2019.
Table 2.
Shows how the S&P 500 returns compare against REIT in different inflationary cycles from 1972 to Q1-2022.
One thing to keep in mind though is that Real Estate investing is not for everyone. It’s not as liquid as stocks meaning your capital will remain invested until you sell the property. Real Estate Syndications also often require a higher investment amount of at least $50,000 versus even less than $100 for stocks.
Conclusion:
The decision whether or not to invest in stocks or real estate depends on each investor. One should decide based on their financial capacity, risk tolerance, time horizon, liquidity requirements, and goals. When investing in stocks, do your due diligence or consult with your financial advisor. When investing in multifamily syndications, invest with someone that you know, like, and trust first before reviewing the asset.
We’re rooting for you! Until next time!
If you are would like to find out more about how we quickly scaled from 0 to 1,400 units in 6 months, we’d love to chat with you and share our experience. Feel free to book a 30-min time slot at your earliest convenience.