Real Estate vs. Stock Investment: Pros, Cons, and Tips for Beginners

Real estate investment and stock investment are both typical methods of asset management, but their structures, characteristics, and nature of risk/return are very different. For beginners, they may often wonder "which one should I start?" or "which one is best suited for my objectives? This article explains the basic structure and characteristics of each of real estate investment and stock investment, their advantages and disadvantages, a comparison from the perspective of risk management, and how to choose the one that best suits your investment objectives. Finally, the importance of asset allocation rather than either/or will also be discussed. Please read this article as a reference for your future asset building. Basic Structure and Characteristics of Real Estate Investment

Real estate investment is an investment technique in which real estate properties such as land and buildings are purchased and rented out to others to generate rental income and future gains on sales. The basic source of income is the monthly rent income (income gain), and if there are tenants, a stable income can be earned over the long term. For example, if you own a property with a monthly rent of ³,000, you can use the rental income to repay the loan while earning the remainder. Furthermore, if the property is sold at a higher price than the purchase price, a capital gain can be earned. Since the purchase price of a real estate property is often high, ranging from several million yen to tens of millions of yen, it is common to purchase a property with a loan from a bank. Another feature of real estate investment is that loans allow you to make large investments with little capital on hand (the so-called "leverage effect"). Another characteristic is that the purchased property itself remains in your possession as a real asset, and even if there are no tenants temporarily, the value of the asset itself remains. However, it should be noted that real estate is illiquid and it takes time to sell it and convert it into cash.

Basic Structure and Characteristics of Equity Investment

Equity investment is an investment technique in which shares (stock certificates) issued by companies to raise funds are bought and sold in the market and profits are earned from the price fluctuations and dividends. You can earn capital gains by buying stocks at a low price and selling them at a high price, and you can also receive dividends (income gains), in which a company returns a portion of its profits to its shareholders. Stock prices fluctuate daily depending on a company's performance and economic conditions, and tend to rise when a company's performance improves. On the other hand, there is always the risk that a company's performance may deteriorate or that the share price may fall due to market fluctuations. Stocks are highly liquid because they can be traded on stock exchanges on a daily basis, and they are easy to start trading with as little as a few tens of thousands of yen. However, it is important to note that stocks themselves are intangible rights, and if the company in which you invest goes bankrupt, the value of the stock becomes zero. Thus, while stock investment has high growth potential, it is also an asset class with large price fluctuations and a high degree of uncertainty.

Advantages of Real Estate Investment

Real estate investment offers the following advantages

• Long-term stable income and resistance to inflation: Since rental operations provide a stable monthly rental income, real estate investment is considered a highly stable investment over the long term. Demand for real estate does not suddenly drop to zero, even during economic downturns, and price fluctuations are moderate compared to equity investments. In addition, since real estate is a real asset, it is considered to be strong in times of inflation, and rents tend to increase easily when prices rise, and asset values tend not to diminish. During times of inflation, the real burden of loans is also reduced, which can be expected to protect the purchasing power of assets.

• Leverage effect of loans: Real estate has a collateral value that makes it easy to obtain loans from financial institutions, and the attractive feature of real estate is that you can make a large investment with a small amount of your own capital by adding loans to your own capital. For example, if you acquire a property with a loan several times the amount of your own capital, you can expand the size of your assets at once. By leveraging, there is a possibility to increase investment efficiency (return on capital). However, because borrowing is involved, you need to pay close attention to the risk of rising interest rates and repayment plans, which are discussed below.

• Real assets remain on hand: Purchased real estate remains on hand as tangible assets in the form of land and buildings. The value of the real asset does not become zero even when there are no tenants, and the assessed value of the land or building itself may increase in the future if it is held for a long period of time. In addition, after the loan is paid off, the real estate can be sold to obtain a large sum of money or inherited by the next generation. Real estate tends to have a lower assessed value for inheritance tax purposes than cash, and in some cases the assessed value can be significantly reduced by using special exceptions for small residential lots, etc., making it the asset of choice for wealthy individuals as an inheritance measure.

• Tax advantages: Since depreciation, interest on loans, and management costs can be expensed in real estate investment, income tax on rental income can be reduced. Another advantage, as mentioned earlier, is that owning real estate at the time of inheritance reduces the assessed value of the asset, resulting in income and inheritance tax savings. By properly accounting for expenses and taking advantage of tax incentives, you can reduce your future tax burden while increasing your take-home earnings.

Disadvantages of Real Estate Investment

Next, let's look at the disadvantages (disadvantages and risks) of real estate investment.

• Low liquidity and time-consuming to convert to cash: Real estate is an asset that takes time and effort to sell. It is not unusual for it to take several months to a year to find a buyer after putting a property on the market, during which time management fees, property taxes, and other costs continue to accrue. If you want to cash out in a hurry, you may have to lower the price below the market price to sell, and there is a risk that you will only be able to dispose of the property at a lower price than expected. This low liquidity is one of the major limitations of real estate investment.

• Large initial costs: In addition to the property price itself, there are a large number of other expenses involved in acquiring real estate, such as brokerage fees, registration fees, and real estate acquisition taxes. Therefore, a large amount of personal funds (down payment and other expenses) is required, which tends to raise the hurdle. In particular, prime properties in central Tokyo with high yields are often priced in the tens of millions of yen or more, and even if a loan is available, a portion of the property price must be paid by the investor. It is undeniable that the hurdles to starting an investment are higher than those for equity investments.

• Risk of worsening income/expense due to vacancy or rising interest rates: In rental management, you cannot earn rental income unless you have tenants. Therefore, the risk of a property becoming vacant must always be borne in mind. If vacancies persist for a long period of time, you may not be able to cover your loan repayments with rental income, and you may have to draw down your own funds. In addition, if the loan interest rate is variable, there is a risk that if the interest rate rises in the future, the interest burden will increase and the net income and expenditure will deteriorate. Particular attention should be paid to the risk that future changes in the current low interest rate environment may cause a deviation from the repayment plan. Regarding the rent market, there is also a risk that the rent level will fall as the building ages. It is also necessary to devise ways to reduce the risk of future rent declines by selecting a property with a good location and good management.

• Management, maintenance, and disaster response costs: Real estate requires time, effort, and expense for maintenance and management even after acquisition. Buildings deteriorate over time and require periodic repairs and equipment replacement. Repair and renovation costs are the responsibility of the owner, and must be systematically accumulated and prepared for. In addition, the risk of disasters such as earthquakes and typhoons is unavoidable. If the property is damaged by a disaster, a large amount of repair costs may be incurred, and it is essential to have fire insurance and earthquake insurance. Thus, it is necessary to understand that real estate investment requires time and effort for management and operation even after the property is acquired. Although outsourcing to a management company can reduce the burden of daily management, outsourcing costs will still be incurred in such cases.

• Investment tends to be concentrated and difficult to diversify: Because of the large amount of money involved in real estate per property, it takes a considerable amount of financial resources to diversify investments across multiple properties. As a result, funds tend to be concentrated in one property, making it difficult to diversify by region or property type. Another disadvantage is that the impact of a poor performance of a particular property or area on the entire portfolio tends to be large. As a countermeasure, it is possible to diversify risk by choosing an area with strong demand at the property selection stage, or by combining several condominiums instead of a single building.

Advantages of Stock Investment

Investing in stocks has the following advantages.

• High growth and return potential: Stocks have the potential for large price gains as companies grow, and long-term returns generally tend to be higher than those of other assets. Data shows that the average long-term yield of the stock market as a whole tends to be higher than that of real estate, and if you choose the right stocks, you have the opportunity to significantly increase your assets through dividends and price appreciation. However, it is important to recognize that this is a "high-risk, high-return" asset class, as there is a high risk (see below) behind the high returns.

• Easy to start with a small amount and diversify: You can start investing in stocks with as little as a few thousand yen by opening an account at a brokerage firm. For example, some stocks are priced from a few hundred to several thousand yen per share, and mutual funds allow you to diversify your investment into many stocks with even smaller amounts. Because the trading unit of stocks is small, it is easy to diversify into multiple stocks, and it is easy to compensate for losses caused by one company's poor performance by investing in other stocks that perform well. Thus, even beginners can easily start managing their investments while hedging risks through diversification, which is a big advantage.

• High liquidity and easy to convert to cash: Listed stocks can be traded at any time during market trading hours and are highly liquid, meaning that they can be cashed in immediately when needed. During the daytime on weekdays, you can place an order online and the sale is completed in a few minutes and the cash is in your account. The flexibility to quickly adjust your portfolio in response to sudden expenses or market fluctuations is an advantage unique to stocks that real estate does not offer.

• Dividends and shareholder benefits: Many, but not all, publicly traded companies pay regular dividends to shareholders or offer shareholder benefits such as discount coupons for their products and services. If you invest in stocks with high dividend yields, you can earn regular income at a rate higher than that of bank deposits. If a company's performance is strong, it may increase its dividend (dividend increase), which can be a source of income gain (dividend income) for long-term holdings. In addition, Japan's unique shareholder special benefit program offers the enjoyment of receiving food and service coupons depending on the number of shares held and the length of time they have been in the company. These benefits are an attraction of investing in stocks that cannot be found in real estate investment.

• Easy to start even without specialized knowledge: Anyone can start investing in stocks as soon as they open an account, and there is no need to go through complicated contracting procedures such as those required for purchasing property. Because it can be completed online, even busy people can find time to trade. Of course, it is preferable to have knowledge of corporate analysis and economic indicators, but recently there are products such as robo-advisors and index funds that are easy for beginners to use, and the advantage is that the hurdle to investing is low.

  (Note: This does not mean that investment knowledge is unnecessary. Ultimately, study and information gathering are essential for success, which will be discussed in the disadvantages below).

Demerits of Stock Investments

Stock investments also have the following disadvantages and risks

• Large price fluctuations and risk of loss of principal: Stocks fluctuate in price on a daily basis and are sensitive to the economy, corporate performance, and domestic and international political and economic news. There is always a risk that the stock price may plummet in a short period of time, resulting in a large loss (valuation loss). For example, an unexpected downturn in business performance or economic crisis can cause stock prices to fall by tens of percent in a few days. Since there is no guarantee that the stock price will recover in the future, the possibility of large losses in a short period of time is a major risk of investing in stocks. In fact, as they say in the stock market, "high risk/high return," high risk of price fluctuation and high return are two sides of the same coin.

• Bankruptcy risk of the company in which you invest: Since stocks are an investment in a company, your investment (principal) will be almost unrecoverable if the company in which you invested goes bankrupt. There is no guarantee of the principal amount invested in stocks, and in the worst case scenario, there is no denying the possibility that the invested amount will be reduced to zero. In particular, when making concentrated investments in the stocks of individual companies, it is necessary to fully investigate and take into account the risk of business failure of those companies. To prepare for such credit risks, it is essential to diversify investments in multiple stocks and check their financial conditions, as described below.

• Specializedknowledge and analytical skills are required: In order to make a stable profit from stock investments, you need specialized knowledge, such as reading corporate financial statements and analyzing industry trends; you need to understand the meaning of investment indicators such as PER and PBR, and keep abreast of economic indicators and monetary policy trends. Although trading itself can be done without knowledge, trading based on intuition or rumors without sufficient knowledge will make it impossible to select the right stocks and make the right timing decisions, and as a result, you are likely to incur losses. If you are unable to devote time to study and gather information, you should consider the option of leaving the management to professionals such as index funds. While stock investment is easy to start, it is important to recognize the fact that in-depth knowledge is required as a disadvantage.

• Mental strain can be heavy: Volatile fluctuations in stock prices can have a significant impact on the psychology of investors. The stress of mounting unrealized losses and the psychological risk of panicked selling when the market plummets cannot be ignored. There are stories of individual investors who are so busy constantly checking price movements that it interferes with their day jobs and causes them to lose sleep. This kind of mental pressure is one of the qualities that are required for stock investment. On the other hand, some people point out that real estate investment is mentally calmer because you do not feel the daily fluctuations of the market (although it is true that real estate investment has a different kind of stress factor). In any case, it is important to choose an investment method that suits your risk tolerance and personality.

Comparison from a Risk Management Perspective

As an investment, both real estate and stock investments involve risk. However, the types of risk and how they are managed differ greatly. Let's compare the main risks and risk management strategies for each.

• Real Estate Investment Risks and Management: In real estate investment, the main risks are vacancy risk, rent decline risk, disaster risk, and interest rate fluctuation risk. These risks can be controlled to some extent by taking measures in advance. For example, to address vacancy risk, you can maintain occupancy rates by selecting properties in high-demand areas and outsourcing management to a reliable rental management company. Rent decline risk can also be mitigated by choosing a property in a location that will remain popular even after a certain age, and by making appropriate repairs to maintain the value of the building. For disaster risk, it is effective to diversify risk by purchasing fire and earthquake insurance, as well as by diversifying property holdings in multiple regions. Interest rate fluctuation risk can be minimized by planning for sufficient repayment capacity when taking out a loan, choosing a fixed-rate product if necessary, and reducing the remaining balance early through early repayment. Thus, risk management in real estate investment depends largely on "property selection" and "advance preparation," and it is important to keep in mind that risk should be factored into the investment process as you develop a business plan.

• Risks and Management of Stock Investment: In stock investment, the main risks are "market fluctuation risk (price fluctuation)," "credit risk (corporate bankruptcy)," and "liquidity risk (ease of trading). Unlike real estate, these are aspects that are difficult for individuals to control. Individuals cannot prevent stock price declines in the market as a whole, and must basically accept the high-risk, high-return nature of the market. However, this does not mean that there are no countermeasures. Price fluctuation risk can be leveled out by diversifying investments across multiple portfolios and taking a long-term perspective. Even if one stock declines in price, losses can be offset if other stocks rise, and long-term holdings increase the likelihood of recovery from a temporary crash. For credit risk, it is important to carefully analyze the financial condition and performance of the company and invest in quality companies that are considered to have a low risk of bankruptcy. Liquidity risk can be avoided by avoiding small-cap stocks with extremely low trading volume and selecting stocks with high trading volume that are easy to trade. In addition, it is also effective to set a rule for loss-cut and sell stocks mechanically without being influenced by emotions when unrealized losses grow beyond a certain level in order to avoid fatal injuries. As mentioned in Section 3.2, market conditions themselves cannot be controlled by individuals, so ingenuity and self-control to limit risk are required in risk management for stock investments.

As described above, real estate investment is easy to reduce risk by responding in advance, while stock investment requires acceptance of market fluctuations while hedging risk through diversification and other measures, in contrast. It is important to keep in mind that there is no guarantee of principal in either case, so it is important to simulate worst-case scenarios and plan your funds well in advance.

How to choose according to your investment objectives

Whether a real estate investment or a stock investment is right for you depends on your investment objectives and the points you wish to emphasize. Let's organize the cases in which each investment is suited for different purposes.

• If you are looking for a stable income and asset preservation: If you are looking for a stable income every month for the future and want to prevent the value of your assets from declining, real estate investment is a strong choice. This is because real estate investment offers excellent long-term income gains, and it is easy to protect the value of your assets even when prices rise. In addition, since the acquired real estate will remain as assets in the future, it can be used as a substitute for a pension in retirement or as an asset transfer to family members in the event of an emergency. For example, real estate investment is suitable for those who "want to secure a stable income even after retirement" or "want to leave a solid asset.

• Tax and inheritance tax saving: Real estate investment is also suitable for those who are looking to reduce their tax burden, as it can be expected to save income and inheritance taxes. High-income earners can reduce their income taxes through depreciation by investing in real estate, or they can purchase rental real estate before inheritance occurs to lower the assessed value for inheritance tax purposes. Real estate investment can also be an effective way to manage assets with a view to future inheritance measures and asset succession.

• If you want to start investing with a small amount of money: If you do not have a large amount of personal funds or if you want to start small, investing in stocks is a good option. With stocks, you can buy from funds of less than several tens of thousands of yen, and you do not need to take out a loan like you do with real estate. For beginners who "do not have much savings but want to start investing" or "are worried about taking out a loan," the method of starting asset building steadily with stock investments (or investment trusts) will be realistic.

• If you value liquidity: If you want to be able to withdraw your money whenever you need it, investing in stocks is a good choice because of their high liquidity. Stocks can be sold immediately during weekday market trading hours, allowing you the flexibility to respond to sudden expenses or changes in the environment. On the other hand, real estate takes time to turn into cash, so if you invest funds that you plan to use in the immediate future, you will not be able to respond to emergencies. For those who value liquidity, it is safer to build a portfolio around assets that are highly convertible to cash, such as stocks and mutual funds.

• If you are looking for high risk but high return: If you are looking for significant growth in your assets and are willing to take some risk, then investing in stocks is the way to go. The stock market offers many high-risk, high-return opportunities, such as investing in growth stocks of venture companies and emerging markets. For those who want to pursue the possibility of multiplying their assets many times over in a short period of time, stocks with large price gains are attractive. On the other hand, those who do not want to take large risks may feel more comfortable investing in real estate, which has a slower price fluctuation. It is important to choose the appropriate investment portfolio according to the balance between your risk tolerance and expected return.

• If you are too busy with your day job to put in the time and effort: If you are too busy to devote to investing, both real estate and stock investments depend on your ingenuity. In general, real estate investment can be made much less time-consuming by outsourcing the management of the property, but it requires a lot of effort in the selection and purchase of properties. On the other hand, stock investments tend to take time for daily price checks and information gathering, but can be managed without much effort if left to index funds and robo-advisors. Therefore, if you "don't want to spend time at all," it is better to choose a fully outsourced investment method. In either case, it is necessary to review your portfolio periodically, as too much neglect is dangerous.

In summary, real estate investments tend to be suitable for those who want stable income and asset preservation, while stock investments tend to be suitable for those who value small amounts, high growth, and liquidity. For many, however, the optimal solution may be to balance both. This point is discussed in the next conclusion.

Summary: The Importance of Asset Allocation

Real estate and stock investments have different attractions and risks, and there is no "one is better than the other. What is important is to appropriately combine the two according to your objectives and risk tolerance. For example, the stable income of real estate and the growth potential of stocks are complementary to each other. Diversifying your assets between real estate and equities will reduce the overall risk of your portfolio and improve its stability compared to concentrating on a single asset. In fact, in the asset management world, asset allocation is said to be the most important factor in determining investment performance. Stocks have high price volatility but can be expected to generate high returns, while real estate has relatively low price volatility and can be expected to provide a hedge against inflation and stable income. By combining these multiple asset classes, a well-balanced investment strategy can be achieved that diversifies risk and does not miss opportunities for return.

Professional investors and high-net-worth individuals also allocate their funds to multiple assets such as stocks, real estate, and bonds, adjusting the ratios according to market conditions in order to build long-term assets. It is important for beginners to have the idea of utilizing the merits of both, rather than worrying about the choice between "real estate or stocks. For example, it is a good idea to take a step-by-step approach, such as first accumulating funds while investing in stocks, and then eventually trying real estate investment. Conversely, a strategy could be to reinvest some of the stable income earned from real estate investments in stocks to increase the growth potential of the overall asset portfolio.

Last but not least, any investment involves risk. Based on the premise that there is no such thing as an "absolutely safe investment," it is important to keep in mind a reasonable investment strategy with an asset allocation that suits you. It is important to understand the characteristics of both real estate and stocks, and to manage your assets wisely by combining them appropriately. In doing so, it is recommended that you consult with a specialist as necessary and make a plan from a long-term perspective. We hope that through sound asset allocation, you will be able to achieve steady asset building for the future.