Hedging Canadian Home Price Risk

While I've been posting periodic quotes to Twitter (@HomePriceFuture) on levels where I'd offer to take either side of a home price index agreement^1 on US cities, I've covetously eyed Canada as a place that could really use a home price hedging product as home prices there have three things that most US markets do not: 1) high volatility, 2) declining prices, and 3) lots of difficult-to-hedge political wildcards (e.g. in Vancouver). With that in mind, I offer this blog as a start on hedging Canadian home price index risk.

Starting with the HPHF template^2, I'll make the following modifications (using Vancouver as the first example):

I'm going to use the Teranet home price index as the reference obligation. While analysts can find fault with every home price index, the Teranet indices have the benefit of being publicly disseminated, independently calculated, and have been a well- acknowledged indicator of Canadian home prices for years. Further, there are a series of city indices, as well as a component index of six larger regions.

The agreements will reference the index value for Jan 2, 2020^3 (which, given practices, should be released in mid-February, so HPHF agreements will have a term through mid-/late- February).

I'm going keep agreements denominated in US dollars (until I get comfortable launching a Canadian version of HPHF).

With certain of the more volatile cities (e.g. Vancouver and Toronto), I'll start by taking only small, one-sided exposure with very short agreements that will settle on 2019 year-end index value. I'll enthusiastically welcome building a book of interest for year-end 2020 agreements -that I'll be happy to share as interest develops (so please contact me if interested).

On longer-dated agreements for the more volatile cities, I'm open to feedback as to whether to maintain the current payout of +/- 10% from the original forward price, or whether the range of the payout (and therefore the upfront payment on an HPHF option) should cover a range of +/- 15%.

Given the above, here's levels where I'd be willing to enter small amounts of forward agreements on Vancouver. (Recall that the notional amount for one agreement is $100 * price, so at the mid-market level of 265.2, that would be a notional value per agreement of ~$26,500.)

The levels I've posted for Vancouver are consistent with declining index values for 2019. (See blue line for historical values, higher red square for offer, and higher purple square for bid, all referring the left axis.) The bid side of 263.9 is 7.25% below the Jan 1, 2019 index value (of 284.58), while the offered side (of 267.1) is 6.15% below the Jan 1, 2019 value.^4 ( See green line for historical YOY % changes, using the right axis for scale). I'd note that the Vancouver year-end index for 2017 (so Jan 1, 2018) is 284.64, so both these bids and offers are also well below year-end 2017 levels.

I profess no specific insight into these forecasts, or Vancouver home prices, but do (as market maker on the CME S&P Case Shiller home price index futures for many years) see the benefit of a forum where discussion of, and ideally hedging of, Vancouver home price index risk can be facilitated. As I noted above, the Vancouver home price index has been falling, and has been volatile. Vancouver home prices have been uniquely impacted by issues that are more complicated than for other cities (e.g. role of foreign investment, taxes on foreigners and empty units, as well as debates about the role of cities in addressing affordability).

In previous blogs (May 17th) I've noted the benefits of longs hedging gains, while for those looking to eventually buy in Vancouver, using agreements as a way to gain bite-sized exposures (and here at a large discount to current levels). Vancouver real estate, more than almost any city, reveals the stress of 100% Rent vs Own vs Sell decisions. Home price index agreements might be useful in reducing that stress/ risk.

Feel free to contact me if you have any questions. Further, I'm hoping to roll out levels for other Canadian cities over the next few days. Please let me know if there's a particular city (referenced by a Teranet index) that you'd like to see next.



^1 Recent quotes include agreements on: Atlanta, Buffalo, Bridgeport, Dallas, El Paso, Hartford, Minneapolis, Nashville, Omaha, Raleigh, Salt Lake

^2 https://www.homepricefutures.com/hphf

^3 ...or whatever release references an index closest to that year-end date. Note when I refer to "year-end" index, I'm talking index released ~45 days later referencing Jan 1 (or Jan 2) index.)

^4 Note that agreements are constructured using prices, as percentage changes may move should prior index values be revised.