How Well Does Real Estate Hedge Against an Overpriced Stock Market?

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By historical metrics, the U.S. stock market is overvalued—to put it mildly. The S&P 500 has a price/earnings (P/E) ratio of 28.75 at the time of this writing, compared to a median of 20.28 from 1970 to today. The “Buffett Indicator,” or the ratio of a country’s total stock market value to its total GDP, is currently 207.7%, compared to a healthy number in the 100%-136% range. 

And that says nothing of the unpredictable trade policies in Washington right now. Investors have grown complacent over tariff policies, inflation risk, and recession risk. 

Stock market crashes are part of market economics. The question isn’t if, but when, the next stock market crash will hit. 

As a real estate investor, that raises an important question: How well do real estate investments insulate you from stock market crashes? It turns out there are several answers to that question. 

Corrections

Sometimes, stock investors just bid up prices too high. The market then corrects, with prices dropping back down to levels justified by company revenues and projections. 

That doesn’t hurt real estate investors at all. It’s healthy and normal in any market, where prices are determined by what buyers and sellers are each willing to accept. 

Geopolitical Risk

Geopolitical risk feels higher than usual right now. Several hot wars continue raging, the U.S. recently bombed an ally to Russia and China, and foreign policy out of the White House feels unpredictable. 

Stock markets react badly to geopolitical events. They don’t necessarily crash into bear markets, but news of wars, air strikes, diplomatic tensions, and trade wars all send stock investors ducking for cover. 

While real estate doesn’t exist in a vacuum, it’s far more local than stocks. Local property values and revenues are based on local market conditions, rather than conflicts taking place half a world away that might snarl supply chains, but won’t put local workers out of their jobs. That makes most real estate investments pretty insulated from geopolitical risk. 

Read this thought exercise for how real estate would perform if a new world war broke out today. 

Recession Risk: Income

Recessions hurt business income and real estate income alike. 

In a recession, consumers spend less, businesses earn less, and they cut workers or freeze hiring. On the residential side, that means higher rent defaults, turnover rates, and vacancy rates, and more household bundling (adults moving in together instead of living independently). 

On the commercial side, the same thing happens with office and industrial tenants. 

Even so, rental income doesn’t disappear. Rents might dip slightly, and landlords may have to offer more concessions. But for anyone relying on real estate income, such as retirees and professional investors, they’ll still collect it.

There are also plenty of recession-resilient real estate investments out there. Every month, I invest as a member of a co-investing club, which has kept an eye out for recession-resilient investments over the past year. 

Stock investors will see lower or paused dividends. But where they’ll really suffer is in prices, especially among retirees who rely on selling off stocks to pay their bills. 

Recession Risk: Prices

Going back to 1957, the S&P 500 declined by an average of 31% in the last 10 recessions. 

In contrast, home prices don’t necessarily drop in recessions. Four of the last six recessions actually saw home prices increase. And while REITs do crash in recessions, they also rebound before other asset prices. 

So why does real estate fare so much better than stocks in recessions? 

Because in recessions, the Federal Reserve cuts interest rates to juice the economy. And that makes both residential and commercial real estate more affordable, so buyers can and do offer higher prices. 

Commercial real estate prices are based on cap rates, which move in near lockstep with interest rates. When interest rates and cap rates drop, property values rise. 

As a passive real estate investor with partial ownership in over 3,500 units, recessions don’t keep me up at night. I worry more about the risk of sustained high interest rates due to inflation. 

Inflation Risk

Inflation is a mixed bag for real estate investors. 

On the one hand, it drives up the nominal property values and rents. For investors with long-term fixed-interest loans, that’s all upside. The monthly loan payment stays fixed in yesteryear’s dollars, while rents and values shoot through the roof. That works out especially well for residential investors with one-to-four-unit properties. 

The downside is that the Federal Reserve raises interest rates to combat inflation. That sends cap rates higher, which means lower property values for commercial real estate. 

Not all commercial properties suffer. Properties with longer-term, fixed-interest debt can enjoy higher cash flow from surging rents. They don’t have to sell while cap rates are high; they can wait for a better seller’s market. 

The problem is that many commercial real estate investors use short-term, floating-interest debt. When we vet investments together in our co-investing club, we pay close attention to the operator’s loan terms. We want to see plenty of runway for operators to rake in higher rents during periods of inflation without being forced to sell or refinance in a high-interest market. 

As for stocks, they don’t perform as well as real estate during periods of inflation. But they certainly do better than bonds. In periods of rising inflation, real estate has returned an average of 10.6%, compared to 7.3% for global equities and 0.5% for Treasury bonds. 

Stagflation Risk

Recessions alone don’t crush real estate investors. Neither does inflation alone. The scariest risk to real estate investors comes from stagflation: a weak economy, coupled with high inflation. 

In times of stagflation, central banks are caught between the rock of recession and the hard place of inflation. If they cut interest rates, it might help jump-start the economy, but it can also spur inflation. The opposite happens if they raise interest rates. 

That’s what worries me the most about Trump’s tariffs: They both hurt the economy and drive up inflation. 

So far, the U.S. economy has proven resilient in the face of dizzying policy changes out of D.C. I don’t know how stocks and real estate will perform over the next few years. But I gave up trying to predict the future years ago. 

Today, I practice dollar-cost averaging with my real estate and stock investments. Every week, my roboadvisor pulls money out of my bank account to invest automatically for me. Every month, I invest $5,000 in a new passive real estate investment through the co-investing club. 

The stock market rises, the stock market falls. I can worry about my stock portfolio’s gyrations as I get closer to retirement, but for now, I keep enjoying passive income from private notes, real estate syndications, and funds.