Mutual Funds
7 ways to beat a housing bubble
You can't totally hedge your home's value against a housing crash, but here are seven ways you can limit the damage -- or at least stop worrying about it.
By Timothy Middleton
It's easy to see why real estate has replaced technology stocks as topic No. 1 at cocktail parties. Nationwide, housing prices soared 15% over the past year, and in the West, they're up 21%, according to the National Association of Realtors.
But it's a lot easier to lock in a stock gain than a home's price appreciation. I've been getting e-mails from readers asking for ways to hold on to these gains if, as they fear, prices could be poised to fall.
First, the bad news: You can't fully "hedge" your homeownership investment. Perhaps some day you'll be able to, but you can't now. The only marketplace offering a pure hedge has just been created and doesn't have enough liquidity to be practical.
Now, the good news: There are a host of tools you can use to give your anxiety a rest. Some are mirror opposites of others, because no single answer can address everybody's concerns. But one or more of them might be useful to you.
Or you might even decide you don't have to do anything at all. "I agree that a bubble now exists, but all real estate has to do is flatten out for awhile and the bubble will go away," says Tom Kirk, president of CPA Wealth Management Services in Melbourne, Fla. "It doesn't have to decrease 20%."
Except in the most speculative markets -- and I'm addressing the concerns of homeowners here, not real-estate speculators -- significant declines in housing prices are both modest and rare.
That said, a 50% or 100% jump in your home's value can induce anxiety. Here are seven ways to tame those concerns.
The pure hedge
For now, this is more of a parlor game than a serious financial alternative. An online exchange called HedgeStreet.com offers hedging contracts in six of the nation's largest cities (Chicago, Los Angeles, New York, Miami, San Francisco and San Diego) and plans ultimately to extend them to other areas. You buy "hedgelets," the equivalent of options contracts that will either pay off if median local prices rise or decline, depending on the hedge.
Each hedgelet costs some fraction of its $10 value at maturity, which is a period of a few weeks or months. The hedgelet only has value if it succeeds: Hedgelets on declining prices expire worthless if prices rise. The most recent trade last week betting that average prices in New York would decline below $425,000 by Aug. 11 was at $6.
Stop and think about that bet. For a hedge of $25,000, you would have to put up $15,000. The most you can gain is $10,000. The most you can lose is $15,000. Maybe that's why only 40 or so hedgelets like that were trading hands when we checked.
Indirect hedges
If you think housing prices will decline because interest rates will increase, you can buy either of two mutual funds designed to capitalize on higher rates. Rydex Juno Investor Fund (RYJUX) is designed to deliver the inverse of the price performance of long-term Treasury bonds. ProFunds Rising Rates Opportunity Fund (RRPSX) is designed to deliver 125% of the inverse of the long Treasury.
The problem, says Anne Ruff, manager of the Rydex fund, is there isn't a high correlation between property values and interest rates. "Property values may go down even if interest rates don't go up," she says. "This could be a partial hedge, but not a lock-step hedge."
Similarly, a partial hedge might be to short iShares Dow Jones Real Estate Index (IYR, news, msgs), an exchange-traded fund. It chiefly tracks commercial real estate rather than homes, however, and those two markets can diverge drastically.
If seeking a housing hedge, "I would short the largest home builders, such as Lennar (LEN, news, msgs), Pulte Homes (PHM, news, msgs), Hovnanian Enterprises (HOV, news, msgs), Ryland Group (RYL, news, msgs), WCI Communities (WCI, news, msgs), M/I Homes (MHO, news, msgs), KB Home (KBH, news, msgs) or D.R. Horton (DHI, news, msgs)," says William Neubauer, president of Comprehensive Money Management Services in Coral Gables, Fla.
Boost your home equity
A homeowner's greatest financial risk is losing more than all of his equity. Let's say you put down $20,000 on a $200,000 house, or 10%, and prices decline to $170,000. If you have to sell, it will cost you $10,000 out of pocket, in addition to losing the down payment.
"Instead of buying a hedge against falling home prices, we need to get back to the old-fashioned way of protecting ourselves from the possibility of falling prices -- build home equity," says Elaine Scoggins, a planner in Tampa, Fla.
That means avoiding things like interest-only mortgages, which give you no equity. On your existing mortgage, round up your monthly mortgage payment -- write a check for $1,000 a month instead of $940, for instance -- to build equity faster.
Borrow and invest elsewhere
If, on the other hand, you have a lot of equity and you're worried about losing some of it, borrow money at today's low interest rates.
"Pull equity out of the property while it still has high valuations and invest it elsewhere," says Ryan Darwish, a financial adviser in Eugene, Ore. Assuming your investments pay off -- Darwish is recommending the energy sector -- you could end up with more than you started with, even in a property rout.
Sell the hot, buy the cold
"Sell in the 'overpriced' market and buy in the 'underpriced' market," recommends Michael Horowitz, a planner with Life Strategies Financial Planning in Austin, Texas.
Sell your $800,000 bungalow in Silicon Valley and pay $400,000 for a four-bedroom house in one of Austin's swank neighborhoods. "When the trade settles, stick the $400,000 (difference) in Treasurys," Horowitz counsels.
That might be impractical if your job is in California. But most localities have top-drawer neighborhoods where prices have gone up the most and more adventuresome areas that are still cheap. Many of Brooklyn's three-story brownstones, for example, were bought with the proceeds from the sales of Manhattan apartments.
Sell and lease back
One sign of a property bubble is investors buying single-family homes as investments rather than to live in themselves. Such buyers are eager to lease the house back to its occupants because it eliminates the cost of finding tenants.
"This can be done in bubble areas while the bubble is on," notes Curt F. Fey, a financial advisor in Pittsford, N.Y. "An increasing number of single-family homes are bought by other than residents."
If you're right, you can buy your house back more cheaply after the bubble bursts. If you're wrong, at least you pocketed your earlier gains. The risk, of course, is that you may have missed out on additional profits.
Sell, rent, buy
"When clients ask us about the current real-estate bubble on Maui, I (suggest that they) sell their house, rent for a couple of years, and then buy another residence at a lower price" after the bubble bursts, says E. Dennis DeStefano, a financial adviser on that Hawaiian island.
If you can rent a home for less that it would cost to buy one that's similar, it's likely prices are too high and will retreat. If my wife weren't so attached to our family home here in northern New Jersey, that's exactly what I would do, because rentals in this area are cheaper than purchases.
Which leads us to the final gambit:
Do nothing
"A house is a typical person's largest expense item, rather than an investment," says John Henry Low, a planner with Knickerbocker Advisors in Pine Plains, N.Y. It represents what economists call a "use" asset rather than an investment asset.
"Since it costs typically 20% of the purchase price to flip (buy and sell) a house, when you take into account commissions, closing fees, relocation costs, 'fix up' repairs to prep a house for sale, etc., you can't trade these things like mutual funds," he says.
Consider your house the roof over your head, and not a risky investment, and you'll sleep better inside it.
,but more importantly we are once again at a critical point in the property market. This is the time of year when property can historically expect to get an uplift from people's migratory instincts....the big question ,will it happen this year and if so will it be enough to buy the market time to stabilise ?
