• Real estate values, especially private real estate, do not move in lockstep with the stock market.
• When the stock market swings, the real estate market (excluding publicly traded REITS) tends to move considerably less or even in the opposite direction.
• This marginal correlation means it is a great way to diversify your investments and nullify the risks associated with a highly correlated portfolio
When we hear about large moves in the stock market, widespread fear quickly follows. Why? Many hold the notion that the stock market drives our economy. Yes, the stock market is a conventional indicator of economic health—so this belief is not entirely unfounded.
But it is not the full truth. The stock market is an indicator that only measures a very specific segment of the economy. It does not measure anything except the value of the companies listed on the stock market. Therefore, it excludes private real estate, government spending, and small business—which is the foundation of our economy.
If you only invest in the stock market, your investments miss a large part of the economy. If you have a diversified portfolio that invests across asset types, you can mitigate the stock market’s volatility and protect your capital.
As a general rule, we can gauge a portfolio’s diversification (or lack thereof) by how correlated the assets are within it. So today, we will answer some FAQs about market correlation, specifically between real estate and stocks.
Q: What is correlation?
A: Correlation is the measurement of how closely investments respond to market shocks in the same way. Note that 1 is perfect correlation; -1 is perfect inverse correlation, meaning they move in opposite directions. Real estate assets have an average 0.19 correlation to stocks and a -0.11 correlation to bonds.
Q: Why does it matter?
A: When investing in assets with little or no correlation, the more diversified your portfolio becomes. Diversification is arguably the single-most-important factor of a healthy portfolio—find out why here.
If poor performance in one investment can be offset by stronger results in another, then extreme losses in the overall portfolio will be reduced. And the more capital you can preserve during market dips, the better off you will be when that market corrects.
Q: What does correlation mean for stock market investments?
A: Assets within the stock market have become increasingly interrelated under concentrated ownership. Index funds now control a significant portion of the US stock market. In 2010, 6.8% of the US stock market was owned by index funds; in 2021, the number has almost tripled.
For many investors, the big indexers control 20 percent or more of their shares. For nine in 10 companies on the S&P 500, their largest single shareholder is one of the Big Three (BlackRock, Vanguard, and State Street). This consolidation of management means that trade decisions are made by a select few stakeholders—correlation at its finest.
Q: What about real estate investments?
A: Real estate has a very low correlation to stocks, bonds, and other assets. When the stock market moves, the real estate market tends to move less or even in the opposite direction.
This correlation excludes publicly traded REITs, which tend to be concentrated in core assets and markets and are traded like stocks, resulting in a much higher correlation to that market.
Compared to the stock market, which operates on a new cycle every day, the private real estate market focuses on the long-term horizon at a much more measured pace. Private real estate is not beholden to moves in other markets, as it is more broadly invested across different types of real estate such as health care, self-storage, and other niches.
Bonus: Real estate has a positive correlation with both anticipated and unanticipated inflation and therefore provides a hedge against it.
Sure, the stock market’s highs can be high. But the lows are LOW. Ten years ago, we decided to get off that roller coaster. If you’re here, you probably are too. Low-correlation investing is how we decided to diversify, and we found that private equity real estate investing was the best way to do it.