Investing in Northern California Real Estate Vs the Stock Market
A little while ago a team combining the think tanks of the University of California, the German Central Bank, and the University of Bonn worked on answering the question of which asset gave a better return over the last 145 years: real estate or stock investing? After crunching the numbers the team essentially concluded that real estate did mildly better returning 7 percent annually on average, but stocks were not that far behind. Bonds and private loans suffered the most in comparison. However, 99.9999% of folks simply don’t live 145 years plus to enjoy such an investment, so the exercise isn’t rooted in reality. Instead, folks invest for shorter windows that are more practical, like 10 to 30 years at best. Here’s how the two assets break down for Northern California.
Breaking Down the Basics
The first thing to realize is that while stocks involve investing in someone or an organization’s performance, real estate investing is based on what people think an asset is worth. These are two very different dynamics for earning a profit on money down.
Investing in Stocks
The fundamental idea behind investing in stocks is by buying shares of ownership in a company to then enjoy the profits and success of that business as it grows. This idea has been diluted a bit from direct profit sharing to today’s idea of a valuation in the company’s capital worth on the market, but there are still stocks that pay a dividend quarterly of profits distributed. Either way, a person’s investment goes up or down depending how the given company or companies they invested in perform over time.
Pros of Investing in Stocks
One of the strongest benefits of stocks is that one can invest in one or a multitude of industries, using each one to hedge against losses in the other. The other big advantage is that when one is done with stock investing, he or she can liquidate a holding into cash very quickly, usually within a day or so after processing the related stock sales. That money can then be reinvested again into another stock holding just as quickly.
Cons of Investing in Stocks
The downside of stock investing, however, is that it can change valuation very quickly, losing significant portions of gain and principal in a single day. Additionally, where real estate value is based on appraisal, a stock’s price can swing wildly on unverified information, rumor, news, and opinions versus just factual data. Worse, in the age of auto-trading, entire industries can crash in minutes as computers speed through predetermined sales positions of larger brokerage houses, setting off ripple effects across the market. In the past, this has been occasionally so disastrous that the public markets have had to shut down to stop the damage from the brokerage computers running out of control.
Investing in Real Estate
Investing in real estate essentially happens in two forms: buy and hold the property and hope it sells for a higher price, or buy a property and turn it into a rental income asset until sold.
The buy and hold approach of the property asset is the most common, traditional investment approach, which entails finding a good property, holding it for a while, and then selling it for more than was spent in the purchase. In some versions of this approach, owners will rehab poor condition homes bought extremely low and then sell much higher to recover the minimal repair costs and profit, known as “house-flipping.”
In comparison to outright ownership, the rental approach is more of a business. The property is either partitioned or rented in whole to a temporary tenant. Ideally, the rent paid covers the operating costs of the home (mortgage, upkeep, etc.) and provides a profit. The owner tries to have no out-of-pocket costs and uses the rent for expenses and profit-making. Over time or with multiple units, income can add up significantly. The owner can also sell the property for a higher value as a rental income generating property, which is worth more than just a traditional real estate sale.
Pros of Investing in Real Estate
The key benefit of real estate investing is that it takes a lot longer for value changes to occur in real estate versus the daily blinding speed of change in the stock market. While there are real estate bubbles, most notably the 2007 mortgage bubble that rolled into the 2009 Recession, most real estate markets tend to rise steadily. This is due to the fact that home prices tend to move towards an average price trend because new prices are based on similar comparables that have just sold. So a single property can’t get too far off field because the market will compare it to similar units and refuse to pay an outlandish price. Similarly, good units hold their valuation and don’t fall because comparables argue homes have to be sold at a certain level or the drop will hurt the entire local market. This sort of internal price regulation doesn’t occur with stocks.
Cons of Investing in Real Estate
A primary drawback of real estate investing is that it takes much longer to liquidate or purchase real estate than what is needed for stocks. The real estate purchase and sale process is highly regulated, heavy with paperwork, and can take months to complete from beginning to end.
What About Real Estate in Northern California?
Anyone wanting to live in Northern California must either drive long distances to work or locate close to labor resources and compete with lots of buyers for a limited number of residential properties. However, despite the fact that the 2009 Recession hit extremely hard in the Golden State, the current market is rising hard again, with a median home price near $350,000 in the more affordable locations, and as much as $750,000 in the urban core locations. For those who timed their holdings right, the current values are producing huge returns on homes that sold for 50 percent of value right after 2009. But anyone interested in real estate investing today in Northern California is probably looking at close to the top end of the market trajectory right now.
How do They Compare?
So at first glance, it may seem logical to think that stocks are the better investment. It’s true that they returned a whopping gain of 16.2% in 2017 over the previous year. For the same time window, California home prices only pumped out a 7.5% gain. However, while stocks are now in a dangerous position of correction, California real estate is still maintaining momentum upward. There are simply not enough units being built to match demand, and companies are hiring thousands more to keep up with needs, bringing more people into the state as a result. So real estate has a very solid argument when looked at closely.
What are the Average Stock Market Returns?
Right now, the Standard & Poor’s 500 Index, a major metric of the biggest U.S. companies, has produced a 9.8 percent return over the last 10 years. However, as noted earlier, for the last 100 years, the rate has generally bounced between 5 and 10 percent only, and that includes the last two big crashes (1988 and 2009) as well as the 1929 stock market crash.
What are the Average Northern California Real Estate Returns?
Nationally, the country has seen a 10.6% return in residential real estate investments over the last two decades. Northern California in particular has produced an annual return in the last few years of 6 to 10 percent, depending which county one examines specifically. The higher end of the spectrum includes all the major urban centers in the state.
How to Estimate Real Estate Returns
When trying to estimate what a given property might produce for your time and money, here are couple of things to keep in mind. First, your cost is not just the value of the home today; it needs to also include all your closing expenses and taxes to obtain the property. That adds up quickly and reduces assumed profit windows by a notable chunk, sometimes as much as 30 percent of assumed profits.
Second, you need to decide whether the property will be just held for valuation or rented out as an income property. The choice triggers one of two very different estimating paths. Assuming one is just holding the property, the next thing to do is to then look at the valuation trend of a property for the last three years. Even if rising, take that trend and cut it in half. So if the average is 7 percent for three years, use 3.5 percent as the gain. This conservative approach will force your estimate to account for future market drops and, if still profitable, produce a very hard look at a property before putting money down on it.
Stock Market vs Northern CA Real Estate – Which Is Better for Investing?
Overall, real estate will continue to be a solid, traditional investment path for the long-term gain. It definitely does not cater to a short-term, fast gain investor. Further, the market may drop a bit, but real estate is likely to retain most of its value because there is simply far more demand to live in Northern California than elsewhere. With a sluggish building pace adding only 100,000 units annually, prices generally will retain their high values.
Stocks, on the other hand, are highly heated and due for a heavy correction downward. A small correction was realized in the Spring of 2018, but continued labor improvement, extremely low unemployment rates, and companies hiring heavily continue to drive the overall market. The question is how long that pace can be sustained.