The Housing Market Is On Shaky Ground. Here’s How To Bet On Its Collapse.

The Housing Market Is On Shaky Ground. Here’s How To Bet On Its Collapse.
Stéphane Renevier, CFA

over 2 years ago6 mins

  • House prices are still in a bull market, but it’s a fragile one and many believe prices may be due for a correction.

  • You can’t bet directly on falling house prices, but you can short REITs, stocks linked to real estate, banks, and currencies like the AUD or the NZD.

  • You can make a lot of money if you’re right, but because of the high cost of implementing these trades, your timing needs to be perfect.

House prices are still in a bull market, but it’s a fragile one and many believe prices may be due for a correction.

You can’t bet directly on falling house prices, but you can short REITs, stocks linked to real estate, banks, and currencies like the AUD or the NZD.

You can make a lot of money if you’re right, but because of the high cost of implementing these trades, your timing needs to be perfect.

Real estate prices around the world haven’t looked this peaky since the 2008 financial crisis, with more and more voices predicting that the bubble is set to burst. And if you’re one of them, there are a few ways you can put your money where your house is…

Why are house prices looking so risky?

House prices generally go up over the long term, but real estate – a cyclical market that responds to the ebbs and flows of the wider economy – is likely to see pullbacks along the way.

And it might only be a matter of time. The factors that have supported the bull market so far, after all, won’t last forever: interest rates could rise if the economic recovery keeps picking up, governments might not be able to repeat their unprecedented support measures, investors may once again become more risk-averse, and central banks may not always be able to save the day by injecting massive liquidity into the system.

Even more worrying is the fact that record-low borrowing costs has boosted the use of leverage, leading to record household debt-to-GDP and housing price-to-income ratios around the world.

Price-to-income ratios are reaching record levels in many regions. Source: OECD.
Price-to-income ratios are reaching record levels in many regions. Source: OECD.

High leverage amplifies returns, but it also makes the system more vulnerable to changes in financial conditions. In other words, a sudden rise in mortgage rates or a contraction in homeowners’ disposable income could set off a significant correction.

What are the opportunities here?

You can’t directly trade house prices, but if you think they’re due for a fall, there are a few indirect ways you can profit.

Short real estate investment trusts

Real estate investment trusts – or REITS – are companies that buy income-producing real estate assets, like residential properties, hotels, hospitals, or offices.

You can bet against the rising value of real estate either by shorting a REIT directly or by shorting a REITs ETF, which tend to be more diversified. In both cases, you’d short it the same way you would a stock: borrow the shares through a broker, sell them at the market price, and buy them back later for a profit if prices have fallen.

There are a couple of challenges when it comes to shorting REITs, mind you. First, it’s expensive, since you have to pay dividends – which tend to be above market average – to the investor you borrowed the stock from. Second, it can be hard to find a REIT that’s both available to short and focused on residential – rather than commercial or industrial – real estate. I haven’t, for example, found any in Australia, one of the countries most at risk right now. For the US however, I’ve created a screen you can use as a starting point here.

Short real estate-linked stocks

Real estate developers are obviously directly linked to house prices, and they’ll suffer if house prices collapse. You could maximize your returns by selecting a smaller and more concentrated developer, but even larger and more diversified outfits – like LendLease Group (ASX ticker: LLC) – should do the trick.

It’s not just real estate developers that are exposed to house prices either: even a “digital advertising” company like REA group (ASX ticker: REA) has exposure to the housing market via the financial services it provides to those looking to take out a loan.

Short the banks

Banks are the main actors in the residential lending market, and their earnings would be directly impacted if their clients can’t repay their loans. And there’s one country where banks are particularly exposed to mortgages: yep, Australia again. In fact, more than 60% of Australian banks’ loans are made to residential real estate, according to Bloomberg. And four main banks are responsible for most of the lending: Commonwealth Bank Of Australia (ASX ticker: CBA), Westpac (WBC), National Australia Bank (NAB), and Australia and New Zealand Banking Group (ANZ).

Source: Bloomberg
Source: Bloomberg

Short the Australian or New Zealand dollar

According to Bloomberg, housing loans at the major four Australian banks represent about 75% of the nation’s economy. In other words, defaults on mortgages could have a big repercussion on the overall economy and ultimately lead to a fall in the Australian dollar (AUD).

You could short it against the US dollar or against the Japanese yen (JPY), which tend to be more resilient in times of stress. And given that the situation is very similar in New Zealand, you could also consider shorting the New Zealand Dollar (NZD).

Bonus: Don’t buy inverse ETFs

You might have heard about inverse and leveraged inverse ETFs on real estate too, but I’d recommend against using them. They were created to replicate returns of their underlying index over a one-day period, but they’re really poor choices for longer-term investments.

What are the risks?

First, it’s important to note that shorting stocks or REITs is an expensive trade to hold over the long term: you have to pay the dividend, the interest on the margin or cash borrowed for use as collateral, and a loan fee – which can be high if there’s a lot of demand to short the stock. And if the REITs you’re shorting end up being the target of Redditors, you might have to stomach a short-squeeze too – and it might not be pretty.

The currency trade is a bit cheaper to implement as it’s more liquid, but you’ll still have to pay the difference in interest rates between the two currencies. That means you’ll be losing money on those trades if prices don’t change – and the longer you hold the trade, the more those losses will add up.

Second, these trades benefit from global growth, and going against them might cost you a lot of money if your timing isn’t right. And timing a real estate fall is notoriously difficult: remember that experts have been warning about the burst of the real estate bubble for many years already, but prices keep going higher.

Third, remember that all those trades only indirectly profit from a fall in house prices, and plenty of other factors also impact their prices. So even if your view on house prices ends up being correct, your realized profit and loss might be quite different from what you expect.

And finally, even if the real estate bubble does reach its limit, it may end with a whimper rather than a bang. Lending standards are stricter than they were in 2008, and many countries have implemented important measures to ensure the stability of the financial system. And that not only means the correction might be softer, but also that the bull market could continue for longer…

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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