Homing in on securities linked to house market

December 26, 2004|By Jay Hancock

NOT MANY of what Wall Street calls "asset classes" did better the past five years than metropolitan Baltimore homes, whose prices rose 50 percent.

Certainly not stocks, which have yet to revisit their 2000 highs. Some categories of bonds gained more value than the domiciles of Dundalk, Guilford and Columbia, as did gold and petroleum stocks, but they did so with many more ups and downs along the way.

An investment in a broad representation of Baltimore homes would have accomplished similar returns without the air pockets and would have turbocharged any diversified portfolio.

You'll note, of course, that such an investment is impossible except for multimillionaires and probably too much hassle for them. But Yale University's Robert J. Shiller is trying to change that and turn U.S. housing into an investment available to anybody - even apartment renters. Even apartment renters in Tokyo or Bombay.

Next year, Shiller and his colleagues hope to roll out securities that would be tied to home prices in regional markets - say, Los Angeles or Baltimore-Washington - and trade on the Chicago Mercantile Exchange.

It could be the biggest innovation in housing finance since Salomon Brothers invented mortgage-backed securities - in which mortgages are packaged and traded like bonds - in the late 1970s. The idea is to bring broader participation, greater liquidity and more efficient pricing to a $20 trillion market.

"Housing is a huge asset class. It's worth more than the whole stock market," says Shiller. But, he says, "because the market is not open to professionals, it's just too costly for a trader to buy and sell houses. It's an amateur's market."

Which is amazing, when you think about it. In the 44 years since President Dwight D. Eisenhower unleashed real estate investment trusts by giving them special tax advantages, almost every kind of property has been professionalized - packaged into portfolios and sold as stock. You can buy nursing home, apartment building, shopping center and office tower REITs. And movie theater, prison, car dealer and timber tract REITs. But not single-family homes.

Shiller isn't proposing to set up a REIT, which would take title to residences. But he wants to professionalize the home market in a different way, by selling derivative securities linked to home-price indexes in certain regions, probably on the East and West coasts at first, he said.

The investment would work by playing off two sets of bets against each other. One pool would bet on the housing index going up; the other, down.

Shares in the pools would trade freely until maturity - you could buy them through your broker. Fluctuating prices would send signals to the "real" housing market, perhaps affecting supply by prompting homebuilders. Upon expiration, both pots would pay out, with losers' losses paying for winners' gains.

Shiller and his partners at Macro Securities Research are still fiddling with details.

What life span should the pools have? He wants it to be as long as 25 years. Should the pools track the home index one for one, or should they be "leveraged," with a 10 percent gain in the index producing, say, a 20 percent gain in the pool?

Shiller is the author of Irrational Exuberance, which predicted the bursting of the stock bubble. Given his background, the ascent of home prices and the fact that he and numerous others believe housing is also in a bubble, much of the attention on his proposal has focused on the idea of betting on home prices to fall.

Speculators could "short" the U.S. housing market, the thinking goes. Or homeowners could "hedge" recent gains with a security that pays off if prices sink - a kind of home equity insurance. Those would be possible, though options tied to Shiller's housing securities would be a more economical hedge than owning them outright.

Institutional investors would presumably be interested. Lenders could hedge against an unexpected decline in mortgage collateral. Housing securities also seem perfect for Rockville's Rydex Investments, which designs mutual funds around asset indexes.

But the true potential beauty of home price securities lies not in wagering on temporary declines but on expanding the long-term benefits of American homeownership. This is probably not the time to dive in, but U.S. homes and their picket fences, barbered lawns and proud proprietors are one of the most intrinsically attractive assets in the world.

Someday I want some in my 401(k).

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