In 2007, Michael Burry — the then-head of Scion Capital — did something unthinkable: he shorted the real estate market. As the housing market inevitably collapsed, Burry and a handful of other savvy investors earned billions on what is still considered a do-or-die investment. Now, with rumors continuing to swirl that a 2022 housing market crash may be more fact than fiction, interest in shorting real estate is growing substantially. What’s more, with the number of investing options available today, anyone can hedge against housing with relative ease. Should you short the housing market?
Frankly, it depends — and in more ways than one. The history of housing is one defined by long-term, relentless growth. Indeed home prices have had a vertical trajectory for the past few years, adding to the industry’s normally strong growth. However, according to a number of economists, conditions are quickly reversing.
Elevated mortgage rates and rampant inflation have pushed many would-be homebuyers out of the market completely. Meanwhile, a growing number of home owners are rushing to sell their houses to avoid losing money when prices fall. As such, many suspect that it’s only a matter of time before home prices ease back down. Whether this results in a true 2008-style “housing market crash” remains to be seen.
Home prices fell in both July and August, the first drop in years. While this means a loss of wealth for many property owners, that doesn’t mean there’s no way to see green from a potentially steep housing correction. Let’s take a look at some ways to profit from a potential housing recession.
Inverse Real Estate ETFs
Inverse real estate exchange-traded funds (ETFs) are perhaps the most straightforward way to capitalize from a wider housing pullback. These ETFs track the inverse of popular U.S. housing indices, like the Dow Jones U.S. Real Estate Index. Essentially, if home prices go up, these products will fall in value. But if home prices go down, the ETFs will rise. Accordingly, if you believe home prices are in for a downturn, inverse ETFs are an effective way to short the market.
It’s worth noting that these funds are undeniably risky. Home prices can theoretically rise infinitely, meaning these ETFs have no limit to how far they can fall. Additionally, some of these funds are 2x or 3x leveraged — if the housing index the fund tracks moves 1%, the ETF might move 2% or 3%. This allows investors both a great deal of risk and reward if they feel confidently in the direction that the housing market is headed.
Inverse real estate funds are not designed to be a permanent fixture in any portfolio. However, if the doomsday theories that many economists are peddling prove to be true, these products offer strong returns.
Some popular examples of inverse real estate ETFs include the ProShares Short Real Estate (NYSEARCA:REK), the ProShares UltraShort Real Estate (NYSEARCA:SRS) and the Direxion Daily Real Estate Bear 3X Shares (NYSEARCA:DRV).
Shorting Real Estate Stocks
Shorting real estate stocks is another fairly direct way to profit off the demise of realtor companies. As home prices recede, it’s only natural for many brokerage services to feel a similar decline in value. As such, savvy investors can take advantage of the impending slide by shorting popular real estate stocks.
Shorting consists of two potential methodologies. The first way is to buy put options on a stock that increase in value as the underlying security falls in value. A put option is essentially a contract that gives the buyer the right to sell a pre-determined amount of a security at a specific price and specific time. A put option includes a strike price, or the price that the security has to fall below in order to be “in the money.” If the stock falls below the strike price, before the expiration date — at least for put options — the owner of the contract will profit off the difference between the stock price and strike price, per share, either by exercising or selling the option.
If you believe real estate is set for a long-term collapse, a savvy investor may buy long-term put options in brokerage services like Redfin (NASDAQ:RDFN) and Zillow (NASDAQ:Z) and wait for their shares to fall, then sell the put options and reap strong benefits. Of course, if it looks like the security ends up higher than its strike price at expiration, the option will expire worthless.
Lastly, it’s worth noting that not every security brokerage offers options investing to every investor all the time.
Short-Selling Housing Stocks
Finally, another way to short real estate stocks is by short selling. Short selling involves borrowing shares of brokerage services, selling them in the open market and then profiting from the difference in value when you return the shares to the lending party at a lower price per share.
Short selling is another risky business — should the price of the stock you’re shorting go up, your losses are theoretically unlimited. However, with some good timing and a risk-aware approach, it’s possible to reap some strong gains.
On the date of publication, Shrey Dua did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.