Chicago exchange looks to give investors a way to trade on the future price of real estate
RISMEDIA, May 19, 2006—(KRT)—You can protect yourself against stock market losses, you can get a warranty on many big-ticket items, and you can insure yourself against all sorts of unforeseen events.
But you can't do anything to protect yourself if the value falls on one of your largest assets: your home.
Housing experts, teamed with the Chicago Mercantile Exchange, are hoping to change that. Beginning Monday, the exchange will open trading on housing futures and options, allowing homeowners, builders, mortgage financiers and others to hedge against the ups and downs of the housing market by betting on its future.
While no one is sure whether the concept will succeed, experts note that managing home-price risk is critical now, at a time when the housing market is more precarious than it has been in nearly a decade.
"The real estate market has been very volatile, and we're in a very uncertain time," said author and housing expert Robert Shiller, who has been developing the housing futures concept for more than 15 years and helped to create the index upon which the Chicago Mercantile Exchange's trading will be based. "We don't have any consensus on where it's going, but once we have a futures market, there will be a set price for future real estate."
That, Shiller noted, could lead to even more developments in the real estate world. Imagine, for instance, being able to take out a home equity insurance policy as an addendum to your homeowner's insurance, protecting you against dips in your home's value.
A risky investment arena
To be sure, this likely isn't a market for the mainstream homeowner who has no experience in futures trading. It's more risky than other investments, experts say, and it can require significant leverage, as you initially put in only a small percentage of the money you might need to cover losses.
"You can have huge gains and huge losses," said Michael Gorham, director of the Illinois Institute of Technology's Center for Financial Markets, who once worked on the Chicago Mercantile Exchange. "With a relatively small dollar position, you can get wiped out pretty quickly."
A look into the future
A futures contract is a legal agreement to buy or sell a product, traditionally a commodity like oil or corn, at a given time for a given price. Investors and speculators use them to attempt to profit from price movements and volatility in that product, while those who use, sell or buy the item use futures to hedge against their risks. Investors could also choose to work in options, which represent the right to trade but not an obligation, and therefore have less potential for losses.
A builder, for instance, could use a housing futures contract to protect himself from price changes between the time he buys land, builds a house and sells it. Mortgage lenders, insurers, bankers and others in related industries could do the same thing. Individuals who have high net worth and own significant real estate might want to mitigate their risk, too. Meanwhile, those who want to invest in real estate could buy futures contracts instead of actual property.
The Chicago Mercantile Exchange will be using the S&P/Case-Shiller Home Price Indexes for 10 metropolitan areas, including New York, as well as a composite that will represent the nation. Each contract will be worth $50,000, and the initial "good faith" investment - known as a margin - will be roughly $2,500, not including brokerage fees, according to Sayee Srinivasan, the exchange's associate director of research and product development. Futures contracts move in increments of $50 as the index moves up or down.
Nonetheless, some investors might consider this a cheaper way to include real estate in their portfolios.
"It's been pretty expensive to actually invest in this market until now, because you'd have to go out and buy a lot of property," Srinivasan said. "With a futures contract, now you can actually do it at a more reasonable price."
Housing futures are already traded on a small, online exchange called HedgeStreet. Based in San Mateo, Calif., HedgeStreet gives mainstream investors a chance to buy far less expensive futures contracts, worth only up to $10 each.
"Many people don't have enough capital to buy a house but still want to participate in real estate," said Russell Andersson, HedgeStreet's vice president of instrument origination. "Here is an inexpensive and interesting way to invest."
HedgeStreet, which recently partnered with the Chicago Board Options Exchange, uses a housing price index from the National Association of Realtors. The options exchange is planning to launch its own housing futures trading by the end of June, also using the Realtors data.
"I would think you want something that's very public and has been under the public's eye for many years," Realtors association chief economist David Lereah said of the use of the Realtors' index.
But Shiller and others said the disadvantage of the Realtors' index is that it is run by a trade association directly connected to the industry. Chicago Board Options Exchange futures exchange managing director Patrick Fay, however, argued that the Realtors data is based on actual sales, compared with an econometric model used by the S&P/Case-Shiller index.
No guarantee of success
Despite all the interest and publicity in these contracts, there's a significant chance the concept could fail, as the majority of new futures products do. "Many products that you think are going to be successful when you set out don't succeed - but you have to keep trying," Fay said.
Those that succeed require lots of volatility and trading volume - neither of which is a given in housing prices.
"We don't think there's enough volatility around the housing contracts to create enough transaction volume for it to be profitable," said Mike Knesevitch, a spokesman for the Trade Exchange Network, whose Intrade online exchange does not include housing.
One potential obstacle to expanding the investor pool: A house can't easily be sold to pay off investment losses. "The money you make or lose is going to be cash, and the asset you're hedging is, in effect, illiquid," noted Lew Altfest, who heads LJ Altfest & Co., a Manhattan-based financial adviser.
Nonetheless, Altfest, who already is broaching the idea with clients, said it appeals - at least for now - to wealthy individuals, foreign investors and players in the industry.
"I think it will take some time to build, but it will be successful as long as housing is a volatile commodity," Altfest said.
Insuring home equity
The real hope among experts, analysts and advocates is that a futures market could lead to the creation of home equity insurance. It's a concept Shiller has advocated for years, but the futures market would provide insurers with a hedge for their own risks. Eventually, there may even be a stock exchange security tied to housing.
Ultimately, he and others said they hope a successful futures market would make real estate more efficient and predictable. "Instead of being fed information on the housing market by people who have a vested interest, now you're going to be receiving a sort of real-time interpretation," said appraiser Jonathan Miller of Miller Samuel in Manhattan.
Nonetheless, Miller said, any conclusions are broad at best for an industry that often changes from ZIP code to ZIP code.
It may take years before anyone knows whether housing futures succeed, analysts said.
"There are some contracts that come out of the gate and do very well and gain traction very quickly," said Craig Pirrong, a professor at the University of Houston's Bauer College of Business. "By the nature of the beast, this would likely take time to build."
And the uncertainty is even greater for housing, since it is a market unlike any other the large futures exchanges have tried. Said Srinivasan: "Here, we are in uncharted territory."
Where to trade
Traders will be able to invest in housing futures on three exchanges.
This Internet-based futures exchange trades everything from foreign currencies to commodities to the Consumer Price Index.
Housing contracts launched: May 2005
Index involved: National Association of Realtors' Existing-Home Sales Series
Regions covered: New York, San Francisco, San Diego, Miami, Los Angeles and Chicago
Contract value: $0 to $10; considering larger sizes
Initial buy-in: $100
Chicago Mercantile Exchange
As the largest U.S. futures exchange, the Chicago Merc is now publicly traded. In the past it has started futures contracts on everything from live cattle to foreign currencies.
Sources: Hedgestreet, Chicago Mercantile Exchange, Chicago Board Options Exchange, Newsday research
Copyright © 2006, Newsday, Melville, N.Y.
Distributed by Knight Ridder/Tribune Business News.
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