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Should You Save for Retirement or Invest in Real Estate?

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save for retirement or invest in real estate

The largest classes of investment for most Americans are retirement funds and real estate. Most Americans have some form of retirement savings, typically held in tax-advantaged retirement account like a 401(k). At the same time, nearly two-thirds of American households own their homes. So it makes sense that someone saving for retirement will consider these two options. If you’re saving up for retirement, should you put your money in a tax-advantaged account or real estate? Another way to ask this question is, should you use your money to buy stocks or property? We explore these issues below.

For more help with figuring out what to do with your money, consider working with a financial advisor.

Invest In Both If Possible

In this article we’ll assume that you have to choose between retirement accounts and real estate. That said, the real answer is that you should choose both if you can.

Investing in both real estate and the stock market gives your portfolio diversity. Although these two asset classes are fairly well correlated (meaning that both tend to do well at the same time and poorly at the same time), they’re still different markets and respond to different pressures.

As a general rule, you don’t want to put all of your money into a single asset class. Whenever possible, don’t just invest in land or stocks. That makes your portfolio more exposed than it has to be. If you have good options for investing in both real estate and the stock market, then we recommend putting some of your money into each.

Investing In Real Estate

save for retirement or invest in real estate

Real estate investment works especially for people in certain situations. It’s good for investors with a lot of startup capital and who can take risks, while it’s less suitable for those looking to build an account overtime or who need more stability. Investing in real estate can mean a wide variety of things. While you can pursue some more sophisticated options such as generating income through rentals or investing in properties to flip, the most common ways to invest in real estate are either purchasing a property directly or investing in a real estate investment trust (REIT).

Investing in an REIT means that you will buy shares in a portfolio-based fund. This is similar to buying shares in a mutual fund or an ETF. The main difference is that an REIT portfolio owns physical properties such as offices, apartments and homes. It rents and sells those properties, and the portfolio’s returns are based on the income those properties generate. The good news about an REIT is that you can include this in most 401(k), IRA or other tax-advantaged retirement accounts. These are share-based products that can fit in any standard investment portfolio.

Buying a home means literally that. You’ll purchase residential real estate, hold it and then sell it years later. If you live there as your primary residence, you can get huge tax advantages when it comes time to sell. Otherwise, if you just hold the property as an investment asset, you will pay taxes on the property as ordinary capital gains.

As far as buying a property, the more money you have up front, the more viable it will be for you to buy and hold a property as a retirement option.

One of the things that tends to shock first time homeowners is just how staggeringly much interest costs on a mortgage. Even with a relatively good interest rate like 3% or 4%, over the lifetime of a 30-year loan you can pay almost as much in interest as on the principal itself.

For example, say you buy a house for $475,000 with a 5% interest rate. (At time of writing the approximate average purchase price and interest rate for a new home.) Over a 30 year mortgage you would pay $442,964 of interest on top of that $475,000 loan.

It’s important to be clear here: We’re not talking deductions on future gains or other forms of opportunity cost. This will be a real, fixed expense. If you pay off this loan over 30 years before selling the house, you will spend $917,964 in combined principal and interest. To make a net profit on this investment you will need to sell the house for almost $1 million.

But that’s only if you borrow everything up front. The more money you can put as a down payment, the less you’ll have to borrow and the less you’ll spend servicing that loan. This is why buying real estate is often a much stronger option for investors with a significant up-front amount of capital. If you can borrow little, or even no, money to buy that house, then you can realize significantly greater net gains when it comes time to sell.

As far as returns go, this is where things get more difficult. Buying real estate is a higher-risk, potentially higher-reward approach compared with stock investing.

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Buying Stocks

By the numbers, the answer to our question is this: in most cases, you will make more money investing in stocks or a simple S&P 500 index fund than by purchasing real estate.

One analysis, which is consistent with the broad set of available data, finds that over the past 25 years real estate has never outperformed stock investments. Until the mid-1990’s, this relationship was reversed. From 1975 until 1995, real estate growth significantly outpaced stock market growth. Since then that relationship has reversed. For the past 25 years the S&P 500 has grown significantly faster than the real estate market.

If, for example, you bought a house at the average market price in 1995 you would have paid approximately $153,000. If you sold at the average market price at time of writing, you would collect $477,000. This is a gain of nearly $325,000 over 27 years.

If you invested that same $153,000 in the S&P 500 in 1995, your account would now be worth $2.4 million.

That said, buying real estate can be a strong speculation move. In some areas, most often revitalized urban areas, the price of real estate has skyrocketed over the years. Today it’s common for people to sell downtown homes for orders of magnitude more money than the spent on that same property. If you had purchased a townhouse in downtown San Francisco or South Boston 30 years ago, today you might easily sell it for several million dollars.

This makes real estate a case-by-case option. If you find the right market, real estate can be an extraordinarily good investment. Buying and holding property can offer outsized returns, so long as you don’t spend too much on costs like interest payments, maintenance and property taxes. However, in most cases, the historic returns on real estate pale in comparison to the compound growth offered by the stock market.

The Bottom Line

save for retirement or invest in real estate

If you’re saving for retirement, a tax-advantaged retirement fund with diversified stocks will offer the highest returns for most investors. However, if you have a lot of up-front capital and a tolerance for risk, real estate can sometimes be a good speculation asset.

Investing Tips

  • Wondering how much money you’ll need for retirement? Consider getting a sense of your goal with SmartAsset’s free retirement calculator.

  • A financial advisor can help you make sure you’re making the right investment decisions. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.

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