Overseas property

Debunking profit myths on real estate and securities investments

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When it comes to investments, stock market experts are quick to sell securities as the best option for higher profits. Nevertheless, the magical formula packaged as the great “higher risk/higher returns” theory does not guarantee a profit. In fact, this notion simply suggests that the actual return on your investment will differ from that expected. For investors this can mean one of two things: higher profits or bigger losses. Those looking for stable long-term gains may be better served by the real estate market which is less risky but can be just as profitable as stock. Here is a breakdown of the major differences between securities and real estate investments.

Real estate is less liquid

Low liquidity is one of the major drawbacks of real estate. It can take months to buy or sell a property while securities can be disposed of almost immediately.

“Say you need to sell your assets off for cash. Those who’ve faced the challenge are aware that selling a real estate item involves a lot of time and effort. Sometimes it takes a few months or even years until a truly willing buyer shows up,” explains Alexander Prosviryakov, investment expert in treasury and commodities.

Real estate investors are less concerned with low liquidity than their stock market counterparts: when property has been owned for several years, it’s not a big deal if the transaction takes a few months to complete.

Trading stock is cheaper

Real estate transactions cost more than securities trading.

“On average, it takes 5–15% of a property’s value to cover transactional expenses like lawyers, agencies and notaries while charges for the purchase of securities don’t exceed 0.2% and commission is much lower on high volume transactions. Expenses incurred by the possession of securities are also dozens if not hundreds of times lower than those for possessing real estate,” says Mr Prosviryakov.

As a general rule, property transaction charges are perceived as more significant by those looking to buy and sell quickly than owners of several years.

No golden rule for high profits

Increased value of investments over time is a prime argument for experts of both camps. However, because growth indices of securities and real estate items differ over time and depending on location, there is no definite answer to this question. Stock market experts promise increased gains for securities over the short term while the chart below, comparing the average annual rise in real estate prices and major stock indices of national exchanges around the globe over the past 20 years, shows that there is no golden rule for making good investments.

Annual growth average of national stock indices and real estate from 1995. Source: Yahoo Finance & OECD

In some countries, real estate grows faster than large-cap stocks while in others, the securities market is a more profitable venture. Additionally, there are specific situations in these markets leading to this. For example, UK property prices have been rising faster than British companies’ shares amid constrained housing supply, growing population and falling interest rates. At the same time, US prices have not recovered from ’07–’08 crisis, thus trailing securities in terms of growth dynamics.

However this index only presents an average for a group of stocks and does not preclude quicker growth for certain securities. The same goes for property and popular locations which boast significantly stronger growth than national averages. A prime example is London where, for the past two decades, real estate prices have grown at an average annual rate of 9% against 6% nationwide. In realistic terms, because real estate cycles are longer than the stock market’s, it’s easier to spot a promising property market than a potentially volatile share.

Indeed, securities can be more profitable and considerably outperform real estate over the short term. Some share prices can rise severalfold in days and even trusted shares like the Down Jones Industrial Average (DJIA) stocks can grow rapidly. For instance, half the DJIA companies saw their shares gain 10% and some even 40% in 2014. In contrast, real estate prices do not experience double-digit growth too often and it goes without saying that no property market is capable of similar short-term performances in terms of profit. Even in the mid-2000s before Spain’s property bubble burst, price growth never exceeded 10–20% according to OECD data.

Profitable low risk investments

Real estate prices are less volatile because the cyclical periods of growth and decline last longer. As opposed to securities, real estate prices don’t drop too low during downturns and hard times. For instance, European property prices lost 4% on average and no more than 10% across most of the region in 2009 according to OECD data. During the same period, all the major share indices lost 40–60% of their pre-crisis value.

Securities are riskier investments because they are more sensitive to market changes while price depreciations are stronger and more common. Furthermore, portfolio diversification is not a guarantee against losses during a recession.

FTSE 100 Index and UK real estate prices (1995 = 100). Source: Yahoo Finance & OECD

The above chart compares average stock fluctuations on London’s FTSE 100, composed of companies from various industries, with real estate prices in the UK over the last 20 years. Stock value on this index has demonstrated less growth overall as well as infrequent but clearly defined downward trends, while real estate prices have shown far steadier growth.

Property is a good investment in terms of savings as it grows faster than inflation, thus protecting money from currency devaluation. In fact, property has outpaced inflation by 1% annually on average since 1990.

Inflation, real estate and EURO STOXX 50 index (1990 = 100). Source: World Bank, OECD & Yahoo Finance

The EURO STOXX 50 is composed of the 50 largest and most liquid stocks in the Eurozone and is also highly volatile, so while there are large profits to be made, the investor must have utmost confidence in his market knowledge or the trader managing his portfolio.

Additional sources of revenue

Alongside steady price increases, real estate owners can also benefit from rental income generated by their property. For example, well-researched investments into retirement homes can yield 15–20% annual returns while 7% is considered high yield for regular property.

In the case of securities, additional regular revenue should be generated by dividends and coupon payments on bonds for instance. However, stocks presenting risk parameters similar to real estate (i.e. government-issued) generate far less income than the latter, nor do safe blue chip dividends bring in much either. At the same time, companies may choose to reinvest dividends in the business rather than distribute them to their shareholders.

Annual yield of various assets, %. Source: Top Yields, Financial Times Markets & Global Property Guide

Coupon payments on corporate bonds are not too generous either. According to Business Insider, over 90% of European companies offer corporate bond payments of maximum 2.5% per annum while average rental yields are 4–5% per annum, sometimes even 6–7%.

Real Estate Investment Trusts (REITs) earned the highest returns compared to all stock market assets, including securities, commodities and cash deposits over a fifteen-year term. At the same time, they also showed the highest average annual volatility.

Average annual returns and volatility for various asset classes, % (2000–2014) Sources: Barclays Capital, Bloomberg, FactSet, JP Morgan Asset Management, MSCI, NAREIT, Russell, Standard & Poor’s

Play it big or play it safe

Real estate and securities investments have distinct attributes in terms of profit, liquidity and risk. Diversifying your portfolio into both vehicles has the potential to balance risky short-term high profit investments with the rigid liquidity and steady long-term gains of property, but the trade-off may cost you peace of mind. Securities are for investors who do not fear risk with big potential while real estate will suit careful investors looking to secure savings and benefit from regular income.

Yulia Kozhevnikova, Tranio

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