Hedging is the practice of risk mitigation for Wall Street investors and we in the real estate investment world could learn a thing or two from the boys in the power ties.
A good working definition of “hedging” to get started:
“An investment made in order to reduce the risk of adverse price movements in a security, by taking an offsetting position in a related security, such as an option or a short sale.”
As real estate investors we could “cover” the “adverse price movements”…loss of 30% of real estate prices…by taking an “offsetting position in a related security”…but how do we do that?
It’s easier than it sounds.
For example, August 2006, I knew (and so did you as a real estate investor paying attention to the market) we had hit the top for real estate values. I also knew in many markets the top was really a bubble top…the builders over built, the Fed over stimulated, and the mortgage industry over lent.
A burst was eminent….it was “baked into the cake”.
As a holder of real estate one would say a proper “hedge” would just be to sell. Take your profits off the table.
I say, “Hogwash”.
As a long term real estate investor, I’m in it for the monthly cash-flow. It was difficult and costly to acquire these holdings…so I’m not about to dump long term cash-flow for a 1 time payout.
Truly hedging the pending fall in real estate is better option. I want to make back $1 for $1 every lost dollar in real estate equity plus the money it takes to buy the offsetting position.
One perfect way I used were called LEAPS or Long-Term Equity Anticipation Securities. Think of them as 3 year options that you can get a 10-1 leverage. As you know you can option hoping the underlying security goes up – a call option. Or you can option hoping the underlying security goes down – a put option.
So I was looking for a real estate hedge…and I figured the bursting bubble would kill subprime mortgage companies like Novastar and home builders like Toll Brothers and others.
The Perfect Hedge: As real estate values dropped so would the stock price of these companies, so my “offsetting position in a related security” would go up if I shorted the mortgage and home builder stocks. The leverage of using LEAPS 3 year puts gave me all the time I needed from August 2006 to August 2009 to show a profit.
I did a few live seminars in Denver CO in November of 2006, showing folks just how to do this under the title, “How To Profit From the Coming Crash in Real Estate”.
In 3 sessions, I must have taught over 60 people. Most had come wanting to learn about foreclosure investing, most already had rentals…and most looked at me like I was an alien from outer space.
I still get emails 3 years later saying…”I should have listened”
Folks it’s not just good enough to make money from real estate. Sometimes you must use your knowledge to make money on real estate.
My hedge trades are up over 385%…many of the companies I shorted with LEAPS went from $60 a share to bankrupt. Those returns dwarf what small amounts of equity lost due to the real estate crisis.
Think about it…