Reduce the stress of 100% rent vs 100% buy decision with bite-sized pieces

I imagine that one of the biggest challenges facing a first-time home buyer (and their real estate agent) is the binary leap from 100% rent to 100% buy.   Such a jump is often the biggest financial decision that people have to make.  With new homes costing $400-750,000 in certain markets, this is a decision that involves a multiple of annual income.  How can the upcoming wave of Millennials get comfortable that they’re making the right decision when looking at homes?

One way to possibly reduce the tension, is to make the decision in increments.  CME Case Shiller home  price index futures allow users to buy much smaller notional amounts of home price index exposure.  For example, one contract has value of $250 * price, so a contract priced at 250, is $62,500 of notional exposure.    That way, someone looking at a $625,000 house, can buy 1/10th of the exposure to a broad region (or more if they want to buy more than one contract.)  While I agree that much of home price value is “location, location, location”, the CME futures allow users to lock in home price exposure to a broad area.  Factors that drive home price across a region (e.g. Wall Street and communication jobs in NY, population inflows in Denver and Las Vegas) also contribute to individual home prices.

Not only can people buy bite-sized exposures to regional home prices, but given the recent sell-off in CME contract prices, in many areas home price exposures for one-year from now can be bought at less than today’s levels.

The table to the right shows  Bids, Asks, Closes on the CME Case Shiller home price futures for Feb 2020.^1 I’ve added the spot index level and the % of the Ask price versus  spot.  Note that in five of the regional contracts, the Ask level is below spot (highlighted in red.)

Note that I’m not saying that the futures contracts suggest where index values will be.  There are lots of reasons that a contract seller -to include me -might want to sell – e.g. hedging other exposures.  However futures prices and index values must converge by expiration.   If the pundits projecting even 2-4% gains across regional areas are correct a buyer at these levels could make money on the contracts, while also breaking down their 100% rent vs. buy decision into a small bite.

While I’ve highlighted CME contracts, the same concept can be negotiated using other home price indices in OTC (over-the-counter) trades for Feb 2020 expiration.  I’m open to inquiries on many indices and have structured a product where the notional value can be even smaller (using $100/point).

I’d be open to structuring a trade on any of the other 10 Case Shiller indices that make up the balance of the Case Shiller 20-city index (Atlanta, Cleveland, Charlotte, Dallas, Detroit, Minneapolis, Phoenix, Portland, Seattle, and Tampa)  the four Case Shiller areas with a condo index (BOS, CHI, LAX, and NYM), or many other public regional indices (e.g. FHFA).  Please feel free to provide me with areas that you might be interested in buying (or selling, as I’d prefer to match parties rather than take the opposite side of all trades).

Feel free to contact me (johnhdolan@homepricefutures.com) if you’d like to discuss this blog/theme, or any aspect of hedging home price indices.

Thanks,   John

 

Footnotes:

1^ -Recall that the Feb 2020 contract settles on the index values announced that month-end, and those values are calculated on information through  Dec 2019.

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