Today I’m going to give you three ways to short the housing market in 2024. The three methods I’ll outline are shorting the following:
- Real Estate Investment Trusts (REITs)
- Home builders
- Mortgage backed securities
These are tailored more toward beginners, so be on the lookout for later articles with some more advanced methods!
What is a Short Position?
A short position is simply earning a profit when an underlying financial instrument, security, stock, etc. declines in price. This can be done primarily via short selling and/or put options.
I’ll get into these more as I discuss each shorting strategy.
Shorting Methods
Put Options
Purchasing a put option on a stock is fairly straightforward. You simply purchase the right to sell a security at a particular price (strike price) before a certain date (expiration date). As the stock goes down in price, the value of your put goes up.
The breakeven point on the put is:
Breakeven Price = Strike Price – Premium Paid
Once you pass the breakeven point, you would make extra cash by exercising the put option instead of just selling the stock on the market.
You don’t even need to own the stock you are shorting in this case. The contract itself has value and could be sold to another investor who does own the REIT.
All in all, puts are a great option for a smaller short position. It does not take much capital to begin your short position, and your risk of loss is only the premium you paid if the contract expires worthless.
Short Selling
This method is NOT RECOMMENDED for beginner investors. But I will briefly explain it anyways as it is a commonly used method to short an underlying.
To short sell, you borrow the shares of the stock from a broker and then sell them on the market at market price. In the meantime, you pay interest on the loaned shares to your broker.
If the share price goes down, you can close out your position by purchasing the shares on the market at a lower price than what you borrowed at. The difference between these two, less your interest paid, is your profit.
This method is EXTREMELY risky as technically your risk of loss is infinite. If the underlying price skyrockets after you sell short, you will have to pay astronomically more for those shares at a later date to close out your position. You also risk a margin call as you generally need to hold some level of collateral against what you owe.
I generally never recommend short selling stocks. If you must, speak with a financial advisor and understand the risks. Be prepared to lose everything.
Method 1 – Shorting REITs
This is probably the most direct method to shorting the overall housing market. This involves entering into short positions on REITs.
REITs are investment trusts that trade like common stock which invest in real estate. They must pay out the majority of their earnings as dividends to qualify as a REIT. So their share prices are heavily tied to the market values of their real estate performance, as well as their ability to generate income.
In the event of a housing downturn, these REITs will be one of the first security types to be negatively impacted. As they are liquid (unlike direct ownership of real estate) the market quickly reprices them to account for this downturn.
Shorts on REITs, in the event of a housing crash, would gain value exponentially.
Method 2 – Shorting Home Builders
When we think back to past housing downturns, we generally only think of housing prices plummeting. But one of the hardest hit industries are home builders.
When home values decline sharply, people don’t want to buy houses or build houses. After the 2008 housing crisis, new home builds hit record lows for years and it decimated the home building industry.
Identifying a few home builder stocks to short, or even ETFs such as the iShares U.S. Home Construction ETF (ITB), would execute this strategy perfectly.
Method 3 – Shorting Mortgage Backed Securities
If we’re talking things that got popular after The Big Short, this is definitely one of them! A somewhat less direct way to short the housing market is by shorting mortgage backed securities (MBS). This method may not be all that it’s cracked up to be… but I’ll get to that.
An MBS is simply a bond that is a pool of mortgages. The mortgages are serviced by local banks, etc. and payments are made to the investors in the MBS. In the event of a housing market collapse, people start defaulting on their mortgages which could affect the price of an MBS.
The easiest way to short an MBS is via an ETF like VMBS that only invests in MBS’s.
As one final note – most MBS ETF’s, like VMBS, only purchase MBS’s that are guaranteed by the government (FNMA, GNMA, etc.) In 2008, these two entities collapsed because of so many defaults and were officially made government entities via their bailout.
So in the event of a housing collapse, an MBS investor would be safer from default risk than in 2008. However, if a housing crisis is truly catastrophic, the loss of faith in that government guarantee may not protect the price of an MBS ETF.
All in all, if you have faith in the government to make good on their guarantee, shorting an MBS ETF may not be the most effective. But for those if you willing to risk it, this is an enticing option.
Bottom Line
To wrap up, you should now know three methods to short the housing market.
REITs are probably the most direct security to short housing. Home builders are a close second, but they are a secondarily affected by a housing collapse. Lastly, shorting an MBS ETF is not what it used to be, but it has its merits.
Thanks for reading as always and happy shorting!
DISCLAIMER – THIS ARTICLE IS NOT FINANCIAL ADVICE. THIS ARTICLE DOES NOT CONSTITUTE A BUY, SELL, OR HOLD RECOMMENDATION ON ANY SECURITY MENTIONED HERE. THIS ARTICLE CONSTITUTES MY OPINION AND NOT A STATEMENT OF FACT. ALL INFORMATION REGARDING THE FINANCIAL SECURITIES MENTIONED IS ACCURATE AS OF JANUARY 24, 2024. DO YOUR OWN RESEARCH.