Home Price Futures Contracts
Let the market predict home prices
Posted: February 07, 2017 by John McClelland
Predictions for residential real estate are challenged by the increasing opacity brought on by mortgage rate increases, a stronger dollar, a new presidential administration and demographic trends that are not well understood, such as the demand for housing by millennials.
In some minds, if increasing interest rates are a response to an improving economy, either through Federal Reserve increases or market responses, on the net, housing demand may remain robust. In other views, homebuyers may have been conditioned to low rates for too long and thus are shocked by increases as small as fifty basis points.
In addition to the bond markets response functions, the Fed is mapping upward movement in rates, which implies further normalization away from ultra-low interest rates. Some argue that if consumers expect increasing rates, they will enter the market in anticipation of increases in order to lock themselves in. Additionally, experiencing rate increases may cause some current owners to hold-off on move-up purchases since they may be facing some higher rates on the up-purchase. This would have the effect of limiting supply, particularly in the entry level.
A final thought on mortgage rates and mortgage availability are the unknowns surrounding the regulatory environment. The Consumer Financial Protection Bureau and the Dodd-Frank act that created it, has received significant challenges in both Federal Courts, the regulated entities and by some members of Congress. In recent homebuilder earnings calls, several executives have cited the regulatory burden applied to mortgage lenders as a throttle on loan availability. Whether or not reforms are made that allow for greater mortgage availability, is uncertain.
Finally, some metropolitan areas are experiencing all-time high housing prices, at least in nominal terms, and in some cases, real terms. It is hard to determine how detached from fundamentals those markets may be. In the Dallas-Fort Worth area, job growth and an increasing population continues to cause households to form. In other metropolitan areas, such as the Bay area, fundamentals may be harder to explain, although continued activity in the technology sector may explain some demand, the flow of hot money from China and elsewhere into the area is even harder to understand. With the price trajectory of home prices, some individuals are concerned about a possible correction.
One can agree or disagree on all of the perspectives noted above and in fact, that’s the point of this piece. Each of the varied perspectives, from bullish, bearish to agnostic, implies a functioning market in both the actual assets and in derivatives, since markets can seize up when all participants have the same view. For those bullish on housing, they may choose either buy real estate directly or purchase a futures contract. Currently, the primary instrument for speculating on large metropolitan area home prices are the S&P/Case-Shiller contracts traded at the Chicago Mercantile Exchange. Additionally, the contracts can be used to hedge housing risk. Now that predictions of home prices seem to be very clouded in uncertainty, we believe that some of these contracts may be of interest to both current owners of housing portfolios and those who want to take speculative positions. Longs may be interested in buying an index performance rather than the underlying assets for management reasons.
In our home market of Las Vegas, there are many owners that hold many homes. We know of at least several hundred that own ten or more homes. We know of a few hundred that own five or more homes. Additionally, private equity shops and REITs have large portfolios in the area, some of which have several hundred homes. These owner types may find the S&P/Case-Shiller contracts compelling.
John Dolan is the market maker in CME Case-Shiller contracts and closely follows contracts for the ten major cities tracked by the S&P/Case-Shiller Index, which includes Las Vegas. We recommend following www.homepricefutures.com as Mr. Dolan provides updates on the market. In our opinion, Mr. Dolan is the primary expert on the Case-Shiller futures and for firms or individuals looking to hedge exposure or take speculative positions, we encourage you to reach out to him.