Real estate investing requires large up-front investments, which makes it difficult to access for most investors. Investing in real estate usually requires a large down payment. If you want to take out a mortgage from a bank, it also requires a good credit score or other forms of collateral. This prices most small investors out of the market. The majority of the real estate market is backed by large institutional investors with the ability to raise capital. The best way for small investors to invest in real estate is through publicly traded REITs.

Real estate is considered a bond proxy. Rental agreements are long-term in nature and generate very stable cash flows, similar to a bond. The average cap rate on stabilized commercial real estate in the U.S. is 5%, which translates to a roughly equivalent dividend yield. Like all bonds, real estate faces interest rate risk. But historically real estate was viewed as an inflation hedge, and interest rate risk was considered minimal. If interest rates go up, landlords can increase rent to compensate. However, rapidly rising rates in 2022/2023 depressed property values more than rent increased. This proved interest rate risk is real and total returns on real estate can be negative in inflationary environments.

Real estate is not a very good investment. You are not adequately compensated for the amount of risk you are taking. Real estate assets are usually fairly priced and highly illiquid. If you are a small investor, you’re investment is usually highly levered and undiversified. All these factors make real estate investing riskier than buying publicly traded stocks, yet returns on real estate (average NOI of 5% + average HPA of 4% = ~9%) are less than average stock market returns (~10%). Risk/reward clearly skews in favor of the stock market. You can increase your return on real estate assets by taking more idiosyncratic risk, such as by buying fixer-uppers. But this requires a specialized skill set that is unavailable to most investors.

Renting is better than buying. Homeownership has been part of the American Dream for a century. You build equity in your home over time, get to deduct mortgage interest on your taxes, and save money on rent. However, this argument fails to consider your opportunity cost. If you invested your down payment in the stock market instead, you would have a greater net worth even after paying rent. You can use margin loans or personal loans to achieve an equivalent amount of leverage as your mortgage. You can deduct interest expense on investments against investment income to obtain the same tax benefits. And you can avoid the steep transactions costs that come with buying and selling real estate by investing in publicly traded securities (6% commission + $10,000 average closing costs).