Tuesday, August 01, 2006

Sell Your Home In Two Years... Tomorrow!

Finally, I read that the first housing futures contracts started trading earlier this year. Robert Schiller (who wrote "Irrational Exuberance" and its successor about the housing markets) began this experiment to see if it was possible to hedge against falling home prices. In otherwords, people are buying and selling the future value of homes. This could have a very interesting effect in the future as (and if) these contracts become more widespread. Less than 100 of these contracts have been written in any one local area - we shall see if they become more popular.
Imagine this: in four years your child is going to leave for college. Due to a runup in real estate prices, you realize that you can sell your home, buy a smaller one with a smaller mortgage, and use the remaining equity to pay for her tuition & board. This sounds great, but how do you know that you are not caught in a housing bubble, the popping of which could seriously jeopardize all your plans? With a housing futures contract, you can protect the price of your home. Here's how it works:
Your home is currently valued at $200,000. You fear that you will not be able to sell your house in one or two years for that much, and you want to find a way to ensure that you can get this price.

The idea behind this future is that you can basically lock in an option to get a certain price at a certain point in time. You are protected, but at the same time you are giving up some possible upside.

According to the press, housing futures were lightly used their first quarter in trading. Most of the contracts written were in Miami, where so many condos are going up. It looks like a good number of them may be sitting on the market, so developers have tried this approach.

Selling a futures contract on a house requires someone else who's willing to gamble that housing futures will go up and the buyer will be sitting on instant profit at the end of the future contract. After all, no one wants to lose money.

Only 10 contracts were written in New York City in the first three months. This isn't surprising, as publicly traded housing derivatives are pretty new. But derivatives have existed for a long time on the down low. People can sign options on individual properties, allowing them time to shop around the contract to someone who is willing to pay $10,000 - $50,000 more. Though some states have tried to restrict this, it is still possible to be done, anywhere, following the appropriate procedures.

So will housing futures take off?? Well, I think that hedge funds and developers will be the first in. As with most futures markets, a mix of professional traders and end users (ie, developers and property investors) will be the first people to actually buy and sell futures contracts. But I do see money to be made there, and as soon as someone figures out a "system", this will become a pretty big market.

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