| Housing Needs a Derivative Based on Sales |
| Written by Jonathan Smoke | |
| 11.18.2008 | |
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Discuss this article on the forums. (0 posts) For residential real estate in the U.S., derivatives remain a relatively esoteric concept. For more than two years now, futures based on the Case-Shiller 10-city composite price index and underlying market price indices have been traded on the Chicago Mercantile Exchange. Trading volumes for the CME housing futures remain relatively thin. Brokers and analysts are perplexed why builders and developers haven’t widely adopted them in such a challenging market. Alternatively, derivatives based on the Radar Logic daily “spot price” have been trading for more than a year through an impressive network of the major brokers and interdealer brokers. Trading is rumored to be more robust on the RPX market, but like the CME only a limited number of markets are covered. I don’t have access to information about the volume of trades, but I would bet that few if any have been on behalf of builders or others directly involved in housing. One more alternative is coming soon to a broker near you— MacroShares Major Metro Housing trusts. MacroShares is a product of MacroMarkets, the firm behind the Case-Shiller Home Price Indices. Fittingly, the MacroShares will be based on the Case-Shiller Indices. These new shares are basically simplified versions of housing futures aimed at the retail masses. The first MacroShare will be based on the 10-city composite. By the end of the year, investors will be able to place trades in the 10-city MacroShare just like an ETF, as it will trade every day. Potential investors much choose if they are betting that the 10-city composite index will go up or go down. If the index does go up, the up share will increase in value. If the index goes down, the up share will decrease in value, but the down share will increase in value. I like the concept—maybe it will occupy the time of those countless land acquisition professionals who are bored out of their skulls waiting for transactions to begin again. But, it’s not so exciting betting on an amorphous collection of markets that have little in common other than their extreme historic price volatility. It's also not addressing what really drives "housing." My biggest philosophical complaint about the developing housing derivatives business is that no one seems interested in the one factor that causes more volatility and historic booms and busts than prices. That metric would be absorptions or sales.  The above chart shows total home sales (both new and existing) for the US and the Case-Shiller 10-city home price index since 2005, which was the peak of the boom. We clearly had a rise and fall in prices, but we've fallen even further in the volume of sales. And this is a composite-- in some markets there has been little to no substantial decline in prices but yet an enormous drop in sales (more on that later). Since there are futures markets for items other than prices (weather, elections etc), it’s not crazy to envision a housing futures market for sales volume. Think of how many players are impacted by home sales volumes—builders, developers, realtors, suppliers, contractors, lenders, local governments, inspectors, insurers, movers and home service providers, to name a few. Clearly we’ve all been impacted by this current multi-year decline in prices, which heretofore was a rare occurrence. But the biggest source of pain for most housing players has been the steep decline in sales of both new and existing homes. You can manage price volatility, but potential returns turn negative fairly quickly when absorptions are less than half of what was anticipated. If anyone out there has the capital and the connections to start such a home sales derivative, I’d love to provide the data and analytics to power such a platform. 
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