Distinguishing between real estate and stocks is like comparing apples with oranges.(Boykin, 2019) Both are fundamentally different asset classes which have their own unique aspects. It completely depends on your investment style, preferences and risk appetite.
Let’s start with the basics
How 8% return can become 17% ROI?
Leverage is a big influencer when it comes to choosing between the two. You can use a significant amount of borrowed money to invest in real estate. Using leverage can amplify small returns. (Frankel , 2019) While investing in Real estate you can get leverage up to 400% of your investment amount. Whereas, you will only get 50% as leverage on equity investments.
To understand the effect of leverage, let’s look at a simple example below in Table 2.
Investing in real estate allows the use of leverage which amplifies your return on investment.
Tax benefits from Real Estate
Taxation is where real estate clearly trumps stocks. There are tax exemptions up to Rs.2 lacs per annum on interest on home loans under section 24 of the Income Tax Act. For the principal amount also, there are additional tax exemptions under section 80C. You can purchase the property jointly to double these tax exemptions.
Upon the sale of your property, you have to pay Long-term Capital Gain tax. You can avoid paying this tax through section 54 or if you buy another property from the proceeds then also you can avoid paying tax. (India Infoline News Service, 2019)
Moreover, in accounting terms, you can depreciate your property over the years. As depreciation is a non-cash charge (expense), you can decrease your taxable income by showing depreciation on your house. (India Infoline News Service, 2019) Thus, you end up paying less tax.
The aforementioned tax hacks are not possible when you invest in stocks. The dividends you receive are taxable under the dividend distribution tax (DDT). Even Long-term capital appreciation is taxed above 1 lac per year. (India Infoline News Service, 2019) This puts equity investing at a disadvantage.
Rental Income vs Dividends
Another reason to invest in real estate is its rental earning potential. Rents received on held properties makes up a substantial portion of the total return. Moreover, rent charges are relatively easier to predict than stocks dividends. This certainty regarding cashflows is one of the most fascinating factors for investors as this sense of certainty is not achievable when investing in stocks for dividends.
Further, it is well-known that a firm only declares a regular dividend when they feel that they will be able to provide this dividend for the near future. If by any chance, there is even a slightest of doubt regarding the servicing of dividends, then no firm in its right mind would opt for regular dividends as a payout option.
However, there is no regulation that once a dividend is paid-out it has to be continued. This is just a market convention. Any firm’s top management has full autonomy and can decide to not pay dividends even when they are making sufficient profits.
The decision-making power rests with company executives and you might not have a say even though you have proxy voting rights. On the other hand, you have some control over rents.
Capital Appreciation of Stocks & Real Estate
It is the difference between the purchase price and selling price of an asset or simply, it is the rise in the market price of any asset. This capital gain is the major reason for investing in real estate and stocks, as it represents the increase in value. Investment targets for capital appreciation tend to be riskier than investment targets for capital preservation. (Chen, 2019)
A stock generally experiences capital gains because the underlying company is growing faster than its competitors within the industry or it is growing at a pace faster than expectations. (Chen, 2019)
Real estate property experiences capital gains due to its proximity to new developments like shopping centres, schools, etc. Only a strong economy will witness capital appreciation because people with stable jobs will push an increase in demand for houses. (Chen, 2019)
Received rents are inflation protected but dividends are not
Real estate has been an awesome inflation hedge in the past. This is no secret, as when inflation appears rents received charged on properties also increase with increasing prices. Generally, all landlords increase rents by 5-10% annually. This increase is what protects against inflation.
However, not all stocks are a good inflation hedge. (Cussen, 2019) This is mostly because not all companies can pass on the increased costs to customers and their profit margins tend to shrink during high inflationary periods. Due to lower margins, companies can not pay dividends that beat inflation. Utility stocks can provide some inflation hedge as compared to other types of stocks. (Cussen, 2019)
If you want to beat inflation and only have an investment choice between the two, then real estate would prove to be a better partial protection against inflation.
Return forecasts for 2020 Q1
Based on RBI’s Database on Indian Economy, the All India House Pricing index is expected to grow by 2.28% for Q1 2020. This represents aggregate capital appreciation of real estate all over India. (Reserve Bank of India, 2019) Moreover, the key growth factors for the Real Estate sector are rapid urbanization and growth of disposable income for the lower strata and credit availability. (KPMG, 2018)
On the other hand, based on the data from Trading Economics, Nifty is expected to fall to 11,733 in Q1 2020, from 11,914 in Q4 2019 which is roughly -1.19%. (Trading Economics, 2019) Further, the same data forecast represents that Nifty could get as low as 11,497 till the year-end. (Trading Economics, 2019)
Historically, real estate has been an excellent asset class for building wealth. There is no doubt regarding its ability to reflect past performance in the future. Moreover, you can magnify your return on investment in real estate by using leverage.
However, it is the responsibility of the buyer to perform due diligence before buying. You should invest only in ready to move-in properties because a delay in getting possession will harm your return.
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Kennon, J. (2019, September 20). Should You Invest in Real Estate or Stocks? (The Balance ) Retrieved December 21, 2019, from https://www.thebalance.com/real-estate-vs-stocks-which-is-the-better-investment-357992
Frankel , M. (2019, September 6). Real Estate vs. Stocks: Which Has the Better Historical Returns? (Millionacres) Retrieved December 21, 2019, from https://www.fool.com/millionacres/real-estate-investing/articles/real-estate-vs-stocks-which-has-better-historical-returns/
India Infoline News Service. (2019, March 16). Investing in stocks vs real estate: Which one will make you richer? (India Infoline) Retrieved December 21, 2019, from https://www.indiainfoline.com/article/general-blog/investing-in-stocks-vs-real-estate-which-one-will-make-you-richer-118122800201_1.html
Chen, J. (2019, November 21). Capital Appreciation . (Investopedia) Retrieved December 23, 2019, from https://www.investopedia.com/terms/c/capitalappreciation.asp
Cussen, M. P. (2019, June 25). The Top 5 Ways to Hedge Against Inflation. (Investopedia ) Retrieved December 23, 2019, from https://www.investopedia.com/articles/investing/060916/top-5-ways-hedge-against-inflation.asp
Reserve Bank of India. (2019). Database on Indian Economy. Retrieved December 24, 2019, from https://dbie.rbi.org.in/DBIE/dbie.rbi?site=statistics
KPMG. (2018). Indian real estate and construction: Consolidating for growth . Retrieved December 24, 2019, from https://assets.kpmg/content/dam/kpmg/in/pdf/2018/09/real-estate-construction-disruption.pdf
Trading Economics. (2019, December 1). Forecasts – Stocks. Retrieved December 24, 2019, from https://tradingeconomics.com/forecast/stock-market