HOUSING SPECULATORS AND BUILDERS have a few things in common. Many in both groups have profited greatly from the rapid run-up in home prices. But they're also heavily invested in such tangible assets as raw land and newly built homes, and they stand to lose a great deal if home prices take a tumble in coming years.
They have some new options, though, for balancing that sticks-and brick risk. Investment banks have begun offering products beyond the traditional builder stocks that make it possible for investors to profit from a housing-sector downturn or continued strength in some of the country's hottest markets.
A number of investment banks, including Merrill Lynch and the Royal Bank of Canada, earlier this year began selling “protected notes” tied to the Philadelphia Stock Exchange's Housing Sector Index. Investors buy the notes, which operate like certificates of deposit, for terms ranging from 18 months to five years. But they make money only if the index, comprising 21 housing-related stocks, declines over the term of their investment. (For example, if the index fell 20 percent during that time, they'd make 20 percent interest on their investment.) The notes are “protected” because a certain amount—say 95 percent or more—of the investment capital is guaranteed safe if the index gains value.
More than $400 million worth of the protected notes has already been sold, says Daniel Carrigan, vice president of new product development at the Philadelphia Stock Exchange. Housing market bears have responded quickly to the new notes, he says, because they are filling the void of housing-related risk management products.
Other institutions are facilitating profitable investment by both bears and bulls. The Chicago Mercantile Exchange plans to begin selling CME Housing Futures in the second quarter of 2006. The futures, as developed by Madison, N.J.–based Macro Securities Research, will be investment contracts based on the home prices in 10 cities across the country, including Chicago, Las Vegas, and San Francisco. Investors—mostly large, institutional types due to the high costs of the contracts—will bet quarterly whether home prices in those markets will rise or fall, as measured by the Case-Shiller Indexes.
Anthony Sanders, a finance professor at Ohio State University, thinks the futures will be attractive to a wide range of investors, particularly home builders. The bets allow builders to hedge the risk inherent in their land holdings, and for small or regional builders to profit from price appreciation in hot markets in which they're not operating. “They can speculate a bit in other property markets without actually having to go in with the chore of buying land and taking all that risk,” he says.
Allan Schoenberg, associate director of the Chicago Mercantile Exchange, expects that other housing-related companies, such as property insurance and mortgage lenders, will also be interested in the futures, and says individuals may benefit indirectly from the investments: “If a mortgage company can [reduce its costs] by offsetting its risk, you hope there will be a trickle-down effect to consumers in those markets.”
Individuals can access this market more directly through similar, but more simply structured and less expensively priced, investments being offered by HedgeStreet, an online brokerage firm. With the company's so-called “Hedgelets,” investors buy a $10 contract that prices will either rise or fall in six cities, as tracked by the National Association of Realtors. “There are lots of people in America with a view on housing,” says Russell Andersson, HedgeStreet's co-founder and vice president of instrument origination. “This is a simple mechanism for them to participate in these markets.”