You bet your house: Home price futures are coming
usatoday.com
By Dave Carpenter, Associated Press ; 11/14/2005
Worried that the value of your home may fall?
You can bet on it. If you don't, maybe your mortgage company will.
The Chicago Mercantile Exchange, a financial marketplace dealing in the value of everything from interest rates and foreign currencies to pork bellies, has committed to offer trading next year in a category many consumers take personally: U.S. home prices.
Housing-price futures, based on the median home price in each of 10 U.S. cities, aren't being tailored for individual homeowners. But they may provide some protection for mortgage companies, home builders and anyone else with a large stake in residential real estate if housing values slide — while giving other investors a way into a lucrative market.
The novel investment product is set to debut in April 2006, based on a final go-ahead given by the Merc earlier this fall after months of exploratory work.
"There really is no way (now) for anyone to hedge home prices," says Sam Masucci, CEO of Macro Securities Research, the Morristown, N.J.-based financial research firm that's developing the contracts with the exchange. "Or for institutional investors to gain exposure to the market without going out and buying homes.
"Housing is one of the largest asset classes in the world (and) we thought it made a lot of sense to give people access to it," he said.
While unusual, it won't be the most exotic contract offered by the world's largest futures exchange. That distinction has been held for six years by weather futures, which are based on regional temperature indexes and enable utilities and others with a lot riding on the weather to hedge their risk.
The concept of real estate futures has been discussed since the early 1990s, but it took a boom in housing prices to propel it to reality.
Home values appreciated 65% nationwide from 2000 through 2004 and more than doubled in some areas, according to the National Association of Realtors. U.S. residential real estate was valued at $18.6 trillion at the end of last year — more than the amount in stocks.
The price run-up has meant a huge increase in wealth. A negative sales forecast from home builder Toll Brothers (TOL) on Tuesday sent stocks falling by fueling fears of an economic slowdown. Recent signs of cooling may have only fueled interest in protecting the market.
"One never knows when you launch something like this, whether it's going to be successful or bomb," Masucci said. "But all the elements are there ...."
Investors will be able to trade contracts electronically based on median home prices in Boston, Chicago, Denver, Las Vegas, Los Angeles, Miami, New York, San Diego, San Francisco or Washington D.C. — or a composite index of the ten cities. The indexes were developed by the real estate research firm Fiserv Case Shiller Weiss.
Those who are optimistic that prices will continue their double-digit rise can buy contracts, making a profit if the increase exceeds their costs by the expiration date.
Investors who want to soften the potential blow of a decline, on the other hand, can buy versions of the contracts called put options that will pay them money if the price drops, ensuring that they recoup some of their lost house profits.
That strategy is akin to taking a short position in a stock, according to Felix Carabello, Merc associate director for alternative investments. But "instead of shorting IBM, you're shorting your house," he says.
For example, a Los Angeles homeowner looking to hedge the value of his $1 million house could buy "puts" linked to that city's housing index, at a cost of several thousand dollars. If Los Angeles housing prices are higher by the time the quarterly contract expires, the puts have no value and the investor is out the purchase price plus commission. If prices go down, the puts enable the investor to sell the contracts for a gain.
While there has never been a nationwide decline in housing prices, there are precedents for sharp declines in regional housing values. Los Angeles home prices fell 41% in real terms from 1989-97, and Boston's dropped 29% from 1987-94.
Experts have mixed opinions about the extent of demand for housing futures.
Anthony Sanders, a professor of real estate finance at Ohio State University and former investment banker, called them long overdue.
"There's a huge demand out there on behalf of financial institutions to hedge their housing exposure, so this should be able to take off," he says.
Robert Hartwig, chief economist at the Insurance Information Institute, a trade group, was more skeptical. He says insurance companies are unlikely to get involved in anything as speculative as housing futures or develop home price depreciation insurance based on them, as has been suggested. The overheated housing market could make the product too expensive anyway, he said.
"While I think that theoretically it's a good idea, I'm not sure how much the market is going to materialize," Hartwig said. "It's like offering to insure stock prices in early 2000. Real estate prices are super-inflated right now."
Individuals already have the chance to invest in housing prices through a retail product offered since May by HedgeStreet, a government-regulated online derivatives exchange based in San Mateo, Calif. Its housing Hedgelets cost $10 or less and allow investors to effectively place bets on whether the government's housing price index for Chicago, Los Angeles, Miami, New York, San Diego and San Francisco will be in a certain range within three months.
But volume for the housing Hedgelets was just $46,716 in October, two-thirds of it in San Francisco contracts. Russell Andersson, HedgeStreet vice president and co-founder, said demand should increase as new products are introduced to attract additional investors.
The Mercantile Exchange's planned offering, he said, is "further confirmation of market demand."
Carabello said the Merc continues to receive e-mail inquiries from home builders, hedge funds, pension funds, construction suppliers and mortgage insurers that demonstrate their intent to participate.
"If anything, the cooling of the housing market increases interest," he said. |
