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Can you hedge housing risk?
Old 04-22-2010, 11:44 AM   #1
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Can you hedge housing risk?

A friend and I have been talking about renting vs owning and which is "riskier". On the renting side you have, effectively, price risk (rents could go up, maybe due to real estate appreciation). On the owning side you have asset risk (in the short term your home could drop in value, require a significant repair, etc).

We came to the agreement that owning is usually riskier in the short term, and renting is usually riskier in the long term. Quite often both balance out in the end.

My thoughts then turned to, ok, you choose one or the other. Say you decided to rent. How do you effectively hedge the price increase risk? Again, by price risk I'm referring to rents going up due to significant real estate appreciation in your area. My thoughts are that you could invest in REITs, but I'm not sure how much you would need to allocate to them to hedge.

On the other hand, my thoughts on hedging asset risk (mainly, falling prices) would be to short REITs. Does that make sense?

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Old 04-22-2010, 12:15 PM   #2
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Is It Better to Buy or Rent? - Interactive Graphic -

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Old 04-22-2010, 12:19 PM   #3
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Some less fancy ideas:

Rent hedging -- sign a long term lease.

Own hedging -- take out as big a mortgage as you can. If prices fall, walk away. If prices go up, profit. Ethics left as an exercise for the reader.

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Old 04-22-2010, 04:31 PM   #4
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Chicago Mercantile Exchange has futures contracts on home resale values. The contracts are based on the Standard & Poor’s Case-Shiller Metro Area House Price indexes, which track price changes of existing homes in 10 major metro markets.
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Old 04-22-2010, 04:58 PM   #5
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It's not what you asked, but more fundamentally you'd need to ask if the risk is one worth hedging (since buying "insurance" always adds costs). For example, if you own the house, there's no price risk unless you need to sell. Yes, your net worth might decline, but it's not a realized loss unless you sell the house. If you rent, the price risk will occur every time you renew the lease.
Regarding hedging using REITs, etc--real estate price changes vary a lot by region. If you specifically need to hedge against a price drop in your area, I guess you'd need to find some local bundle of similar RE and short it. It wouldn't be inexpensive.
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Old 04-22-2010, 10:12 PM   #6
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Originally Posted by schmidtjas View Post
On the other hand, my thoughts on hedging asset risk (mainly, falling prices) would be to short REITs. Does that make sense?
A major conundrum with this supremely rational analysis is that housing is a supremely emotional issue. Pretty hard to persist with the rational analysis part in the face of the emotional part.

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Old 04-22-2010, 10:42 PM   #7
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Another key point is that REITs hold primarily commercial real-estate, not homes. And they really are different animals and don't appreciate/depreciate in lock step at all.


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