Sun, 27 Feb 2005

Shorting Residential Real Estate

Patrick wants to short the housing market. This is something I've thought about over the past year or so.

I could short builders, mortgage banks, or Fannie Mae, but that's not exactly the same, and I'm not as confident they will fall.

I'm not sure why he doesn't want to take a short position in equities that are likely to track housing prices. If prices start to fall it'll likely be because people are defaulting on their mortgages. This will negatively impact those holding mortages, i.e. banks, Fannie Mae and Freddie Mac. As Greenspan pointed out, the GSEs are holding onto lots of mortgages.

I read How to Profit from the Coming Real Estate Bust yesterday, and the author, John Rubino, suggests a number of ways to make money when the euphoria ends. He, of course, suggests shorting the GSEs, banks, and builders. But the housing market doesn't exist in a bubble (pun intended). The fall in housing prices is likely to correspond to a fall in the dollar. It is foreign investment in dollar debt that is helping to keep interest rates low. When foreigners get tired of financing American consumers, and not making much money doing so, they'll take their money elsewhere causing the dollar to fall. (Yes, I realize it's not that simple. Foreign governments also want to keep their exports affordable.) To get them back, we have to offer higher returns, i.e. higher interest rates, on their investments. Higher interest rates make for grumpy homeowners with ARMs, over half of recent home buyers. For a thorough discussion of the problems ahead for the dollar, check out The Dollar Crisis: Causes, Consequences, Cures. Rubino thinks Swiss Francs are the way to go. I'm not sure of that. I have money in Yen and Canadian Dollars right now. Subscribe to Chuck Butler's Daily Pfennig for daily commentary on foreign currencies.

Gold and other precious metals are another way to make money from a falling dollar.

Some more directly housing related stocks to short are those of title insurers, appliance and furniture manufacturers, property development companies and REITs. He also suggests going long apartment REITs and health care REITs. Apartments should do well, but I'd be more wary of the latter. REITs that own nursing homes should do OK, but I'd be hesitant to invest in hospitals which seem to be closing with increasing frequency as doctors are required to provide services to people who don't pay their bills.

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The state is that great fiction by which everyone tries to live at the expense of everyone else. - Frederic Bastiat