Company Outlines Model behind New Housing Derivative

The Chicago Board Options Exchange
(CBOE) will soon permit futures trading in housing through a derivative based
on the Radar Logic Composite Price. 
According to information released by Radar Logic, a New York City real
estate data and analytics company, this derivative will allow institutions both
to hedge against downturns in housing prices and to allocate portions of their
investment portfolios to housing assets without the search, transaction, and
maintenance costs association with purchasing physical properties.  Or, as the background information the company
released today says, “RPX futures will allow you to invest in residential real
estate without having to mow the lawn.”

It is not our purpose to assist Radar
Logic in its promotional campaign nor is this intended as a discussion of the
appropriateness of encouraging further speculation in the housing market
although that discussion could be a worthy one.  However, the “RPX Housing Market Review”
released by the company last week does explain the methodology underlying
calculation of the Radar Logic Composite Price and provides a context for
anyone who is interested in following this new market.

This is not the first such venture into
housing derivatives.  In the fall of
2007, Radar Logic helped launch a market for a privately traded product which
reached $4 billion in 14 months.  The
subsequent housing bust demonstrated that values can decline nationwide in
unison and presenting investors with additional motivation to hedge against
downturns in values.

Home prices are now in a range that
would have been expected absent the boom and bust of the last decade.  As a test of its model, the RPX figures which
date back to 2000 have been augmented with housing data from SP, the
Federal Housing Finance Agency, and Freddie Mac.  From 1991 through 1996 housing was in the
worst slump in 20 years and price increases were at a very slow pace.  During this period RPX Composite prices
increased just $0.35 per quarter compared to the average of $.83 from 1970 to
1999.  This rate was used to calculate
the pessimistic scenario for home prices over the 2000 to 2011 period.  For the optimistic scenario the designers
used the average quarter-over-quarter growth rate from 1997 through 1999 when
the tech bubble ended the stagnation of the preceding six years and the
Composite grew at an average quarterly rate of $1.82.

Using the pessimistic scenario to
project growth over the 11 year period since 2000 would have resulted in a
composite of $142 per square foot (psf) as of September 30, 2011, 27 percent
lower than the actual value.  Using the
optimistic scenario, the projection would have been $213 psf, 18 percent above
actual value.  “Back in early 2000,” the
review says, “most housing market observers would have expected housing values
to grow at somewhere between the rates in these scenarios.  Home values, as measured by the RPX Composite
price, are now within this range.”

As of January 31, 2000, the 28‐day RPX Composite
price was $121.96 per square foot. By December 31, 2005, it had increased to
$261.21 per square foot, reflecting a 13 percent average annual growth rate
from 2000 through 2003 and a 16 percent average annual growth rate from 2004
through 2005 (Figure 2). The 28‐day
RPX Composite price peaked at $278.32 on June 8, 2007, 109% greater than its
value seven years prior. In other words, housing values doubled in less than
seven years.  

This growth resulted from several
factors.  An extended period of very low
interest rates was instituted by the Federal Reserve to spur the economy after
the 2011 recession.  This was bad for
fixed-income investors and they went searching for new investments with higher
returns, overwhelmingly choosing U.S. mortgage debt through mortgage backed
securities.  This sparked the pursuit of
more and more loans, leading to lower mortgage standards, increased demand for
housing purchases and rising prices. 
This then led to riskier loans, increased defaults, a glut of
foreclosures, falling prices, etc.

Sales at auctions and through lenders,
i.e. “motivated sales” resulted in substantial price discounts and rapid
falling of the RPX Composite price in 2007 and 2008 and these sales still
remain a significant percentage of sales, seasonally ranging between 20 and 38
percent.

According to Radar Logic, home prices
have fallen back to about where we would expect them to be given pre‐bubble growth
rates.

  • Home prices have dropped to the point
    where some institutional investors see portfolios of distressed properties as
    attractive investments. Demand from such investors has helped stabilize home
    prices.
  • Inventories are slowly decreasing,
    including distressed inventories in non‐judicial
    foreclosure states and new home construction is down.
  • Housing is now cheap relative to other
    tradable asset classes. In historical perspective, housing is cheaper than
    gold, which is just slightly off its all‐time
    high. Housing is also cheap relative to bonds, as bond prices have been driven
    upward by the impact of public policy.

The
company feels “as the largest asset class there is, housing represents an
investment for which everyone should consider an allocation.”   We
leave that decision to you.

Article source: http://www.mortgagenewsdaily.com/01062012_housing_derivatives.asp

Leave a Reply

WP Facebook Auto Publish Powered By : XYZScripts.com
Bunk Beds