The notion of an impending housing market crash has been a trending topic on Wall Street for much of the year. With housing affordability at a historic low, interest in how to short real estate has been rising.
So, is now the time to short housing?
Well, as was established repeatedly in 2015’s The Big Short, shorting real estate is a notoriously risky affair. Generally speaking, home prices tend to rise over time. To short housing is to make a bet against a nigh-guaranteed long-term winner.
That isn’t to say there aren’t some signs of softening, however.
Indeed, with 30-year mortgage rates ticking as high as 7.49% recently, a function of the Federal Reserve’s brutal rate-hike campaign over the past two years or so, demand for homes has slipped. This is reflected in declining mortgage applications and slowing home sales.
That said, prices have remained surprisingly elevated. Average home prices are at $406,700, close to their all-time peak. With mortgage rates liable to continue rising in the face of a still-hawkish Fed, and recession concerns continuing to swirl, some believe home prices may be liable to fall.
One of the only major barriers to declining home values is the limited inventory of homes in the U.S. There is currently just a 3.3-month supply of available homes for sale, well below the roughly six-month supply typical of a balanced housing market. Should a recession hit, as many economists have projected, it’s possible the influx of forced sellers could relieve the pinched home supply, pushing home prices down in the process.
So, with that in mind, here’s how to short real estate.
Two Ways to Short Real Estate
1. Inverse Real Estate Exchange-Traded Funds (ETFs)
Inverse real estate ETFs represent perhaps the single most straightforward way to profit from the demise of the wider housing market. Indeed, these funds track the inverse of popular U.S. housing indices, like the Dow Jones U.S. Real Estate Index.
Essentially, if home prices go up, the ETF will fall in value, and, more pertinently, if real estate prices fall, the ETFs increase in value. As such, they’re a clear-cut and effective way to bet against housing.
That said, like any other shorting mechanism, there are risks involved. Home prices could theoretically rise indefinitely, meaning your losses could only continue to grow. On the flip side, assuming real estate doesn’t go to absolute zero, your gains are, by comparison, limited.
Many of these ETFs are also 2x or 3x leveraged — meaning that for every 1% the tracked index moves, the ETF might tick up or down 2% or 3%. This allows investors greater returns for making a notoriously counter-cyclical bet.
It’s worth noting, however, that inverse real estate ETFs are not designed to be a long-term hold in just about anyone’s portfolio. As established, home prices, by merit of the limited supply of land in the world, rise over time. However, if you have a read on an imminent decline, inverse ETFs are a good, easy way to capitalize on your hunch.
Some popular examples of inverse real estate ETFs include ProShare Short Real Estate (NYSEARCA:REK), the ProShares UltraShort Real Estate (NYSEARCA:SRS) and the Direxion Daily Real Estate Bear 3X Shares (NYSEARCA:DRV).
2. Shorting Housing Stocks
Directly shorting real estate stocks is another popular method of profiting off of the anticipated deterioration in housing companies. Shorting real estate stocks is fundamentally the same as shorting other kinds of companies. As such, shorting real estate is as simple as buying a put option on a stock connected to the greater real estate market.
A put is an options contract that gives the buyer the right to sell a specific amount of a security at a given price and at a given time. Inherent to options contracts are strike prices. For puts, if a security falls below the strike price ahead of its expiration, the owner of the contract will profit off the difference between the stock price and strike price, per share, minus the premium paid for the contract. On the flip side, if the stock rises above the strike price by expiration, the put is out of the money, effectively worthless.
Another benefit of shorting real estate is that if you’re unsure over a specific period during which a given real estate stock will decline, you can buy a put with an expiration date far in the future, giving plenty of time for the security to fall below the strike price. As you might imagine, however, long-term options warrant higher premiums.
Real estate brokerage services like Redfin (NASDAQ:RDFN) and Zillow (NASDAQ:Z) are prime examples of companies that would decline in line with a deterioration of the wider housing market.
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.
