How to short the housing market and REITs
Shorting the housing market and real estate investment trusts (REITs) are common methods used to take advantage of declining real estate prices. Discover what it means to short the housing market and how you can get started.
What does it mean to short the housing market and REITs?
Shorting the housing market is the practice of taking a position to sell an asset with the view that real estate will fall in value. This enables traders to hedge their exposure to the market and even profit from the decline.
Traditionally, short-selling involves borrowing the asset in question from a broker, and selling it at the market price. If the asset declines in value, you’d close the trade and sell it back to your broker – profiting from the difference in price. However, if the market price increased, you’d have to buy back the asset at a higher market price.
In this case, the asset in question will be related to the housing market. Sometimes, you might hear the phrase ‘short-sell a house’, but this is not the same strategy – it refers to the act of selling a house at a lower price than is currently owed by the homeowners. This usually occurs when a homeowner is in foreclosure.
What is actually meant by shorting the housing market is speculating that the price of houses will fall. There is no way to directly short the housing market, so investors and traders will trade alternative assets such as real estate investment trusts (REITs) or shares in companies within the industry.
As finding a broker who will provide REITs or shares available to short is difficult, most shorting is done with a derivative product such as a CFD. With these products, there is no need to own the underlying asset in order to open a short position, as you are simply speculating on the future direction of the market price.
Ways to short the housing market
There are a few different ways that you can short the housing market, these include:
Shorting an individual REIT
The most common way of speculating on the housing market is by investing in REITs – these are companies that buy income-producing real estate. REITs are classified as publicly traded companies, and as such investors can either buy and sell shares of a REIT itself or invest in a REIT exchange traded fund (ETF).
There are a variety of different REITs, depending on what you want to focus on, including industrial buildings, residential, hotels, hospitals and student housing.
Normally, you’d invest in a REIT if you thought that the housing market, or that particular area of the housing market, was due to increase in value. But if you thought that the housing market was going to decline, you might choose to short-sell a REIT.
If you wanted to short a REIT in the traditional sense, you’d have to find a broker that is willing to loan you the shares. However, when you trade CFDs, you can speculate on the price of REITs whether they are rising or falling. To start shorting REITs, you should:
- Research which REIT you want to short
- Carry out analysis on that REIT, both technical and fundamental
- Decide which trading strategy you want to use
- Start shorting REITs by opening an account
Shorting a real estate or REIT ETF
Exchange traded funds (ETFs) are instruments that track a basket of assets – such as a stock index, the shares of companies involved in the housing market (house builders, material suppliers, etc) or REITs. By opening a position to ‘sell’ an ETF, you are speculating that its price will decline.
For example, the ProShares Ultra Real Estate ETF tracks the daily performance of the Dow Jones US Real Estate Index – a stock index that includes REITs and other companies that invest in the development, management or ownership of US properties.
If you’d chosen to short the ProShares Ultra Real Estate ETF, and the housing market declined, it is likely the ETF would also decline as the constituents of the stock index lose value. You could then close your trade for a profit. However, if the ETF increased in value instead, your position would decline in value and you’d close your trade for a loss.
Going long on an inverse REIT ETF
There are also ETFs specifically made for shorting purposes, known as inverse ETFs – the price of these assets rise as the underlying market falls in price. If you wanted to short-sell the housing market, you would do so you would do so by going long or ‘buying’ an inverse ETF, as the tracker is inherently short-selling the market. This means that any bearish investors and traders can immediately get exposure to a declining housing market. If you wanted to take a short position on a reverse ETF, you would do so in expectation the underlying market would rise in price.
Inverse ETFs will usually have ‘short’ or ‘bear’ in the name to distinguish it from the regular ETF. For example, the Proshares Short Real Estate Fund or the Direxion Daily Real Estate Bear 3X ETF (DRV). The DRV inverse ETF is leveraged to return three times the amount of the Morgan Stanley Capital International (MSCI) US REIT index – so if the index declines by 1%, you’d gain 3% from the DRV. However, it is considered high risk, as if the index increased by 1%, you’d lose 3%.
Shorting individual real estate stocks
Finally, traders can choose to go short on shares of individual companies that are involved in the housing market and real estate. This largely includes home builders, such as Crest Nicholson and McCarthy & Stone, as well as building material suppliers, such as Travis Perkins.
To short a real estate stock, you would:
- Decide whether you want to deal real estate shares directly or speculate on their price movements via derivatives
- Open a position to ‘sell’ the stock you want to short
- Monitor the market price and housing market as a whole to see if your prediction was correct
- If the market fell, you’d close your position by ‘buying’ the shares back, and profit from the difference in price
- If the market price increased instead, you would have to buy the real estate shares back at a higher price
Homebuilding stocks are closely tied to the outlook for the housing market as a whole, as everything from builder confidence, labour costs and rising commodity prices can have an impact on housing prices. For example, if commodity prices increase, it becomes more expensive for these companies to buy raw materials and their revenues would suffer as a result.
The prices of homebuilding shares are seen as a leading indicator of the sector as a whole because if there is a squeeze on these companies, the price of houses could increase and buying could become less affordable.
Risks of shorting the housing market
Although the idea of shorting the market has been glamourised by films like the Big Short, it is very much a risky business for a number of reasons. For example:
- There is the potential for unlimited loss, as theoretically the underlying asset could rise exponentially
- Traders can get stuck in ‘short squeezes’ when the market price rises and short-sellers rush to exit their positions, driving the price higher and higher
Before you start to short-sell, it is vital to create a suitable risk management strategy, such as adding stops and limits to your positions.
It is important for traders and investors to be aware of interest rates cycles. If interest rates are low, the cost of borrowing is less, and more people are able to afford mortgages. This means that the housing market will likely boom, house prices will be higher, and companies will thrive.
However, when house prices skyrocket, it can lead to a housing bubble and financial crisis. For example, in 2006, in order to meet the demand for housing in the US, banks and mortgage brokers offered home loans to pretty much all applicants. When the Federal Reserve (Fed) raised interest rates, the mortgage rates soared, and house prices plummeted as borrowers defaulted on their loans. This led to the 2008 financial crash.
It is difficult to predict if and when a market crash will happen, which can make knowing when to open a short position difficult. This is why many traders and investors will perform both technical and fundamental analysis to identify possible turning points in the market.
Many analysts believe that if house prices and share prices do fall, it is likely that a strong rally will follow as sentiment improves. Just as house buyers and investors watch prices for a key level at which to enter the market, it is necessary for short-sellers to be aware of the same levels. Knowing when to exit your position is absolutely vital.
Shorting the housing market summed up
- Shorting the housing market is the practice of taking a position with the view real estate will fall in value
- Traditionally, short-selling involves borrowing the asset in question from a broker to sell
- But with derivative products, such as CFDs, there is no requirement to own the underlying asset to open a short position
- The most common way of speculating on the housing market is by investing in REITs but short-sellers also use ETFs, inverse ETFs and the shares of real estate companies
- Before opening any position, it is important to perform thorough analysis of the housing market, using both technical and fundamental methods
- Short-selling the housing market comes with a number of risks, which is why traders need to have risk management tools in place
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