Think Housing's Bad? You Ain't Seen Nothing Yet

The Chicago Mercantile Exchange offers futures contracts on the US housing market which track the S&P/Case-Shiller Home Price Indices that provide median home sale price data for 20 cities across the country. CME offers futures contracts for 10 of the 20 cities along with a composite index of the 10 cities that expire over various months from November 2007 through November 2011.

From the current price levels of these futures (July data released Tuesday), the housing picture is not pretty going forward. Below we have created charts of the 10 cities that include the actual home price data from S&P/Case-Shiller (blue lines) along with the prices of the futures contracts over at CME (red lines). The percentage number that we provide is the difference between the current median home price and the lowest priced contract for each city.

As shown, Miami home prices are expected to fall 28% from current price levels. San Francisco is second worst at -26% and San Diego is third at -19%. Investors are predicting the composite index to fall 14% before coming back slightly by 2011. So while some are hoping home prices have already bottomed, investors actually putting their money to work are betting on much more significant declines.

click to enlarge

Comments

[grs44:]

We have been here and done this before, with housing dropping in California in the 1990's. I used to live in Silicon Valley, so I know the market a bit, and it is highly inflated. One house I owned was 1600 sf, 3 bedrooms, 2 baths, with the requisite small yard, and it is now worth over $800,000? If you look at average prices, and household incomes, you have to have a household of income o $190,800 to afford an average house in California.

Oh, and the average household income is only $53,600. The housing bubble will burst, which is why buyers are simply waiting for it to happen, and sellers won't reduce their prices to reflect reality, that and sellers will have a mortgage worth more than their house.

This housing mess is going to take a few years to straighten out. In the meantime, if I owned a house in Calfornia, Florida or any other inflated area, get ready for a very rude awakening.

2007 Sep 26 10:10 AM

[Uncle Bill:]

I think these estimates look about right. But isn't there a built-in downside bias to this particular futures market? Who would want to go long the futures, when there are so many other vehicles available to go long the housing market? It seems the only viable use for these futures is to hedge against the underlying (home) you already own, whether it's in a portfolio or you're sitting in it now. Any ideas out there about who wants to take the other side of a short position in housing futures? By the way, Shiller is one of my heroes. "Market Volatility," from the late '80s, is a classic, yet it still reveals many truths about today's market.

2007 Sep 26 10:16 AM

[Spec:]

Whers's the info on Houston, Austin, Dallas, and Texas Real Estate in general? I guess those numbers don't attract too much attention...

2007 Sep 26 04:23 PM

[Griz:]

The futures contracts represent a nominal future target price so the real price declines will be greater, correct?

2007 Sep 26 08:32 PM

[Yev:]

I am sorry, but a 15% decline in Los Angeles? Whomever came up with this number needs to get out more. LA market is one of the most unaffordable, even a 15% drop would keep it unaffordable based on the average income in this city. Last 2 years have been financed mostly by no-down, no-doc, stated income, option ARM loans. LA will be down 30-50% conservatively, if not than people here will be living not just on negative savings but they will be borrowing using their friends credit.

2007 Sep 27 10:17 AM

[Robin:]

Just wait 'til the Reality of Peak Oil arrives. Parts of it are here already.

The American Dream of suburbia never was sustainable for more than a few generations

Cities will see the largest loss in value, and suburbia will be next to worthless.

Either deal with Reality, or Reality will deal with you.

2007 Sep 27 11:34 AM

[anger:]

The only houses in Los Angeles you can get for 275,000 is a cardboard box "fixer upper" in a shooting zone. Even the crappiest of houses sell for over 300,000. This data doesn't seem accurate at all. My best "guess" is that the percentage of the fall is waaaaayyyyy off, and must go much lower than you've predicted.

2007 Sep 27 12:53 PM

[Geoff Consi...:]

Nice article. One note of caution. The current forward curve (the red lines in your charts) is often not a very good forecast when you look broadly across commodities that have futures contracts. The forward curve is the current price at which a people are currently trading those months, but for the forward curve to be a good forecast, a number of other criteria must be met. I recall that you guys have anayzed this issue--can you remind me of those results? Have you updated those?

2007 Sep 27 02:43 PM

[head scratcher:]

Thought provoking article. My thoughts are that the CME real estate futures are not liquid enough to support your results. There are almost no contracts beyond 12 months. The "last price" you refer to appears to be a kind of mid-point between the ask and bid prices (does anyone know where it comes from?).
The "window" of % change in house prices is very large that far in the future. The "ask" price for 2011 San Francisco is 185, meaning that in 2001 someone is willing to sell a future where realestate in San Francisco is %185 of its jan 2000 real estate prices. The "bid" price is 152%, meaning that someone is willing to buy a future where realestate is %152 of its jan 2000 real estate price. If the latter is accepted, and San Francisco real estate ended up being 200%, the person who sold you that future must pay the difference i.e. they pay you 48% for each unit (1 unit = $250 ?). If you really think this is a bubble, then you can buy the 185% future now and you'll be rich (because the seller must pay you bubble prices when the bubble is gone)! If you think prices will increase to 300%, you can sell some futures to the %152 clown and he'll have to give you San Francisco real-estate at half price. It'll be interesting to see what happens if the 401k's start to diversify into this area. Can you imagine rebalancing your contributions with imaginary houses based on housing futures? I guess i find it strange that we have housing futures but no underlying "house" stock we can buy and sell now. Anyway, this is half speculation because no-one is actuallying buying/selling these futures. If it really was a bubble, wouldn't people be buying the 185% futures??
i found the following article a comprehensive assesment of deriving house prices from market data
www.federalreserve.gov...
and its conclusions are based on the 3 "moments" of investor expectations
1. Where are prices going
2. how certain are we in 1.
3. are the housing projections skewed to the downside implying a bubble?
The conclusions based on more concrete statistics are
1. prices will have a modest decline
2. volatility of future contracts are high compared to historical trends i.e. there's a lot of uncertainty
3. They analysed the futures of home building company equities to deduce that there is not a significant skew downwards. Only a modest bubble?

2007 Sep 27 06:11 PM

[head scratcher:]

oh, now i understand...
1 unit = $250 * index value
so in my example above, they pay you 0.48x250x152=$18240.
(i'm assuming it's based on index value when future bought?)
www.cme.com/trading/pr...

2007 Sep 27 06:35 PM

[head scratcher:]

On second thoughts....
they pay you 48x250x152=$1,824,000

2007 Sep 27 08:18 PM

[Fowler:]

The areas that are truly, truly vulnerable are those that have been developed based on the second home market and places like Vegas and Phoenix where developers can actually find land or lots to develop (these are always the most vulnerable areas). In the other markets where you have both jobs and great school systems, say Mill Valley or Atherton in NorCal, Sudbury or Brookline outside Boston or Manhattan Beach in SoCal, real houses (i.e., 4 bedrooms) are still appreciating today. In terms of this data, it is based on medians and the median numbers have to come down because the fools kept building houses as long as the street made the money available. Your best strategy is to try to find the best piece of property in the best market you can afford at a fair price and use as much leverage is you are comfortable with. If you can not afford a high quality market, buy income property and save up.

2007 Sep 28 01:50 AM

[jay stokes:]

Frightening stuff; actually, as a potential home buyer in San Francisco, kind of helpful. In terms of accuracy, is there any information about how predictive these futures have been? For example, what where the futures looking like in 2004? 2003? How did they match actual price gains?

Thanks,

Jay

2007 Sep 28 04:47 PM

[User 109762:]

goff article..

it looks like early 2011 we will begin a recovery in most areas of the country..

whats interesting is looking at those city charts,a good number swing back up after late 2010-into 2011,but that chart only goes as far as 2011,and if you look at Miami,San Diego/San Fran..no upward recovery movement on prices even by 2011.

it looks like California and florida have a long way to go for a real estate recovery.

Those numbers are percentage drop predictions from current price levels..so while it says they expect a 19% drop in San Diego prices by 2011,thats not taking into account the price drops San diego has already had over the past 18-24 months.

so it you figure San diego has already lost about 8-10% in it's median price over the past 18-24 months ..they expect a total of about -28% drop in median price all together in SD by 2011,again I see no upward hint of movement in SD by 2011 in that prediction chart,so who knows after 2011 if the drop will be more or if it will swing back up after 2011.

2007 Sep 29 12:10 AM