Have you ever heard of the following scientific statement?
“All compounds are molecules, but not all molecules are compounds.”
In Chemistry, you get a compound if you combine two atoms different elements. If you mix two atoms of the same element, you have a molecule but not a compound. Two Hydrogen atoms (H) still make Hydrogen and qualify as a molecule, but not a compound. Add an Oxygen (O) atom to the mix, and you get the compound H2O (water).
As I sat and pondered the whole molecules vs. compounds idea, I thought of real estate and real estate bubbles.
Applying the idea of compounds to real estate, we tend to lump all types of real estate under one big real estate umbrella. We’ll lump housing with commercial real estate (CRE), and under the CRE banner, we’ll even lump all the different segments together.
When the press talks about the real estate market, they tend to lump everything together:
- How will inflation affect the real estate market?
- Are we in a real estate bubble?
- How will rising interest rates impact real estate prices?
Suppose you think about compounds, molecules, and elements. In that case, most people understand that an external stimulus will have a different effect on a compound compared to its effect on the individual molecules or elements. You heat water to a certain degree, and you separate the Hydrogen and Oxygen, which is a different reaction than when you heat just Hydrogen or just Oxygen.
My point is that certain macroeconomic stimuli may influence the real estate market as a whole, but these same stimuli may not have the same influence on the individual segments. The effect of heat on Hydrogen will be different from the effect on Oxygen.
The effect of inflation on the single-family housing segment won’t be the same as the effect on a CRE segment like – say – multifamily.
Speaking of the real estate market as a whole, here are some of the latest alarms being sounded in the press:
“Will inflation and rising rates cause a housing market crash?”
“U.S. single-family starts to tumble.”
“3 signs another housing bubble is looming in the U.S.”
The press likes to point to single-family housing as a bellwether for the entire industry, but here’s the truth about real estate bubbles and crashes:
A dip in the housing market won’t necessarily point to a dip in all other real estate segments.
Economic factors may impact the real estate market as a whole and the single-family housing market in particular. Still, not all segments react the same way to a negative economic event or trend. There may still be opportunities in other real estate segments you might miss if you don’t keep an open mind.
So, housing starts are down. Does that mean we should shun real estate investments altogether? Absolutely not!
Think back to 2008. In 2008, the housing market crashed along with many CRE segments, but one noticeable segment trended the other way. Multifamily and mobile homes, for example, not only withstood the housing crash but thrived – with demand consistently outstripping supply, with the gap even widening over the years.
The pandemic is another example of how you shouldn’t lump all real estate into one basket. While office and retail suffered in the wake of pandemic-induced lockdowns and social distancing, industrial soared and multifamily – once again – stood firm.
With real estate, separate the molecules from the compound. The real estate market as a whole may experience a downturn in the coming years but don’t listen to the naysayers that say you should avoid the real estate asset class altogether.
While many ponder or speculate about a downturn – that potential downturn doesn’t deter savvy investors from the real estate market entirely because they know how to separate the elements from the compound. Just because single-family homes are expected to take a hit doesn’t mean other segments will do the same.
Smart investors have never relied on single-family performance as a barometer for all real estate. They look at the individual segments standing on their own and decide which one will weather a particular storm the best.
Commercial real estate is and will always be where the ultra-wealthy allocate their assets for capital preservation, tax benefits, and passive income. The financial climate may change, and new economic developments may arise that impact the real estate market as a whole, but amidst all the chaos, there are always real estate segments that thrive (e.g., multifamily post-Financial Crisis and industrial and multifamily post-COVID).
Wanna know the truth about real estate crashes? Not every segment will crash, with some even thriving. The key is to keep an open mind. How are office and retail properties performing now? Much better than anticipated in a post-COVID world and yet the crowd finds them out of favor. Why? A misunderstanding about the fundamentals of value, desire to invest with the crowd, and investors tendency to invest in assets at highs and not lows (where the value truly is).
