Have You Considered Investing In Housing Futures?

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Let me begin with the fact that while I have been spending a fair amount of time researching housing futures for academic purposes I am not advocating this investment route for all investors.

In fact I am a brick and mortar investor across five cities and would not trade it for anything. I need to be able to “touch’ my “retirement accounts” whenever I choose. However, this is not to say I don’t see the value of the housing futures market for an investor that is comfortable in this arena.

Related: Investing In Real Estate Is Better For Retirement – PERIOD!

For example, if I were flipping homes in one of the areas that the index was reflected in I may consider adding it to my portfolio to hedge my pricing risk. The reason that I say I “may consider” adding it is because of the number of contracts that I would need to buy in order to cover my portfolio.

While this would act as a form of insurance on the market price movement it does cost money and would by default reduce my maximum profitability. Similar to each of you I am fairly confident that I complete my due diligence adequately and that this insurance may not be worth the cost. The question for us is whether we should actually consider using this in our portfolios?

The Basics

In 2006 CME began trading housing futures contracts and options as a result of an increased attention to risk.

The goal was to provide real estate participants and speculators of all sizes an opportunity to transfer housing risk. The futures contract discussed here is based on the S&P/Case-Shiller Home Price Index.

The ten cities that contracts were opened for within this category are Boston, Chicago, Denver, Las Vegas, Los Angeles, Miami, New York, San Diego, San Francisco and Washington.

While this list is limited you need to remember that it is based on the Case-Shiller Index which has its own issues as has been discussed by other authors on BP.

Related: Should Real Estate Investors Care About the Case-Shiller Home Price Index?

Investors have argued that the S&P/Case-Shiller Home Price Index can provide a hedge or offer exposure to a single family housing portfolio without the direct investment in the housing sector.

In other words, an individual interested in this market may be able to invest in the movement of real estate prices before being able to buy a parcel.

The way this particular contract works is that the contract is set at 250 times the level of the index. As an example, if the index was at 200 the value of the contract would be worth $50,000 (200*250).

If you wanted to bet on a gain (price appreciation) you would benefit from buying the contract, and as the index increased you would profit. If you thought the market was set to decline you would sell a contract and make money when the price declines.

What This Means

With such large numbers I know that I am intimidating a few of you but when working with these contracts we don’t actually contribute this figure, $50,000.

Instead we are obligated to put up only a fraction. This allows you to use leverage in much the same way we use leverage on the brick and mortar side of real estate.

There are many other trading details to take into account such as the minimum price fluctuations and contract months, but I only wanted to introduce the topic and see if anyone in the BP community has considered using these instruments. If you are interested on reading more the two links below will give you a pretty detailed breakdown.

So the question is…

Given that these contracts were originally meant to reduce risk is there anyone in the BP community that is actually using these?

Be sure to leave your comments below!

http://www.cmegroup.com/trading/real-estate/files/housing-fact-card.pdf

http://judassociates.net/pdf/Jud%20and%20Winkler%20Page%20Proofs.pdf

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About Author

David Rodriguez is a professor of finance and a managing real estate broker/owner. As a real estate investor himself, David has been able to leverage the academic and practitioner experience. This shows through the development of his own residential real estate portfolio across three states and his goals to help investors to do the same. David has published courses, chapters and articles in the realm of finance and real estate and is always looking for ways to get information to those that are interested.

5 Comments

  1. Futures, like options, expire. It’s more of a gamble than an investment. However, if you have a huge portfolio it could be a hedge.

  2. This is my first comment on BP perhaps because this is something that I really know about after having spent over 20+ years in that business as a broker.

    My advice would be for most people to stay out of the futures market. If you are very knowledgeable about the market that do what you want. Most people will never have the time or desire to really know the market.

    Ask yourself how long did it take you to learn RE? Why do you think using the future market will be a shorter learning curve? Did you have any bad moves starting out? Your future mistakes will happen much quicker.

    When you hedge with futures that means you are taking the opposite action in futures with the hope of taking risk out of your cash position. When you hedge you are really trading the “basis”. This is the spread between the two markets. If you put this trade on at the wrong spread you will pay. There are professional trader who do nothing more than trading the basis.

    Basis is not the only issue. There is the mechanics of order entering, technical and fundamental position of the market, there is … lots of stuff.

    My final note is be very cautious. This is not a weekend project.

    • David Rodriguez on

      Bob,

      Your post is well stated. Education is needed on both fronts and even though futures may appear to be easier to grasp they are not. I have always thought of these as a hedge for big guys and a way for smaller guys to speculate. In both scenarios I do agree that caution is needed.

      Thanks for the read

  3. James Evertson on

    I would agree with the above poster as risk management using derivatives is generally a very, very technical field. That being said: this type of activity is what virtually all major corporations (and even mid and small caps) engage in today to hedge their risk to something whether it be interest rates, housing markets, or even something like weather. Speculators are on the other side of the transaction just trying to make a buck. It is a great concept and maybe some of the biggest guys on here would benefit from it but at the scale I would assume most of us are on it is too expensive of an insurance policy to engage in.

    Great post though, and I agree with your concepts.

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