The perennial question: Should You Invest in Commercial Real Estate or Stocks?

The perennial question: Should You Invest in Commercial Real Estate or Stocks?

updated July 27, 2020
The perennial question: Should You Invest in Commercial Real Estate or Stocks?

Nowadays, there are more choices than ever on where to invest your money.

Yet, most investors come back to the basic choice between investing in commercial or residential real estate or stocks. When making financial investments, not everyone is comfortable with investing in government bonds, buying cryptocurrencies, or trading currencies to try and achieve their investment returns.

Therefore, the questions “Should I invest in commercial real estate or in stocks?” or “Is investing in real estate a good idea?” are ongoing discussion points.

In reality, few investments have created as much wealth as investing in real estate. Yet stocks can also offer opportunities if you are nimble enough. You must be prepared to ride out the bad times when so-called “Black Swan” events such as financial crises, pandemics or political upheavals occur and stocks plummet in value.

In short, prudence dictates that you need an investment strategy that fits your budget and your investment objectives.

So, let’s compare some of the pros and cons of an investment in commercial real estate with investing in or buying and selling stocks.

Investing to get the best returns

Obviously, the key objective of any investment is to make money (maximising profit) whilst minimising risks. Within the commercial real estate sector, there are different types of assets (properties) which offer different returns or yields. The same is true for stocks where some can be considered high-risk investments with others offering more stability in their share prices.

Comparison between investing in commercial real estate and stocks:

Tangibility: Property assets are real, that is they can be touched, felt and even lived in if necessary! Property is an immovable asset. Stocks, in essence, are only paper (or more likely electronic copies), traded every day and worth what the stock market values them at;

Liquidity: Real estate generally takes longer to buy or sell than stocks with extensive due diligence to be undertaken, contracts signed, deposits paid and so on. But, on balance, there can be more security for a real estate buyer and seller than with stocks. By their very nature, stocks are more liquid (i.e. can be sold or bought quicker) but sometimes the window for profit is very small;

Entry levels: Stocks are sold in “board lots” which can be relatively small, and it is possible to enter the stock market with limited capital. Conversely, although, not many people have enough money to buy real estate in central London outright, there are usually plenty of lenders around to fund a purchase or opportunities to invest in property bonds or real estate investment trusts (REITs);

Returns: Investors in real estate tend to expect to receive rental returns from their investment on a monthly or annual basis. The amount depends on the covenants and security of the occupier, the nature of the investment (commercial or residential) and market rental levels. There is also the prospect of capital appreciation over time and, generally, investment in real estate has been an excellent hedge against inflation. Stocks also offer returns in the form of dividends, but these depend on the performance of the company in which you own shares. Short-term investors will, however, be looking for an increase in the share price to achieve their profits;

Risks: The commercial real estate market in London is driven by supply and demand for space, as well as the overall health of the domestic economy (and to some extent the world economy). Yet, as land is limited in supply and real estate planning and development takes time, short-term risks may not always impact the value of returns associated with real estate. Over the long term, property in central London is always likely to be in demand, given the international audience of investors who constantly invest there. On the other hand, the stock market is subject to several different kinds of risk: market risk, economic risk, and inflationary risk. As a result, stock values can be extremely volatile, as many markets are highly sensitive to headlines and emotions and are easily affected by a Black Swan type event mentioned above, with resulting fluctuations in share prices. Volatility can also be caused by more macro related issues which may be geopolitical as well as company-specific events, which can be considered micro. In summary, stocks are also subject to economic cycles as well as monetary policies. Then there are the regulations, tax revisions, or even changes in the interest rates set by a country’s central bank which all impact stock prices;

Funding/availability of debt: Buying real estate outright in central London invariably needs funding, and there are plenty of entities prepared to finance attractive developments. Such funding can be by way of a single entity providing the debt or syndicated amongst several parties. In some cases, reputable developers such as Nao Group offer investors the opportunity to participate in the funding of commercial developments by offering commercial property bonds with attractive returns for investors. This arrangement allows investors who only wish to set aside a certain amount of funds for investment into real estate to enjoy being involved in a development from the outset. Stocks can be funded too, with many share brokerages providing leverage or margin trading facilities. Whilst there is definitely potential for positive returns, in a volatile market, it’s easy to see large decreases in the value of the equity invested as the amount borrowed has to be paid back first. Falls in share prices are, obviously, magnified as stock prices drop.

Options to invest: There are two primary ways to invest in real estate, either via direct purchase of property and or indirect investment. Direct purchase involves a larger up-front cost but generally provides higher potential returns as you are the only investor. Indirect investment can be made through commercial property bonds or real estate investment trusts (REITs). Options are available for stock purchases via specialised funds which will invest for you in stocks and markets of their choosing, for an annual fee.

 

Some key differences between real estate and share ownership:

 With regards to real estate assets:

  • They will always have a residual value even if their prices fall.
  • It is possible to acquire assets, and “add capital value”, either by renovating, remodelling, changing the use of the property and/or repositioning it;
  • You can also enhance the receivable income by pro-active, judicious asset management;
  • Investors can create value where a site is acquired in a growth area or a “first mover” advantage is obtained when a certain niche (such as coworking spaces) have been identified in the market and which offers the opportunity to capture values;

On the other hand, with stocks:

  • Unless you become a majority shareholder, the shares you own in a company do not allow you to participate in the business decisions or voting relating to the company;
  • They rely on the management of the company to continually perform; to keep their customers buying and for profits to increase. It’s possible that even in a good economy, for share prices to fall if the board of management do not make the right business decisions;
  • The value of and returns from stocks can differ greatly according to the type of business the company is involved in. Different types of stocks have different yields and prospects for growth, e.g. a fast-growing tech company compared with a well-established consumer goods company. The stock price of the former may increase dramatically even if dividends are low. The latter’s share may be relatively static, but it could offer attractive dividend yields.

How do you decide which type of investment is better for you?

Fundamentally, the decision to invest in real estate or in stocks, like many others to do with investing, depends on what type of person you are, your investment objectives and your tolerance of or appetite for risk.

But why invest in real estate?

Well, the real estate investor is, typically, looking for a long-term income stream showing a good return on his/her investment. They prefer calculated risks and, for example, by tying up with a reputable developer can enjoy the benefits of the developer’s experience and track record in developing property.

Furthermore, such investors are usually looking for stability and security in the knowledge that their property assets can appreciate in value over the longer-term. After all, real estate markets are founded on “bricks and mortar” and the assets backing the market are tangible.

Buying stocks, on the other hand, offers a lower entry cost, the prospect of capital appreciation and, maybe, dividends, however, it is not always for the faint-hearted. Volatility in values can be much greater and the period of recovery after dramatic falls in value is hard to predict. In short, the stock market is heavily impacted by external factors which are not easy to control.

Getting into Real Estate Investing

Nao Group has successfully developed commercial real estate properties in London with a focus on coworking projects. Over the years, we have issued bonds and investment opportunities to a broad range of investors.

So if you’re keen on investing in real estate in London and are looking for an investment option that is asset-backed, don’t hesitate to contact us today.

 

 

 

 

References

Investopedia.com

mystockmarketbasics.com

fool.com

thebalance.com

mashvisor.com

 

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