Real estate futures: preserve and increase capital

Real estate is among the most popular tools for preserving and multiplying capital. This asset allows you to earn in two ways. First, real estate properties generate stable rental income. Second, real estate values rise in the long run. For example, from 1970 to 2006, the average sale price of residential homes in the United States increased more than 10-fold: from $26,000 to $305,900.

Participants of financial markets have an opportunity to earn on changes in real estate prices with the help of derivative financial instruments, including futures. The underlying asset of futures contracts is real estate indices, which effectively track changes in the average value of houses or commercial properties in a particular region.


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Which futures can be used for real estate investment

S&P/Case-Shiller Composite Index (CUS) is the most popular indicator of the state of the U.S. residential real estate market. This index is calculated according to the average price of residential homes in the 10 largest cities in the United States. In the mid-2000s, the Chicago Mercantile Exchange launched a futures on the S&P/Case-Shiller index.

S&P/Case-Shiller index futures are traded in the electronic trading system of Chicago Mercantile Exchange Globex. Operations with this instrument can be made from 8:15 a.m. Monday through 3:00 p.m. Friday CST=US Time.

The contract value is calculated on the basis that one index point is equal to 250 US dollars. The minimum change in the futures price is equal to 0.2 index points or USD 50.

S&P/Case-Shiller index futures are not among the most traded instruments on the Chicago Mercantile Exchange. For example, during 2007, when the peak of the boom in the U.S. real estate market was observed, investors bought only 2,935 futures on the S&P/Case-Shiller index. On average, exchange traders hold real estate contracts in their portfolios for 14 months. This confirms that futures on this asset are interesting for long-term investors and hedgersHowever, speculators are not interested in them.

Real estate futures are also traded on the Eurex futures exchange. They have the ticker FSTL. The underlying asset of the contract is the STOXX® Europe 600 Real Estate Value Index. The value of one index point is 50 euros. The minimum price change is 0.1 point or €5.

Real estate futures: trading ideas

It was noted above that real estate futures are suitable for long-term players or investors looking to hedge a portfolio. Counting on the growth in the value of houses and commercial properties in the long term, a bidder opens a long positions. Counting on falling real estate prices, he opens short positions.

Currently US real estate market shows recovery growth after the mortgage crisis, which turned into a global financial crisis. For several years, this growth was determined by the stimulus measures of the US Federal Reserve System. However, the gradual winding down of the quantitative easing program brings back the dependence of the real estate market on the state of the real economy.

Fig. 1. Dynamics of the S&P/Case-Shiller index. Source: (Y-axis values are in points, X-axis - in years)
Fig. 1. Dynamics of the S&P/Case-Shiller index. Source: (Y-axis values are in points, X-axis - in years)

The beginning of the article states that between 1970 and 2006, U.S. real estate appreciated more than 10 times in value. The chart above shows that most of the increase occurred from the late 1990s through the mid-2000s. Real estate rose in price due to the demand from the population. However, this demand was created artificially by American bankers.

American banks granted mortgage loans to practically everyone, paying little attention to assessing the solvency of borrowers. Real estate was used as collateral. Moreover, banks "packaged" mortgage assets into packages and issued bonds against their collateral. They used the raised funds for mortgage lending again. This situation led to the formation of a speculative bubblewhich is clearly visible on the graph in the form of a peak.

When speculative real estate appreciation exhausted itself, house prices began to fall. Falling collateral values worsened the financial situation of borrowers and lenders. Many U.S. citizens found themselves in a situation where the amount owed on a loan exceeded the value of the house. The banking system is facing a mortgage crisiswhich had a negative impact on the real economy and transformed into the global financial crisis.

To combat the crisis U.S. Federal Reserve reduced the key rate to zero and launched an asset purchase program called "quantitative easing". These actions led to a fall in the cost of mortgage loans. In 2013, U.S. mortgage rates hit a record low (the interest rate on a 15-year mortgage fell to 2.61 % per annum). Buyers returned to the real estate market and homes in the US started to become more expensive again. In particular, from January 2013 to January 2014, real estate in the 20 largest US cities rose in price by 13.2 %.

The US Federal Reserve is currently winding down the third round of its quantitative easing program, the main driver of the recovering real estate market growth. The cost of mortgage in April 2014 increased to 4.41 % p.a. from 3.54 % p.a. in April 2013. Recovery growth in U.S. real estate values has slowed downas can be seen in the illustration below.

Fig. 2. Dynamics of the three major S&P/Case-Shiller real estate indices. Source:
Fig. 2. Dynamics of the three major S&P/Case-Shiller real estate indices. Source:

The winding down of monetary stimulus again makes the real estate market dependent on the state of the economy. The U.S. Federal Reserve proposes to focus on the labor market: if employment grows, the wealth of American households increases. This creates demand for real estate and creates the conditions for house prices to rise.

The article was prepared by Sergey Krasikov, Senior Financial Consultant at Saxo Bank

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