How to profit from falling house prices

By Bengt Saelensminde Jun 01, 2010

Bengt Saelensminde

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My view on house prices is controversial to say the least.

Most people don't agree with me. In fact one kind soul went as far as to call me an idiot. But being in the minority is something I'm perfectly comfortable with.

And now it's not just me who's saying house prices are about to resume their down-trend, the markets are saying so too.

UK House Price vs. FTSE 100

Source: IG Index

Here's a chart of UK house prices against the stock market since the financial crisis began in the summer of 2007. I've rebased both the FTSE 100 and the Halifax's house price to 100. The blue line is the FTSE. You can see how it tanked at the beginning of 2009 and then began the great come-back rally. House prices (the red line), didn't fall as sharply, but the recovery was pretty similar.

Now, I find most charts a little disconcerting, as they only tell you about the past.

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However, you may notice that my chart goes into the future too. This is because I've downloaded data on where people are betting that house prices are going. That's the part of the red line on the right hand side of the chart.

IG index (the spreadbetting company), offers bets on the quarterly index published by Halifax. The latest data says that the average UK house price was £168,400 at the end of March. And right now, the spreadbet for the end of March 2011 is 163.8 – 166.6, indicating prices are going down to £165,200 (the mid price of the quote).

To arrive at the quote, they take off three decimal places from Halifax's data. So if you wanted to get exposure to 'an average UK house', then you can either sell (short), or buy (long) the quote at £1,000 per point.

These figures aren't screaming a warning... yet. At the moment it's pencilling in a gradual fade, rather than a crash. But bear in mind, up until recently, these futures were indicating higher prices, but with all the recent gloom, the curve has moved downwards.

But I reckon there's a bit more mileage in a down-bet. I reckon that prices will soon resume their down-trend...

So what about the UK economic recovery?

Up until recently, the markets have been basking in the warmth of the global economic recovery. The stock market is said to be a 'lead indicator', meaning it goes up before the economy does, as it's anticipating all those lovely profits from a recovery.

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But over the last month or two, that's all changed. The FTSE's begun to slide again... could it be that we're not going to get that economic recovery we've been promised?

Europe's gremlins are coming out of the closet. There are all manner of structural economic problems for nation states and we could well be heading into another downturn. So why am I still reading about house price recovery?

The stock markets react to news instantly and often violently, losing or gaining several percent in a day. Not so the housing market. As the chart confirms, if the stockmarket is the hare, then the property market is the tortoise. But don't think that this means housing doesn't react to the wider economy.

That's the mistake that much of the media is making now. I'm still reading about how house prices will continue to recover next year, but these guys are taking their cue from the past. They're looking at the traditional spring bounce we've just had and extrapolating it forwards.

I'm taking my cue from today's economic reality.

I'm looking at European-wide stagnation (at best), I'm looking at government cuts and I'm looking at rising unemployment. I'm looking at a stock market that's heading back into its down-trend and sapping confidence as it goes. And don't even mention the banks...

If the banks are about to get hit again, then they're hardly going to be in a position to increase mortgage lending.

So while the spreadbet prices are already bearish on housing I reckon they've got even further to fall. Property markets are cyclical and we're still on the down-curve.

How to take advantage

The most direct way is to short sell house prices using a spreadbetting account (you can compare the top twenty spreadbetting accounts, and apply for one online, here). So, if you sell the March 2011 quote at £163.8 at £10 per point and house prices fall say 8%, then the bet will close out at £155 and you'll pocket 8.8 points (163.8-155 = 8.8) times your stake. In this case we put on £10, so it would be £88.

If house prices go up, the maths goes into reverse. In fact, if you disagree with me and you think that house prices will go up then why not place an up-bet on the house prices?

• This article was first published in the free investment email The Right Side on 26 May 2010.

Spread betting is not suitable for everyone - ensure you fully understand the risks involved and never risk more than you can afford to lose. Spread betting carries a high level of risk to your capital. Prices can move rapidly against you and resulting losses may be more than your original stake or deposit. Margin amounts vary between spread betting companies and the type of markets spread bet. Commissions, fees and other charges can reduce returns from investments. Tax treatment depends on individual circumstances and may be subject to change in the future. Your capital is at risk when you invest in shares - you can lose some or all of your money, so never risk more than you can afford to lose. Always seek personal advice if you are unsure about the suitability of any investment. Please note that there will be no follow up to recommendations in The Right Side.

Managing Editor: Theo Casey. The Right Side is issued by MoneyWeek Ltd. MoneyWeek Ltd is authorised and regulated by the Financial Services Authority. FSA No 509798. http://www.fsa.gov.uk/register/home.do

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Published in Property | More articles by Bengt Saelensminde

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  • 1. CRM

    (01 June 2010, 12:21PM)  Complain about this comment

    You might think it prudent and appropriate to warn readers of the dangers of spreadbetting on the Halifax HPI to reflect bearish market sentiment. For example, the Tradition Future HPI just over a year ago (see http://www.tfsbrokers.com/pdf/news/2009/april/TraditionFutureHPIPressReleaseApril.pdf) predicted a 21% fall in the Halifax HPI over the following 12 months using OTC residential property derivatives as its basis. For readers' protection (and for balance), you might wish to reproduce the calculation for how much they would have lost had they chosen to short the market in this way. Or perhaps you're comfortable that your final paragraph suffices in this respect....

  • 2. Beta adjusted

    (01 June 2010, 02:10PM)  Complain about this comment

    sure CRM, you could say that about shorting the market since March '09. A 5-year old can do the maths and only a fool wouldn't. You also refer specifically to speculation vs hedging. For people who simply want to live in their house and not have to worry about the direction of house prices , provided they have sufficient liquidity they can at least partially hedge their property exposure i.e. partially neutralize their property exposure.

    It might also be of interest to the odd first-time buyer, who might have a substantial potential deposit but be wary of getting exposure to property at this time. One could purchase a house and could e.g. hedge half the value; this might limit their losses in a big fall to 15 - 25% which is mitigated somewhat when you consider the benefit of paying a low mortgage rate vs rent. Similarly, if you want property exposure, why not just go long a diversified residential property fund trading at discount to NAV?

  • 3. CRM

    (01 June 2010, 03:33PM)  Complain about this comment

    Thanks, Beta Adjusted. Fair and vaild points.

    My key concern is the advocating of spread-betting (and taking an uber bearish position) as a means of hedging against notional house price falls on notoriously volatile monthly measure to those who may have been previously unaware of the existence of the trading platform (who are by definition unsophisticated investors). I'm a little suprised that MW would proffer this.

    But as you say, even a 5 year old would put in sensible stop losses or ensure that they had the available funds to close out on a position should the market move the wrong way (and be prepared to lose that amount).

  • 4. Chris

    (01 June 2010, 04:45PM)  Complain about this comment

    With the present weakness of the pound, the changing value of money has probably a greater influence on house prices than the changing values of houses. Therefore, beware of betting on falling house prices when sterling could fall even faster than house prices, making them appear to go up. I believe the stock market and house price rally of the last year has really been a fall in sterling, not a rise in prices. Even if house prices are falling in real terms, this type of bet could lose you a lot of money unless you short sterling as well in order to hedge yourself.

  • 5. RON

    (01 June 2010, 05:18PM)  Complain about this comment

    I am very surprised that Money Week is promoting spread betting,
    why not tip a few horses ?
    you have lost credibility in my view.

  • 6. John

    (01 June 2010, 08:45PM)  Complain about this comment

    Back in the early 90's, I took interest in the other property index, the Nationwide. I found one quarter that had all categories bar one falling by solid amounts, but the exception was 3 bedroom houses in Ulster. This category apparently went up by over 20%, apparently. Obviously a questionable result, being either a typo, freak or outright error. Frankly this should not have been included in the overall average, but this was done.
    Surprise, surprise, a quarterly national average that was positive.
    Basically the figures stank.
    Now I am not saying that Halifax is other than pure as the driven stuff, but the index is compiled by an organisation that has a very strong interest in a housing market that goes up or at leastdoes not decline much.
    Do you not recall the failure of the property futures market 20 years ago?
    I prefer to speculate on something that is verifiably linked to reality. Housing indexes are not verifiable.

  • 7. noah

    (02 June 2010, 12:06PM)  Complain about this comment

    Here we go again, you fool! with 90 percent and 95 percent mortgages making a steady comeback , it wont be that long before 100 percent mortgages are back, requiring no deposit. So i seriously doubt the housing market will struggle for long. Banks, and to some extent government, will encourage a strong recovery in house prices and house purchases. its the only way this country makes any money! those with money lend to the poor. If govt and banks run out of cash to lend, they print more, or buy more of it in , in order to lend it out at massive profit. simples!

  • 8. Tony Loton (LOTONtech)

    (02 June 2010, 03:54PM)  Complain about this comment

    RON:

    Financial Spread Betting is just a trading vehicle, like a regular brokerage account, and has nothing to do with horses -- unless your place a sports bet, of course ;-)

    Taking a very-seriously-researched stock, and placing a spread bet on it with a 'stop order' and / or small 'position size' (to limit your risk) is really no different from buying the shares in a regular brokerage account. With a 'rolling bet' you could even hold it 'for the long term' and collect the dividends along the way.

    What I mean is that, just like cars and dogs, spread betting is not in itself dangerous... in the hands of a responsible user.

    Tony Loton,
    author of the "Trading Trail" (blog)

  • 9. Alex

    (04 June 2010, 02:04PM)  Complain about this comment

    I agree with John, you're encouraging people to place leveraged bets on an index that is illiquid, opaque and open to manipulation. I'd steer very well clear.

    I also would question whether the IG Index spread bet housing contract has any predicitive merit what so ever as an indicator of the likely direrction of house prices......

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