Tag: hedging

Reduce the stress of 100% rent vs 100% buy decision with bite-sized pieces

I imagine that one of the biggest challenges facing a first-time home buyer (and their real estate agent) is the binary leap from 100% rent to 100% buy.   Such a jump is often the biggest financial decision that people have to make.  With new homes costing $400-750,000 in certain markets, this is a decision that involves a multiple of annual income.  How can the upcoming wave of Millennials get comfortable that they’re making the right decision when looking at homes?

One way to possibly reduce the tension, is to make the decision in increments.  CME Case Shiller home  price index futures allow users to buy much smaller notional amounts of home price index exposure.  For example, one contract has value of $250 * price, so a contract priced at 250, is $62,500 of notional exposure.    That way, someone looking at a $625,000 house, can buy 1/10th of the exposure to a broad region (or more if they want to buy more than one contract.)  While I agree that much of home price value is “location, location, location”, the CME futures allow users to lock in home price exposure to a broad area.  Factors that drive home price across a region (e.g. Wall Street and communication jobs in NY, population inflows in Denver and Las Vegas) also contribute to individual home prices.

Not only can people buy bite-sized exposures to regional home prices, but given the recent sell-off in CME contract prices, in many areas home price exposures for one-year from now can be bought at less than today’s levels.

The table to the right shows  Bids, Asks, Closes on the CME Case Shiller home price futures for Feb 2020.^1 I’ve added the spot index level and the % of the Ask price versus  spot.  Note that in five of the regional contracts, the Ask level is below spot (highlighted in red.)

Note that I’m not saying that the futures contracts suggest where index values will be.  There are lots of reasons that a contract seller -to include me -might want to sell – e.g. hedging other exposures.  However futures prices and index values must converge by expiration.   If the pundits projecting even 2-4% gains across regional areas are correct a buyer at these levels could make money on the contracts, while also breaking down their 100% rent vs. buy decision into a small bite.

While I’ve highlighted CME contracts, the same concept can be negotiated using other home price indices in OTC (over-the-counter) trades for Feb 2020 expiration.  I’m open to inquiries on many indices and have structured a product where the notional value can be even smaller (using $100/point).

I’d be open to structuring a trade on any of the other 10 Case Shiller indices that make up the balance of the Case Shiller 20-city index (Atlanta, Cleveland, Charlotte, Dallas, Detroit, Minneapolis, Phoenix, Portland, Seattle, and Tampa)  the four Case Shiller areas with a condo index (BOS, CHI, LAX, and NYM), or many other public regional indices (e.g. FHFA).  Please feel free to provide me with areas that you might be interested in buying (or selling, as I’d prefer to match parties rather than take the opposite side of all trades).

Feel free to contact me (johnhdolan@homepricefutures.com) if you’d like to discuss this blog/theme, or any aspect of hedging home price indices.

Thanks,   John

 

Footnotes:

1^ -Recall that the Feb 2020 contract settles on the index values announced that month-end, and those values are calculated on information through  Dec 2019.

Using futures to hedge under-exposures (future purchases)

The sell-off in SFR contracts described in my Oct 11 blog continued last week, but seems to have paused with the rally in stocks over the last two days.  However, even with prices stabilizing, quotes on SFR contracts have fallen to levels that may be of interest to those looking to buy a house in San Fran at some point in the future.  That’s because the offered side of longer-dated SFR contracts is only a small amount above current spot levels.  After years of 10+% home price gains, someone looking to buy a house today, but who doesn’t yet have enough for the down-payment, can lock in prices on the San Fran index 2-3 years from now, at levels that are consistent with home price gains of <2% per year.

For example (using the table below), Nov 2020 SFR home price index contracts were offered at 280, a level only 3.7% above the current spot index of 270.1, for an annualized gain of ~1.83%.  Someone able to save at a greater yield, or who might be able to add to their savings toward a down payment, can hedge against further runaways in San Fran prices.

To recall, the ability to lock in future index levels comes from the fact that the CME Case Shiller futures contracts prices “cash settle” on the index value at settlement.  As shown below, the SFRX18 (Nov 2018) contract, that expires next month, and SFR index have converged to narrow differences.  The X20 (Nov 2020) contract will similarly converge to the spot index -at some unknown price in the future.

Some notes:

  • Futures hedge against changes in index values, so aggregate movement in home prices, not prices of individual houses.
  • An individual contract has notional value of $250* price, or using a price of 280, $70,000.
  • There has not been much volume in SFR contracts, but 5-10 lot orders (so $350-$700k notional amount) can be traded. (Best to use limit orders, or contact me if interested).
  • Futures prices can rise/fall for a variety of reasons before expiration as traders have multiple reasons for buying/selling.

Please feel free to contact me (johnhdolan@homepricefutures.com) if you’d care to discuss this blog or any other aspect of hedging home price indices.