Hedging on equity may be on horizon

A few years ago, my mom sold the family home and moved to a more convenient, secure condominium nearby.

At the time, there was serious conversation among a few of my six siblings that mom had overpaid for the condo and that the place would never be worth what she paid for it.

“She’s 83, it’s where her friends are and it’s the place she wants,” I told them. “So, if it goes down, that’s a gamble we’re willing to take.”

However, not everybody is willing and able to gamble with the value of his or her home.

Many owners in many areas are concerned that escalating home prices cannot continue much longer. What would happen if they were forced to sell – loss of job, divorce – after a drastic “correction” in home values?

The subject of ways to insure home equity surfaced again recently at an Inman News-sponsored housing conference in Los Angeles that sought definitions and ramifications of a “housing bubble.”

Robert Shiller, a professor of economics at Yale University, co-founder of Case Shiller Weiss and author of the book “Irrational Exuberance,” said that price drops of as much as 10 percent a year could happen in areas where local economies are struggling and home appreciation has been soaring.

“The run-ups in prices can’t go on forever,” Shiller said. “It would diminish the idea that housing is a good investment. The question is when?”

For years, Shiller has been a proponent of “housing futures” – a risk-management tool for homes that would operate similar to the hedge asset vehicles found in today’s financial markets. For a fee, a homeowner could purchase the right to sell a futures contract that would be at a price similar to comparable homes in a specific neighborhood.

The concept can be viewed as a home equity insurance policy. For an upfront premium, say, approximately 2 percent of the home’s value, the owner buys the right to exercise the option for a definite period of time. If the owner decides to sell and prices have dropped, the owner receives the guaranteed price determined at the time the policy was written. If home prices rise, the owner is out the cost of the premium.

For a basic example, let’s say a homeowner with a $100,000 house is skittish about the economy in his town. He thinks the local factory could lay off hundreds of workers who will have little chance of finding other employment. The homeowner decides to buy a home equity insurance product for $2,000. Four years later, he decides to move to Arizona and open a miniature golf course. The best offer he receives is only $84,350. The insurance would make up the difference and the owner would lose no money. If the sales price were greater than $100,000 (or the agreed-upon insured price) the owner would be out the $2,000 paid for the premium.

Patrick Stone, CEO of Fidelity National Information Solutions, a huge corporation specializing in title insurance and housing data, said the market for a vehicle such as home equity insurance was too narrow. In Stone’s view, such a product would not be necessary in most of mid-America – where housing prices typically show gradual appreciation – and would be a tough sell to some of the more volatile housing areas on both coasts.

Stone said other investors would “arbitrage any opportunity” or quickly try to create another hedge (“hedge the hedge”) to ensure their initial investment. Stone indicated this would complicate the offering for consumers and make any such market less inviting for investors.

“The no-risk hedge environment often sounds better than it really is,” Stone said.

Apparently, a couple of Shiller’s Yale faculty members are willing to try and have landed a $5 million federal grant to help launch a pilot program. Will Goetzmann and Barry Nalebuff, Yale Business School professors, along with NYU’s Andrew Caplin, have formed Real Liquidity to test the residential real estate financial protection market. Their efforts are now centered on Syracuse, N.Y., but the company hopes to expand to other, higher-priced markets.

Are you betting that your home’s value will continue to soar? You soon may be able to hedge your bet.

Tom Kelly, former real estate editor for The Seattle Times, is a syndicated columnist and talk show host. You can e-mail Tom at news@tomkelly.com.