A Different House Hedge

July 15, 2011

by Ben Gimpert

4 comments

Where do stock market winners buy houses?

Prices in certain local real estate markets are bolstered by a rally in the stock market. The recent murmurings of another IPO bubble suggest that newly minted paper millionaires will soon be shopping for homes in Los Altos Hills and Cupertino. We can put numbers behind this story by calculating real estate price sensitivity to a stock market benchmark. If we choose the S&P 500 as the benchmark, the sensitivity number will be a sort of real estate beta. Since real estate is far less liquid than most stocks, I regressed quarterly changes in our Altos Research median ask price against the previous quarter’s change in the S&P 500. Historically speaking, those real estate markets with a high beta have gotten a boost in prices after a good quarter in the stock market. Those markets with a low, negative beta are not “immune” to the stock market, but tend to be depressed by a stock market rally.

Below is a map of the Bay Area’s real estate betas. These numbers were calculated using prices from Altos Research and benchmark levels from Yahoo! Finance. The darker red a zipcode, the greater an increase in the market’s home prices after a quarterly stock market rally. As we might expect, the betas in Silicon Valley are above average. However there are also some surprises in Visalia and Wine Country.

Real Estate Beta, Bay Area

Our hypothesis for positive real estate beta is easy: those IPO millionaires. But what could cause a real estate market to tank after a good run in the stocks? Perhaps negative real estate betas are in more mobile labor markets, where stock market wealth triggers a move away from home ownership. Or maybe negative real estate betas turn up in markets where the condo stock is higher quality than single-family homes, like in some college towns. Remember the betas mapped above are based on only single-family home prices.

Real estate remains a difficult asset to hedge, an asset almost impossible to short by non-institutions. This is unfortunate, because a short hedge would be a convenient way for people with their wealth tied up in real estate to ride out a depressed market cycle. However like long-only fund managers, real estate investors could benefit from thinking in terms of benchmark sensitivity. If we choose a benchmark that represents the broader real estate market, we could hedge real estate buy purchasing non-property assets that have negative real estate betas. You would want your value-weighted real estate beta to net out to about zero. Now there is a plethora of problems and assumptions around making investment decisions with a crude linear sensitivity number, but at least real estate beta gives us another tool for thinking about housing risk.

(A version of this post with more background details can found be at http://blog.someben.com/2011/07/diff-house-hedge/ on Ben’s blog)

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