I want to dive deeper into home prices by focusing on City vs Metro home prices.
It's been a long time since my last blog (in May). Between a busy work schedule (from May to October) and the ease of posting on Twitter/X, I let production here lapse. However, now with that work behind me, and lots of debate about where to find value/express ideas gong forward, I'm back.
It should be no surprise that with the news about distress in the CRE markets - particularly office properties -that I've received a number in inquiries from users looking to take positions here as a way to hedge. The challenge some users have realized is that the CME Case Shiller contracts referenced metro home price indices ("MSAs") while most of the office problems are in the often more-narrowly defined cities.
The map below illustrates the issue for DC. The WDC Case Shiller index covers all of the counties listed below, with exposures in Maryland, Virginia and and even West Virginia. See the Case Shiller Methodology link^1 for descriptions of all 20 publicly quoted Case Shiller indices or here^2 for other MSAs. (Note that i've created a set of graphs for 24 top cities that is referenced on my website^3. i will discuss that graph in a future blog.
While I believe that the primary industry of the major city in an MSA will drive home prices in that region (e.g. Las Vegas and Orlando/ entertainment, NYC/Finance, DC/Government) and that therefore home prices across an MSA may be highly correlated, changes in preferences between living downtown or in the suburbs, and the prices people are willing to pay in either area, will shift. This seems to be generally true when the city physically differs substantially from the suburbs, when the city is very small compared to the metro, and with other changes in where to locate.
The graph below shows a new derived index, computed by the ratio of the Zillow DC City index divided by the Zillow DC Metro index, and illustrates my point. Note that the ratio for DC climbed from 2012 through 2019. This was during a time where prices at the City level (the numerator) went up faster than prices at the Metro level (the denominator). (FYI -The ratio would also be rising in a down market if the City prices fell slower than those in the Metro.) Then in about 2020 -when Covid hit - the trend reversed. This is consistent with the notion that people left downtown DC to obtain more space, work from home, and to isolate as Covid played out. Not surprisingly, since DC has one of the weakest Return to Office measures (per Kastle^4) the downward trend has continued as the moves out of DC may have become more permanent. (BTW - DC has one of the most volatile City/Metro ratios of the 24 cities cited above).
As with HPHF Metro Ratio Agreements, a user might want to express a view or hedge a position on the City/Metro Ratio. For example, I'd like to hedge my personal real estate exposure in DC, but can only short the CME WDC contract as a public hedge. As such, I might have an incentive to get short the City/Metro ratio.^5 The green square reflects indicative levels that I'd suggest.^6 However, as a market maker, I'm willing to go the reverse (long the forward ratio level) at a lower implied price as reflected by the red triangle. Note that both prices are consistent with City home prices underperforming Metro home prices between now and May 2026 by another ~5%. ^7
As users move from a market of ~national home prices (e.g. the CME Case Shiller 10-city index) to ten metro contracts to >50 OTC Agreements on other metros, to City vs Metro ratios (and with analysis at the neighborhood level to follow), the number of permutations of possible exposure climbs rapidly. As such, I'm more likely to limit my indications to areas where I (or another user) has an interest, or where I think that there is an interesting story.
So, while I've started with DC as I already have personal exposure that I'm looking to hedge, I'm game to responding to inquiries on other cities.
Feedback on this new approach would be appreciated. Again, for some metros (e.g. San Diego) City and Metro prices are highly correlated and the City/Metro ratio is fairly flat. This suggests that someone looking to hedge San Diego City might consider San Diego Metro derivatives (to include CME SDG contracts?!?).
Feel free to contact me with any questions/ideas.^8
Thanks, John
^1 at https://www.homepricefutures.com/resources
^2 https://www.bls.gov/oes/current/msa_def.htm#
^3 at the bottom of the middle column at www.homepricefutures.com
^4 https://www.kastle.com/safety-wellness/getting-america-back-to-work/
^5 Implicit in this analysis is that the Zillow DC Metro index and the Case Shiller WDC index highly correlated. Open to sharing that analysis.
^6 Note that any Ratio Agreement will be structured on the HPHF platform as a deep in-the-money call or put. See https://www.homepricefutures.com/posts/adding-more-information-to-reformatting-hphf-ratio-agreement-template for more information.
^7 Note that I'm posting indications for May 31 expiration -instead of the benchmark Feb expirations on the CME contracts - as that closer to the peak in activity in the DC real estate markets.
^8 https://www.homepricefutures.com/contact
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