The Dutch Tulip Bulb crisis was the first economic “bubble” in world history. Although it was around 400 years ago, the investment lessons learned were profound and still apply today. In this Commercial Real Estate Mastery podcast we’re going to explore what happened in this catastrophic event and how to protect your investments from future “bubbles” – including the one we’re in now.
Episode 7: Lessons Learned From Tulip Bulbs Transcript
Do you remember the Dutch tulip bulb bubble? I bet you don't, because if you did, you'd have to be about 400 years old. The Dutch tulip bulb bubble happened between 1634 and 1637, and it served as the world's first speculative bubble. And of all things, and I know it seems insane, it was focused on tulip bulbs. Now, why tulip bulbs? Well, remember that in the 1600s, there weren't a lot of products in the world. And the Dutch, they had a hankering for the prettiest tulip bulb. People would try and outdo the Joneses by having a prettier form of tulip in their yard. Everyone coveted trying to have the prettiest ones. And then suddenly, people started paying more for the tulip bulbs to outdo each other, and it just got completely out of control. It really wasn't people trying to outdo each other with the quality of their tulip bulbs. It was really just a way to try and make money. Because if you bought the tulip bulb one day, the expectation was you could sell it for more the next day. And let me tell you how crazy it got in the Dutch tulip bubble.
At one point, a single tulip bulb would sell for four ox, eight pigs, 1,000 pounds of cheese, a complete bed, a complete suit of clothing, and a silver drinking cup. And that bag of assets cost, back in 1634, about 2,500 guilders. Think how insane that is. So you're going to trade for one tulip bulb, effectively the entire net worth of an individual. That's how much they would speculate on these tulip bulbs. And then one day in 1637, the bubble burst. And that tulip bulb that someone just paid for with four ox, eight pigs, a thousand pounds of cheese, a bed, a suit, and a silver drinking cup was worth nothing. Literally crashed and burned like no other speculative bubble before or since. One of the worst nuclear wipeouts of money that the world had ever seen. But what's the whole point of talking about the Dutch tulip bulb bubble? You might say. Well, the problem is that it serves as an example for everyone over the last 400 years of what happens with certain styles of investing. So let's review the styles of investing that kind of created this whole tulip bulb fiasco to begin with. The first one is investing in the greater fool theory.
It's very, very risky endeavor. You've already seen that a little bit with Bitcoin. Huge highs and lows. Bitcoin goes to $100,000 and plummets down to $30,000. Why was anyone buying the Bitcoin at $30,000? What was going on? Well, they were buying it because they thought if they bought it they could sell it later for a profit. And that's called the greater fool theory because you have to assume there's somebody crazy enough to pay more than you just paid. And that's a very risky style of investing. It's not even really investing. It's more speculations. And assets that have no income are the ones that are typically targeted in these bubbles because it's all based on perception. Look at gold for example, which has gone up a ton recently. It's over $4,000 an ounce or bouncing around that level. What's gold worth? Does gold make any income? Nope. Can you eat gold? I don't think so. Probably never healthy for you. So what changes with gold is our perception of the value of gold, but not based on any science, algorithm, sense of income, Nothing. Just the fact that, oh, gold's valuable. And I think that buying it at 4,000 an ounce, I can sell it later for $4,100.
Why? Because there's probably some greater fool out there to buy it from me. Assets that are valued based on nothing but perception are very, very risky. Another item is irrational exuberance. Now what's irrational exuberance is when people just think it's going to keep going up no matter what. You're seeing that right now in the US stock market. It doesn't matter what the news report is. Interest rates go down, stocks go up. Interest rates go up, stocks go up. Corporate earnings miss the mark, stocks go up. Doesn't matter what anyone says, stocks go up. When you see situations where stocks go up for no reason on every news announcement, that's called irrational exuberance. You saw that in Dutch tulip bulbs. You saw it prior to the dot com bust with the Internet. And right now you see it building under the AI bubble. People are just so irrationally exuberant in AI that no matter what AI stocks make the world go up. Now, right now, stocks on the US stock market are valued at a 40 price to earnings ratio. Let me put that in perspective for you. When I was back in at Stanford, economics major back in the late 70s, we were told that never invest in a stock with a PE ratio, which is price to earnings ratio greater than 10.
Today we're at 40. That's four times what the classical thought was on the value of a stock. Last time it was at 40, you guessed it. 1999, right before the dot com bust, which happened in March of the year 2000. Now, why am I telling you all these facts? It's because I'm hoping to steer you away from getting involved in speculative bubbles. And let's go over why real estate is so different than Dutch tulip bulbs or the dot com bust, or probably the AI bust that's coming up very soon. The first one is that real estate is always valued based on income. And it's all comes down to a ratio called the cap rate, which is the net income of the deal divided by the price that you pay. Cap rates in real estate typically range from a range of probably about 4 or 5% up to roughly 10%. There are some that go higher and some that go lower, but we're always right in that range. But we're dictated by income. It's not based on perception. It's not like gold, not like Bitcoin. It's based simply on how much the property earns. And in that way, you rarely have a big bust because everything ties back to something.
You're in that little limited fashion now. You can't have a Tesla in real estate. Tesla. Right now, price to earnings ratio is 3 or 400. It's absolutely insane. You have a company which makes very little money but is hugely prized by investors because they believe in the future. They trust Elon Musk to go big places in the future. But it's a form of rational exuberance. It's not based on actual income. You can't do that with real estate. Real estate's always valued on basically a cap rate. And another thing that makes real estate different than tulip bulbs or dot com stocks or AI is the fact that we are vetted constantly by lending. That's a huge deal. So when you buy real estate, typically you're putting 20 or 30% down in a bank is financing the rest of the money. And banks are very cautious. They are very conservative. When you buy stocks, when you were buying Dutch tulip bulbs, there was no bank, there was no sane rational person saying, oh no, you know, you can't do this, this is crazy. But in our industry, in real estate, you can't make those choices alone. You have to typically get a loan and the bank is more conservative than you'll ever be.
On top of that, banks are going to vet real estate deals using appraisals and other third party reports. So even if the banker has irrational exuberance, it can't transfer to the values going significantly up the bottom line is that America is probably about to hit some kind of terrible bursting bubble. Just like Dutch tulip bulbs. Just like dot com. I don't know when exactly it will happen. It could be tomorrow, it could be six months from now. But the bottom line is that real estate should do fine. Real estate, in fact, will do well when you have an implosion like the dot com bust, because it forces interest rates down, which takes real estate values higher, make mortgages amounts of lower. So fear not, whatever irrational exuberance we're in right now. Because just like the Dutch tulip bulb, there's always winners and losers in the apocalypse. And real estate should be a winner. Hope you enjoyed this. Talk to you again soon.