I often use reader inquiries as prompts for blogs. This week was no different in that I received a question on how might hedging condo price risk differ. That lead me to reviewing some of the information posted on S&P websites.
It turns out that there are S&P Case Shiller indices for condos on five regions- BOS, CHI, LAX, NY, and SFR. The graphs below are derived from the NSA (non-seasonally adjusted) condo and aggregate indices available (once you register) on the S&P website. https://us.spindices.com/index-family/real-estate/sp-corelogic-case-shiller . I’ve run three sets of graphs for each of the five areas to include: 1) a review of absolute levels between condos and aggregate CS indices, 2) the percent YOY changes over time, and 3) a scatter diagram to test the theory (potentially useful for those looking to hedge condos) of YOY returns of the condo vs. aggregate indices.
In four of the five regions (BOS, CHI, LAX and SFR) it appears that the condo indices are highly correlated with the aggregate indices. This might be useful for those with condos in those regions as it suggests that a hedge using CME Case Shiller futures has/ is (?)/ likely to track the comparable Case Shiller condo index. Now, of course all the same caveats apply in hedging any one house versus a Case Shiller index, to include that basis risk (i.e. the risk that your house’s price movements vary from that of a Case Shiller region). That said, if you can get comfortable using a CME future or option to hedge a home, there seems to be a strong relationship between home and condo prices.
Note that each of the five condo indices has outperformed the aggregate index. (No surprise with Millennials and AARP members both looking for smaller places in 24/7 cities.) From a trading perspective this means that one might need to adjust hedge ratios.
The outlier is New York. While there’s no difference in the geographic coverage areas, it may be the case that condos in the NY region are more heavily concentrated in the metropolitan NYC area, and that the city has – at least since 2007 – outperformed the suburbs. (I added “since 2007” as correlations look more robust over a 25-year period). This suggest that someone with a condo, or maybe even just NY City exposure, might prefer hedging via an OTC (over-the counter) trade that references the NY Case Shiller condo index. I’d be happy to help with such, but the menu of OTC issues -price discovery, counter-party risk (and associated margin issues), and lack of fungibility, would need to be addressed. I’ve written about OTC trades before in a Dec 2016 blog. and think that the Case Shiller NYM condo index would be great place to start OTC trades, as: 1) it’s a pretty big market, and 2) the traders that live there are more likely to be receptive to dealing with derivatives. (BTW- Seattle would be 2nd choice).
So, to get back to the reader’s inquiry, it seems that the aggregate indices are highly correlated with condo prices in 4 of 5 regions. While CME Case Shiller futures and options present challenges (i.e. basis risk) if you want a listed, publicly traded contract to trade with no counter-party risk, they might be worth a second look.
Feel free to contact me (email@example.com) if you have any questions on this blog, or any other aspect of hedging home price index risk.