Covering Your Natural Short Position in Housing


Many bears in the housing blog space emphatically declare their intention to short the housing market.  Some have posited the viability of shorting some REIT or housing sector related equities.  The thing is, as financial journalist Felix Salmon and Carleton University’s Nick Rowe have written, we are born with a short position in housing.  Professor Rowe explains:

The rent on a house is like the dividend on a stock.  If I do not own a house, and rent one to live in, I pay rent, which is like having a short position. If I own a house and live in it, I neither pay rent nor receive rent, which is like being neither long nor short. If I own two houses, live in one and rent out the other, I receive rent, which is like having a long position.

So we are born with a short position in housing. We need shelter, and must pay rent to live somewhere.  When we buy a house to live in, we are covering that short position.

So if you’re renting, you’re already shorting the Vancouver housing market.  If you’re a bear, you don’t need to actually do anything. Just keep renting.  The same goes for all of you that sold your homes hoping to cash in later IF the market goes down.  Being long or short is just a bet.

Anyways I think this kind of thinking sheds some light on the local market.  In his article, Professor Rowe goes on to state some of the risks associated with owning:

1. My house may burn down, fall down, or in some other way stop providing me with the shelter I need. Some of those risks I can insure against; others I cannot.

2. The house may stay the same, but the type of shelter I need may change. I may need  a bigger house, a smaller house, or one in a different place. I face the risk that my old house may fall in price when I sell it, relative to the price of the new house I buy. True, but if my old and new house prices are positively correlated, I have at least partly hedged my risks, which is better than renting.

3. If I need to borrow money to buy the house, the future interest rate may be uncertain, and the risk that my mortgage payments will rise needs to be compared to the risk that my rents would rise.

4. If my house will last another 100 years, but I will only live another 40 years, I will have covered 60 years more than my short position. The future reverse-mortgage value of my house is uncertain. But if I make a bequest to my children this is not a problem. My children will have a short position in housing too. They will need somewhere to live.

The reason why the above risks are useful is that it can explain additional motivating factors to own a home in Metro Vancouver beyond mere cap rates or other like-minded metrics.   If we quantified these additional factors, you could call it an ownership premium, i.e. a justification for paying beyond what “fundamentals” call for.

Risk #4 above is particularly salient for the local market.  If you have kids, I’m sure you’ve probably wondered how your children are going to afford a place here.  As well, there are other risks (such as potential high rates of inflation, which penalizes cash holdings) that adds more weight to the hedging notion.  So logically, the ownership premium is your housing hedge.  For individuals in the right circumstances, owning is risk management.

So if housing is an absolute must and you don’t want to gamble, hedge your bets and take the plunge as many homeowners have done in the past.  However, if you’re sure of the future direction of the market, then take a short position if you think it’s going down (by renting or selling your principal residence) or going long (by purchasing additional homes beyond your principal residence).  At the end of the day, the rational foundation for prices above “fundamentals” is this ownership premium.  Ownership depends dually on the importance of housing to you as well as your tolerance of the risk of “being priced out”.


10 responses to “Covering Your Natural Short Position in Housing

  1. No

    If you are renting – you do not have a short positon in the market. You have no position in the market.

    You are not ‘born’ with a short position. You are born with ‘no’ position.

    If you have a short position you would profit from a downturn. If you just rent you will not ‘profit’ from a decline.

  2. I get what you are saying. Jon’s being a little too testy, albeit right.

    The overall analysis seems to ignore that the size of the mortgage is really the key. There’s Long, very long, and neutral. Neutral is a mortgage comparable to rent. You don’t have to own 2 houses to be “very long” and you have the risk of a margin call if you can’t keep up the payments.

    A family with take home pay of $100k and and a $5000/month housing bill (all in) is pushing it. If they don’t have a pension and they save another $30k to max out there RRSP….they have next to nothing to live on.

    That’s “very long” with just one house. Of course, we all know how this will play out. Generation Grasshopper will then whine 20 years on the road that they don’t have any savings and pension and want to retire at 55. Hopefully Generation Ant will tell them to sell their house, shut up, and start renting.

  3. I have long argued the same thing. No, not owning is not a short position in the literal sense. But since most people do intend to own housing at some point in their life, it can be seen as that in the practical sense.

  4. Investors don’t care about an “ownership premium”. This is obvious by looking closely at the business cases of successful REITs.

  5. Just because people intend to own housing in the long term does not make it shorting in the practical sense. They are deferring the purchase because they are bearish.

    I intend to own some shares in company at some point; but it doesnt mean I’m shorting it.

  6. I am so sick of the phrase “priced out”, particularly “priced out forever”.

    At the end of a bubble if the average person cannot afford a close to average home in the city then prices will go down. Forget all of the speculators and foreign investors. Eventually the price has to be set by incomes in the region.

    I make slightly about the average income in Vancouver (last time I heard the average was around 43K a year before taxes). I am also single (well, unmarried with no kids) so if I was to buy a SFH I would have to compete with dual income families, so it is reasonable to say I could not afford a SFH without making serious sacrifices. On the other hand those families have kids to feed while I have no dependents.

    Anyway if I continue to rent and save money, I will eventually be able to afford. After all, if the average working person cannot afford to live here, what is the financial incentive to live here? People keep saying there are thousands of immigrants each year, but what keeps them coming here if they can buy in Toronto for half the price, or many american places for 1/4 of the price? Unless salaries are reasonably in line with housing prices there is little incentive to move or stay here from a financial perspective.

    • Heywood U Blomee

      Hey Davers, There IS NO financial incentive to live here! There’s a nature incentive. We live in the most beautiful city in the world without many of the problems in other cities (but they’re starting to creep up here now too). Some want to live here because of the natural beauty, or the quality of life, while others are buying to speculate or think they can sell to a ‘greater fool’ in a couple of years, or, they don’t want to live in TO because it’s too muggy in the summer, too nippy in the winter and there’s nothing to do there but work and cultural stuff. Where ya gonna ski there? Ppl buy here because realtors and the media scare them into buying before the price gets even MORE ridiculous and then they will never again be able to afford — they think, and they think paying rent is throwing their money away (again the realtors convince them of this great lie)! Shelter has a cost, but so does borrowing money to pay for future shelter in advance, and they don’t think that a mortgage is paying rent!

  7. There are lots of people who are on the verge of losing their own homes because of the current economic crisis, but the bailout plan is only giving a little positive effect about it. But I’m still positive that in due time, the plan will eventually help these homeowners to save their houses from

  8. One paradox is the supposed demand coming from immigrants. If the population is always growing hence real estate will keep going up….how come there are less kids in school every year and they are shutting down schools…..

    • Heywood U Blomee

      rf: they’re DINKS (dual income, no kids) or their kids are grown up and finished school. Have you tried to get into a university in the last 15 years? Or maybe they live in the outer suburbs because they can’t afford to live in Vancouver (proper) in a big enough house?

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