Trading Houses (cont.)
The WSJ just came out with a Saturday edition that emphasizes personal finance. Their lead article made me want to revisit a blog I posted a few days ago.
The WSJ article (subscription req’d) “New Tools to Hedge Your Home” discusses a new and old way to hedge your home.
A problem with the old way, selling short an index of homebuilders, is that this is an imperfect hedge. In addition, the index of homebuilders has performed extremely well historically — often much better than the increase in home prices. It’s not a good long-term strategy to be short something that historically has performed extremely well.
There is a new way to hedge the value of your home through the use of derivatives. The first to market is HedgeStreet. Through their website you can speculate on the short-term direction of real estate prices in six markets. If the value of your home is correlated with the value of the real estate index in any of the six markets listed, you can hedge the short-term value of your home.
But I would advise against using derivatives to hedge the short-term value of your home. First, if you do not plan on selling your home soon, a lower price only means that your property taxes might go down. (The site currently does not allow for long-term hedging — the longest contract is for three months.)
Second, the markets are currently very illiquid and so hedging can be very difficult and expensive. As more contracts and market-makers enter the market, hopefully these problems will be fixed.
Third, derivatives are complicated instruments that can easily be misused.
Fourth, the hedges will probably be far from perfect for your circumstances.
The biggest problem I have with the products is that it reflects our current preoccupation with short-term changes in real estate values. Currently, real estate values are generally overvalued, but over the long-run values should increase from their current prices. I would not recommend investing more in real estate at this point, but there is no need to speculate in a negative NPV transaction that isn’t really hedging your real risk.
