Why Real Estate is Less Volatile than the Stock Market

Although it is rarely talked about, in the US, there is more money invested in real estate than is invested in the stock market. Figures from 2018 show that while US real estate was estimated to be worth around $49.3 trillion, the total capitalization in the stock market was $30.4 trillion.

Additionally, for almost a decade, data shows that real estate is ahead of stocks as American’s most favored long-term investment option. This is partly due to the clear advantages that real estate holds over an investment in stocks.

Although the stock market offers the twin advantages of easy access and high liquidity, these benefits have not been enough to make stocks more attractive than real estate. That’s because, as upkeepmedia.com explains, real estate trumps stocks in one important respect; it is less volatile.

What makes stocks volatile?

There are two aspects to stock’s tendency to a high degree of changeability: volatility and correlation.

• Correlation defines how the performance of one investment affects the performance of another one.
• Volatility refers to the size of swings – in either direction – in the value of a security and the risk of those changes happening. A volatile investment can experience changes in value that is spread over a large range of value.

Increased volatility of the US stock market is mainly due to the following:

• The rise of index investing. Back in 2010, index funds owned 6.8% of the US stock markets. But in 2019, that figure had risen to 13.6%. With a huge slice of the market in a few hands, buying and selling decisions have become more correlated.
• Correlation in the stock market also increased due to a marked decline in the number of public investment options. The number of public traded companies fell from 8,090 in 1996 to 4,397 in 2018.
• Along with correlation, market volatility has increased. From 1950 to 1999, daily movements in the S&P 500 which exceeded 3% were no more than 81. But between 2008 and 2018, there 120 daily movements of 3% and over. Between 1950 and 1999 annual average movements was 1.6. Between 2000 and 2018, it was 6.3.
• The quality of the stock market, which is generally considered positive, is the degree of efficiency with which prices are set in the market. Because information about each investment is accessible and widely circulated; it is difficult for a single investor to use their knowledge of an investment’s historical performance to gain an advantage. The high efficiency of the stock market enables large volumes of publicly traded investments to be sold quickly – five billion shares are traded daily in the stock market. But the high trade volume created by the market’s efficiency also contributes to its volatility.

Why real estate is less volatile

There are several important differences between real estate and the stock market which make the former more stable than the latter.

• The high level of inefficiency of real estate creates the exact opposite effect that high efficiency creates in the stock markets. Information about real estate transactions is not easily accessible or widely distributed. Transaction costs are higher and there are fewer buyers and sellers. These add up to much smaller trade volumes and lower levels of volatility.
• Due to real estate being traded at a lower frequency than stocks, these investments are more illiquid than stocks. There are fewer changes to the real value of the investment; daily changes in real estate values are fewer and often minuscule. Because real estate is less susceptible to price swings it is more attractive as a long-term investment
• Real estate values are unlikely to respond to daily price movements in the stock market. There is a little correlation between the two investments. Events that have the capacity to impact the entire financial system – such as wars – are more likely to affect property values than fluctuations in the stock market.
• The value of every kind of investment changes in response to inflation. But the values of a class of assets, known as ‘hard assets’ have the singular ability to outpace the rate of inflation. These assets hold intrinsic value due to the fact that they are finite in supply. This fact allows such assets maintain to their value at a rate above the rate of inflation. Land is one such asset; as it becomes scarcer, its demand increases and its value appreciates.
• Furthermore, owners of real estate can capture the value created by the scarcity of real estate through value appreciation or capital gain and increased rental income.
• Because information about real estate transactions is unequally shared, there is room for investors to make above-market returns. Given that there are fewer buyers and sellers and they all do not have the same level of information, an investor may use their knowledge to buy below market value and sell for above-market returns. They cannot do this in the stock market.

These reasons make real estate the go-to investment for investors looking to hold an asset in the long-term. It also makes real estate the best option for complementing stocks and introducing a measure of diversity into a portfolio.