The current debates about home prices have morphed from one-sided optimism from 2012-2019, to near-universal bearishness during the fall of 2022, to the current state, where the negative factors of higher mortgage rates (and resulting lower affordability) are being weighed against the positive factors (for higher prices) of low inventory and a desire to purchase homes by Millennials. As illustrated in the diagram below, quotes for the CME 10-city Case Shlller home price futures contracts have bounced off their 2022 year-end lows (depicted by the yellow line), consistent with an abatement of one-sided pessimism.
Today's prices of CME closing prices (in purple) generates a graph that is downward sloping until about 2024-2025, and then turns up.
The question I want to focus on for this blog/ the debate I want to foster/ is when will home prices bottom, and specifically will prices for year-end indices for 2024 be higher than those for year-end 2023.
During the GFC home price indices fell for ~four years (with variations across the country) as the prospect of liquidations of homes owned by (or foreclosed on) under-water, defaulted borrowers loomed. However, current statistics (thank you Black Knight ) show no meaningful spike in delinquencies (consistent with conservative underwriting over the last few years, and homeowners' desires to prioritize their 3.00% mortgages). Without the weight of pending supply, there seems to be less impetus for a repeat of the selling wave from the last cycle. In addition, if one embraces the view that home prices are an inflation hedge, it can be argued that forward price curves should always have an upward sloping component.
On the other hand, reduced affordability may be a longer-term phenomenon, particularly if the Fed has embarked on a multi-year battle to reign in inflation (similar to the Volcker Fed?!?). Longer term levels of low affordability, combined with concerns about Commercial Real Estate that may take years of lease resets to manifest, might be more consistent with a longer, but smaller, sell-off in home prices.
So will the market see a short-term purge, that pricks the bubble prices of 2020-21 before returning to "normal" or is this the beginning of a smaller, but longer duration, negative trend?
I don't have the answer to that question, but I can steer readers to a platform where they can express views on that debate: CME calendar spreads on Case Shiller home price index futures for the Feb 2024/2025 (G24/G25) ten-city (HCI) contracts.^1 ^2 Recall that the February contracts settle on the index values released in that month, and that those indices reflect home closing activity through two months earlier -i.e. year-end 2023 and 2024.
Also understand that calendar spreads allow users to simultaneously get long one contract and short the same amount of another, at a pre-determined spread. In this case the quote (on Friday Feb 24) for the HCIG24_G25 calendar spread was 1.0/6.0. That translates into a buyer of the spread being willing to buy the front contract (G24/Feb 2024) at a 1 point premium to where they'd sell the back contract (G25/Feb 2025), while the offer is the reverse. In that case the seller would sell the front contract 6.0 points above where they'd buy the back contract. (Note that all longer calendar spreads, e.g. G25/G26, G26/G27, G27/G28 are currently priced with the longer contract at a higher price).
Some of the advantages of a YOY calendar spread position include:
* Trades are more likely to be done in size, as the absolute, short-term risk of price moves is smaller than for absolute trades. For example, I'd buy 20 lots of the HCIG24_G25 at a price of 1.0.
* Both sides of the trade can be held for a long time (in this example for about one year from today) allowing holders a long transition period if they care to move into an outright position by lifting either leg. (Note that the front leg will expire at some point, and even become less volatile than the back leg, months before expiration. in addition, once the front leg rolls off, a calendar spread holder with be left with only the back leg position. In this example, that's well down the road).
* Seasonal factors are dramatically reduced.
* Margins for calendar spreads are often lower than for outright positions.
* There's no need to negotiate the level of absolute prices. That is, contract prices can rise or fall 30 points and the mechanics remain the same. However, if users believe that the absolute level of prices will influence the level of the spread, they can buy/sell more of one leg.
* In the case of the HCI contracts, given past experience, the G24 and G25 contracts are likely to be the most frequently traded, and the contracts with the tightest bid/ask spreads.
I've presented the above to address my question of whether home price indices will be higher/lower in Dec 2024 versus Dec 2023. What the spread contract cannot take into account is whether home price indices dip during 2024 before rising. That is, the calendar spreads are not a tool to capture the absolute bottom in home prices.
That said, I think that these calendar spreads offer users a great way to express a view on the question posed above, which gets to the bigger issue of when/how will home prices bottom.
Feel free to contact me with any questions.
Thanks,
John
Footnotes:
^1 Note that calendar spreads can be arranged on any of the ten regional contracts. I'm using the 10-city index as an example. Feel free to contact me for quotes on other metros.
^2 Different platforms use different labels for the 10-city index contracts e.g. HCI, and CUS. I'll use HCI here.
^3 Often me