Do you think home prices will be higher five years from now?
This is actually a four-part, somewhat tricky question.
At the first level, it seems obvious that prices should increase over time. Millennials are approaching traditional home-buying age, inventories have been tight, construction has slowed, and interest rates are near historic lows. Possibly based on these factors, money had flowed into co-investment programs (e.g. Unison, Point) where investors had hoped to capitalize on leveraged, positive returns.^1
At a second cut, the question is tricky in that today's home prices (as measured by repeat-sales home prices indices, to include here the Case Shiller indices) have not yet begun to price in the COVID-virus induced market collapses that have crushed stock and credit markets. Recall that repeat-sales home price indices are backward looking (as they measure home purchases that have closed, not sentiment), aggregate data over a number of months to collect a large enough sample size (i.e. the Case Shiller index is a three-month moving average), and are produced with a lag (in the case of CS, two months). As such, even the Case Shiller numbers to be released later this month (or the FHFA numbers released earlier) reflect activity through the end of February, well before investors starting pricing in recessionary fears.
By contrast, CME Case Shiller futures (that settle on future index levels) have fallen 10-12% (for the 10-city contract). To get back to prices unchanged five years from now, would require an expectation that those losses will be reversed. (See below for a more detailed analysis on five-year forward prices).
Answers to the third aspect of "where will home prices be five years from now" question, probably need to be based on what kind of economy one envisions for the post-COVID, "new normal" world. Crises tend to accelerate existing changes, and this one appears to be no different. There are some winners (e.g. AMZN + 30% since Dec. 31) that continue to expand, and that appear to thrive in both the current environment, as well as in the "new, even more tech-friendly economy". On the other hand, it's hard to see how some industries (e.g. those affiliated with the world of business conferences, such as hotels and airlines) will ever recover to past volumes. Where will home prices fit in that continuum?
My sense is that the answer will depend on the rising use of gig workers, the substitution of labor with technology, and the growing concerns about the source and duration of work prospects. Home-buyers (and lenders) will want to see that a potential buyer has a stable source of income that will cover both ongoing expenses and the turnaround costs associated with buying and selling a house.^2 The COVID recession has thrown 20 million into unemployment and left others with an understanding that jobs are not as secure as they once thought. Younger workers may feel the need for flexibility to pursue job opportunities in other areas. All suggest that enthusiasm for rooting in one place, may not be as keen as it was (even way back in January).
Finally, "home prices" is a catch-all phrase. My sense is that the fourth component of the original question will be answered with the reply -"which home prices?". While the benefits of urbanization and density have been touted for decades, the fear of being stuck in New York City during a pandemic (even with the support of the heroic medical community) might influence both Millennials and retirees on their preferences for future home locations. Some of the allure of big cities include access to professional sports, theater, public transit, and global airports. These features may not have the same appeal going forward (on the margin). Having the mobility of a private car, might increase interest in suburbia.
The CME Case Shiller home price futures represent ten of the largest metropolitan areas in the country (sorry, Houston). The contracts have an urban bias relative to second and third-tier cities that may continue to grow in popularity. (For example, if Austin, Boise, Nashville and Salt Lake were booming before, and each has companies in the health care or tech industries, it's hard to see them under-performing the Case Shiller 10-city index any time soon).
Net, the answer to the question is "it depends".
Now, if you believe that home prices will be higher five years from now, the CME Case Shiller futures contracts might provide the best pure-play on that theme.
A positive aspect of CME Case Shiller home price index futures is that they represent the price of an asset at some future point in time, that can be traded today. That is, unlike stocks, that include a company's earnings over the next few years, home values in Feb 2025 don't explicitly include activity over the next few years.^3 That might allow users to debate the fortunes of home prices in the post-COVID world, without concern of prices along the way.
As highlighted in the graph above, and as detailed in the table below, offered prices on longer-dated Feb 2025) CME Case Shiller home price index futures have fallen since late February.^4 (Note that I've recently written how prices might decline should volatility pick up. Why might Case Shiller futures clear at a discount to expectations? )
The table below shows (in green) the offered prices on the G25 contracts today (April 16), and the percent of those prices divided by year-end index values. Those values can be contrasted with the offerings (in blue) as of Feb 21, 2020. Ask levels have dropped 10-26 points and the "% vs. year-end index" has fallen 6-15% (with LAV being the outlier on both metrics).
Again, these contracts are illiquid and the few bids I've seen, or have been willing to post, may be 15-20 points below these offers. That said, if your answer to the first question was "Yes, I expect home prices to higher in five years" then you might consider the CME Case Shiller futures as a way of expressing that view.
Please feel free to contact me if you have any questions on the blog, reactions to levels on longer-expiration contracts, or have any questions related to hedging with home price index derivatives.
Thanks, John
^1 I have an advisory relationship with a co-investment program.
^2 A five year holding period has been viewed as the break-even, rule-of-thumb to recover costs associated with buying and selling a home.
^3 I'll concede some notion of path-dependency, but let's look at home prices just based on the factors that will be in place as 2024 ends (the period that will drive Case Shiller index values for the Feb '25 release).
^4 Note that I'm comparing offered sides as the normal qualifier about limited trading goes to the extreme here. There haven't been any G25 trades since the contract was introduced earlier this year. I tend to update offers, as in down market it helps to bring closes in the direction of where I believe a trade would take place. I've been very "generous" in pricing longer-dated exposures (using +8-10 point spreads versus Feb '24 offers, or premium prices versus HCIG25 quotes from IC (intercity) spreads. Further, populating offers, allows me to create graphs on contracts across expirations.
^3