Redfin recently published a great piece that detailed how some residents look beyond their local area for their next house. They noted that many many people in a region look at the same next cities (sorted both by in-state and out-of-state searches) with certain marked preferences. For example, many LA residents eye San Diego, New Yorkers frequently consider Boston, and Denver homeowners seem to covet Seattle’s low taxes.
The graph below (from Redfin) show the net flow of users searching for other regions. (Net flow is the number looking to leave versus the number looking to take up residence). Seattle has recently re-taken the award for most people looking to move there, while Denver residents are looking elsewhere in larger numbers. This is interesting data to those who believe that population flows are a key component to changes in home prices.
Residents moving from one region another may face the risk that home prices will fall where they live, while rising where they want to move. Fortunately, my analysis suggests, and other research confirms, that home prices on many of the common pairs that Redfin identified are highly correlated, using region-wide measurements. ^1 For example, using YOY changes in Case Shiller indicies, the LAX, SDG and SFR regions have all been >90% correlated since 2013.^2,3 Surprisingly (to this former Connecticut resident now living in DC) the correlation across the three Northeast regions is not as strong, ranging from as low as 43% between NYM and WDC, to >75% between BOS and NYM and WDC.
For those in the later categories, intercity spread trades may be a useful tool for going simultaneously short futures on the region they’re leaving, while going long on the region to which they hope to move.^4 In effect, users might be able to hedge some of the risks of their move.
The table below lists (on the left side) the top 6 interstate 2018 transitions highlighted in the Redfin highlighted report. (I’ve added the intrastate move from LA to San Diego, as there are CME contracts on both). While the Redfin article has much more detail on the net number of people moving, my contribution to this discussion is to share how the CME markets (using the Feb ’20 contract to capture 2019 year-end values) might be used to possibly hedge these moves.
First, here’s a few explanations and observations:
- For both the “From” and “To” cities, I’ve listed the current spot index, the bid, ask, and mid-market for the Feb ’20 (G20) contract on each city, or levels that I’d consider OTC trades (i.e. for Seattle, and Phoenix -highlighted in yellow)^5. The “Mid/ Spot -1” columns show the difference (in percentage terms) between the spot index for each city (both “From” and “To”) versus the spot index for each city.
- Note that between the pairs of “From” and “To” cities, there are a total of 10 cities, and that for all but 3 (Seattle, Denver, and Phoenix) the “Mid/Spot -1” is a negative percent. Recall that the CME figures (at least for one-year forward contracts) don’t necessarily represent expectations of lower prices. The bids and offers are just levels that traders are willing to buy or sell contracts.
- Note that in 6 of the 7 moves that Redfin highlighted, the “Mid/ Spot -1” value is higher in the destination city. (The difference between the two is shown in the “Diff” column.) Thus, it seems that either people may be moving to the more booming cities, or the act of people moving to those areas is correlated with better performing home contracts (as measured by the “Mid/Spot -1” metric.
- Note that, the San Fran to Seattle move looks to have the biggest “payup” (i.e. going from a region where these quotes would be consistent with the SEX (Seattle) index outperforming the SFR index. By contrast, the move from Washington DC to New York, seems like the best bargain, as these quotes are consistent with WDC (Washington DC) index prices falling slower than NYM.
- Finally, I’ve added levels where I’d be open to an intercity spread trade. For example in the NY to Boston move, the difference between the NYM and BOS “Mid/ Spot -1” numbers is 1.85%. Since both regions have a CME contract, I’d buy a NY contract while selling a BOS contract (a pair someone moving might be interested in ) where Boston outperforms NY by 3%, or go the reverse (buying Boston/ selling New York) where Boston outperforms by 1%. (See example below).
- I’ve not posted this particular IC trade (or any of the others) as best orchestrated off-exchange, or users will need access to a broker who can execute IC trades.
- While I’ve focused on the pairs Redfin highlighted, and for the Feb ’20 contract, in concept it’s possible to construct any other pairs of indices, for any other expiration.
Please feel free to contact me (johnhdolan@homepricefutures.com) if you’d like to discuss any aspect of this blog, want to move forward with any of the IC proposals discussed, or have questions on any aspect of hedging home price indices.
Thanks,
John
Footnotes:
^1 This might be no surprise as the people that like the attributes of one region seem to see similar attributes in another.
^2 Recall that correlation means that they move in the same direction at the same time, but not necessarily by the same amount/percent.
^3 Note that these are changes on the index, not any particular expiration of a futures contract.
^4 Even for those moving between two highly correlated regions, futures might be a useful tool should one be increasing/decreasing exposure.
^5 Contact me for details on how one might trade any home price index, not listed on the CME.