The title here was from a Twitter post started by another user. (Thank you @RampCapitalLLC for prompting this discussion). It asks readers to propose which of two cities would do better than another, however the brevity of the post lacked key information on how to convert any such views into a market trade.
(Note that I had posted an earlier version of this blog with less precise formulas. The information in this Aug 23 version supersedes any information in earlier blogs on this topic).
What was missing, and what I'll detail here includes:
1) What index would the parties reference,
2) What dates would they measure performance (start and end),
3) How would they structure such an agreement,
4) The reality that forward markets on home prices on some cities, already exist, and that those markets are priced to reflect the relative out-performance of one city versus another.
By way of background (to new readers) I am involved in two platforms where such bets can be formalized- the CME Case Shiller home prices futures contracts, and my Home Price Hedging Fund ("HPHF") platform for OTC agreements.
The CME hosts trading in the 10-city(HCI) Case Shiller non-seasonally adjusted home price index futures, as well as having contracts on each of the ten components (BOS, CHI, DEN, LAV, LAX, MIA, NYM, SDG, SFR and WDC). For each region there are ten expirations ranging(today) from next week (the Aug 2020/ Q20 contract) to 4+ years (the Feb '25 contract is the longest today).
I post slightly dated outright quotes on my website 1-2x/week to give readers a sense of clearing levels. The table below shows where risk might clear on the 11 Feb '21 contracts. Note that some regions are priced to under-perform the 10-city index, and other regions, e.g. CHI and LAV, while some are priced to do relatively better, e.g. BOS. As such, the question that needs to be posted is not only which city they think will do better, but in cases where one is already priced to do better, by how much? (see discussion on “N” below). That is, the markets are already pricing the Case Shiller NSA BOS to outperform LAV in the Feb '21 (G21) contracts. To attract interest in a BOS v LAV bet there needs to be clearing level (akin to the line in sports gambling) that will balance the views of the longs and the shorts (on such a relative performance bet). For BOS/LAV (Feb '21) I might buy BOS 3.25% over where I’d sell LAV, or offer BOS 4.25% over where I’d buy LAV.
In addition to outright trades, the CME also allows for Intercity ("IC") Spread trades, where one can buy one regional contract while simultaneously selling one on a different city. (See my March 8th blog on Intercity Spreads for more details, including the positives and negatives of using CME IC spreads, as well as other blogs relevant to hedging with home price derivatives.)
While CME IC spreads have certain benefits, they are only contracts on ten cities. Given that, I created the HPHF platform was created to accommodate potential interest in many more cities.
My blog from April 27th details how HPHF Relative Performance ("RP") can be used to express views on the prospects of one city versus another. For example, the table below shows bids and offers on the ten other cities in the Case Shiller 20-city index,versus the CS 10-city index. (See recent blog for more details and how to interpret these quotes. Note that many of these "other ten" regions (using the same index, and the same measurement point) are already priced to out-perform the 10-city index, as well as components of the 10-city index. (This reflects some of the flight from more urban areas to smaller cities). As such, areas like Phoenix (PHX) are priced to show gains byFeb '21, while (from the table above) CHI, and SFR (two of the oft-mentioned shorts on Twitter) are not. However, even some of the cities that others liked(e.g. Dallas/DAX) are priced to not perform as well, while others that were"shorts" in some people's minds (e.g. Portland/POX and Seattle/SEX) are priced consistent with doing better. Net, given the levels I've posted, I'd be open to buying Seattle/Selling Dallas, buying Tampa/Selling Miami, Buying Boston/Selling NYM, all at much better than even up.
Finally, while I've highlighted the"other ten" Case Shiller cities as examples of what might be part ofan OTC, I am also open to referencing HPHF Relative Performance Agreements on multiple other cities that have been mentioned on Twitter, but that do not have a public Case Shiller index (e.g. Salt Lake, Philadelphia, Houston, Austin,Baltimore, Pittsburgh and Nashville). For those cities I use the Freddie Mac NSA home price indices.
The template below (from HPHF tab on the website) illustrates the moving parts of an RP Agreement. Parties need to pick a starting point -and both spot, and a past, or forward-year end index value would work – determine the end measurement date and agree on a notional amount.
If there are strong existing views on the difference in forward returns of the two cities, or if one wants to quote two-sided levels for various forward markets, the remaining point to negotiate the value of N. (see table).
The graph below shows how tracking ratios between two indices might shed light on historical trends, and as to which city might do better. Here, I'm showing the ratio of the Miami Freddie Mac NSA index divided by the Freddie Mac Dallas index. I've highlighted year endvalues in orange, a) to reduce seasonality issues, and b) as I'd like to steer inquiries to agreements referencing year-end values both for netting, and to focus discussion on how much prices might grow during given years. (The same could be done for any two indices and are available upon request). The graphshows that there are times when Dallas out-performed Miami (e.g. Dec 2013-Dec2017), and when the reverse was true (Dec 2017-Dec 2019).
In an effort to stir the pot on such discussions, I’ve listed bids and offers on N for agreements that would settle on year-end 2020 and 2021 values (assuming that those values are being compared to today’s spot levels) for Miami vs Dallas RP Agreements.
The bid/ask spread on N for “spot vs year-end 2020” straddles neutral, and in this case is less than 1%. For “spot vs year-end 2021” the bid/ask is slightly wider (given greater uncertainty) and averages slightly above even-up,i.e. I’ve priced Miami as outperforming on both the bid and ask side (for 2021).
I believe that the HPHF platform is a great template for expressing views on which of two cities will perform better. I'd be open taking either side of modest RP Agreements (i.e. < $100k) and would be open to touting anyone looking to do something larger.
Feel free to contact me if you have questions about this blog, have particular cities that you'd like to express a view on (either relative to others or outright), or if you have any questions related to the use of home price index derivatives in hedging strategies.
Thanks,
John