These things will happen, and those that are prepared to handle these market fluctuations will be better off in the long run.
Another drawback of investing in real estate stock is that you are betting that the company's management will act in your best interests. As fundamental as that may sound, not all management teams act in this way. Part of your job when choosing stocks to invest in is finding management teams that will be good stewards of your invested capital.
Finally, another thing to consider about real estate stocks is that they tend to be cyclical like the real estate market. Stocks in cyclical industries like real estate tend to have periods of rapid revenue and profit growth followed by periods of flat to declining results. A cyclical industry can be challenging to invest in because even great investments can lead to low returns depending on what time during that cycle you invest. Understanding how stock prices work and basic valuation concepts like the P/E ratio are some concepts you will want to brush up on when investing in cyclical stocks.
What makes a good stock investment?
If you go into investing in stocks knowing full well that there will be up and down years and have the temperament to see beyond these short-term fluctuations, then you are likely ready to invest in individual real estate stocks.
Just like investing in property, investing in stocks requires that you do some homework upfront to identify your best opportunities. After all, by definition, a stock is a small portion of a business. That means you need to spend a considerable amount of time understanding the business you are buying.
There have been enough books written on investing in and analyzing stocks to fill a few large libraries. Trying to cover all that here would do it a disservice. With that in mind, here are some questions for which you should seek answers to determine whether a stock is worth buying:
- How does the company make money?
- Does it do something different or better than anyone else?
- What do some of its competitors do, and is it a better product or service?
- What are some of the risks to its business that could prevent it from being profitable in the future?
- What are the opportunities in front of it to make more money?
- Does the current stock price seem like a reasonable amount to pay for this company?
It sounds incredibly simple, but sometimes the answers to those questions are complex and can take a long time to figure out.
One of the things that makes real estate stocks unique to so many other stocks, though, is that they tend to follow the market cycles of the real estate market. Remember, cyclical industries can be good investments, but buying a company at the top of a market cycle will likely take much longer to generate a decent return than someone with the poise to identify market dips as investment opportunities instead of times to avoid stocks. If you do intend to invest in stocks, you should keep tabs on the current state of the real estate market and where it could go in the coming years.
Are real estate stocks right for you?
Any kind of investing that helps make your financial future more certain is a good thing, whether it be stocks or real estate or some blend of those with other asset classes.
Another thing to consider, too, is portfolio diversity. The amount of money required to invest in stocks is orders of magnitude lower than typical real estate deals, and the ability to allocate that money to several stocks all at once allows one to diversify their holdings. To achieve the same amount of diversity in real estate, it can take hundreds of thousands, even millions, of dollars.
Real estate stocks are also a great entry point into the real estate market as a whole. Reports from a home improvement retailer like Home Depot can provide a lot of insight into new construction and renovation activity across the U.S. Or the speed at which homebuilders are selling homes in certain areas can tell the strength of a particular real estate market. Information like this can be valuable for both investing in real estate stocks as well as other real-estate-related asset classes.
Whether stocks are right for you comes down to whether you have the right kind of temperament to handle the volatility of stocks and are able to identify good businesses in which to invest over the long haul.