“I believe that home prices are a function of the local economy. If you can figure out future population trends and income per capita, you’ve got a great start toward predicting home prices. Demographic flows and better-paying jobs drive up home prices. or hedge an exposure.“
John Dolan has been the market maker for the S&P CME Case Shiller contracts for ~10 years. His previous roles include being the Managing Director at Salomon Brothers, President of the Fixed Income Analysts Society (FIASI), and Chief Investment Officer at Hyperion Capital Management (HCM). His Home Price Hedging Fund (“HPHF”) efforts are platforms (www.homepricefutures.com) where one can see quotes on forward home price indices, and one can express a view or hedge an exposure.
Q.1 Tell us your life story, how did you go from Wharton to HomePriceFutures?
In hindsight, my career was straightforward, in that, I went from getting my MBA, straight to trading on Wall Street, at age 23 and then asset management. I had planned on focusing on public finance (to do some good for municipalities). Still, when management saw how young I was and that I was a math major, they said (in 1977), “Oh, you know math. We’ll put you in this new Mortgage-Backed Securities (MBS) market for a few years to start. It requires math. You’ll see how markets work”.
I figured that I’d learn one aspect of Wall Street and later get back to my goal. Forty-plus years later, I’m still involved in discussions of mortgages and home prices. (I did later satisfy my desire to help municipalities via roles in local government).
My journey took me through management of MBS trading desks, including a stint as Managing Director at Salomon Brothers, as a board member of the Public Securities Association (which later evolved into SIFMA), and as President of the Fixed Income Analysts Society (FIASI).
In 1995 I switched to the “buy side” and in a few years found my way to Hyperion Capital Management (“HCM”) (my second employment by Lewis Ranieri). I went on to become Chief Investment Officer and ending touring the world, describing our firm and mortgage investing as we raised assets under management.
I left in June 2007 after HCM was bought out by Brookfield, just in time to watch the markets meltdown from the sidelines.
I had a friend who had been part of the expert witness world for the (somewhat forgotten) subprime lending crises of 1997-1999 (e.g., Conti, Money Store). He said that he was being bombarded by his old legal contacts in anticipation of litigation related to the (then-current) subprime market collapse and asked if I could help.
I did sign on for a short time as a consultant, and one of the first cases (in 2008) posed the (Watergate vintage) question, “what did they know, and when did they know it,” with the “it” here being when home prices would collapse. I recalled that a contract on home prices had been introduced in 2006, and as someone who thought that markets revealed sentiment, that market might hold the answer.
In time (so 2009-10), I formed my own company and decided (as a former trader) to dig deeper into these Case Shiller home price index contracts. I was bidding and making offers on markets that were incredibly wide but saw no reactions. After not being able to contact the market makers listed on the CME website, I called the CME to ask why my quotes weren’t getting a reaction. They said that all of the market makers, or their firms, had left the business during the crash and quickly offered, “Would you like to be a market maker?”
Seeing that I was already posting bids and offers, I decided to go forward, as at least then other users would have someone to call. That was 2010.
The CME Case Shiller futures have given me a reason to stay current on things driving home prices (so the macro-economy, state of the MBS market, mortgage rates, housing policies, demographics) – all in the context of bids and offers on forward settlements that required comfort from math (whether how indices worked, or how forward markets should be priced).
I still have an active role as an expert witness in cases related to the Financial Crises (so that pays the rent). Still, the notion of creating a platform that people and companies might use to hedge one of the biggest financial exposures is what gets me out of bed.
There is no financial compensation, you can’t make much money on small volume, and there are people who are much smarter than me on price moves in individual cities, so this hasn’t been a financially lucrative effort. That said, I’ve gotten to brainstorm over the years with Bob Shiller, people at HUD, FNMA, the National Realtors Association, and the Mortgage Bankers Association. I’ve been invited to speak at industry groups and colleges. My original market-making efforts have led the CME to invite me to make markets in two new contracts (one on water prices in California and the second on voluntary emissions), where I am getting paid.
Q.2 What should people know about the Home Price hedging fund?
The most important thing to take away from the CME Case Shiller futures contracts and my Home Price Hedging Fund (“HPHF”) efforts are platforms where one can see quotes on forward home price indices, and one can express a view or hedge an exposure. Merely increasing the visibility of both platforms is the necessary (but not sufficient) first step.
Q.3 How does HomePriceFutures help investors?
One of the most anxiety-provoking issues people face is the binary Rent vs. Buy vs. Sell decisions. The decision to buy a house is often the biggest financial exposure that many individuals face. Yet, unlike stocks for their retirement programs, where they can incrementally add or reduce exposure (think dollar-cost averaging) or buy a diversified portfolio of stocks, in real estate, it’s “all or nothing,” “buy or rent,” “stay or sell,” with all the implications of having all of their eggs in one basket, and all at one time. There are few halfway decisions. The most significant decision that some Millennials make before buying a $500,000 home is a $20,000 car. They go from that to making a one-time decision (if they can) that will be incredibly influenced by the luck of timing.
By contrast, home price index derivatives allow users to make bite-sized decisions (e.g., $50-75,000 notional exposure per CME contract) to add or reduce exposure to a regional index of home prices. Real estate agents are fond of saying that the three most important real estate features are “location, location, and location.” I agree but interpret that as regional, neighborhood, and property-specific features. While real estate agents add great value on the last two aspects, the first has a huge influence on home price -and can be hedged! That is, home prices in Las Vegas will be a function of tourism, prices in Austin will be driven by its increasing role as a tech center, Miami prices will be impacted by climate change, and Nashville prices will be impacted by growth as a health care center, across all neighborhoods and individual homes. If you’re concerned about (or enthusiastic about) the trends driving the first “location” factor, home price index derivatives should be a way to express those views.
Future buyers can add exposure, those preferring to rent can still have price exposure, and those worried about having too much home (either due to gains or because they intend to sell/move) can attempt to hedge with home price index derivatives.
Q.4 Which cities are you bullish on?
One of the first lessons any trader learns is not having an emotional attachment to a position or thinking that they know more than the market. As such, I try to stay neutral, merely aiming to find a clearing level where buying interest is close to selling interest. However, as a fan of markets, I see that implied forward HPA (home price appreciation) is highest for the San Diego, Denver, and Boston contracts. Each city has compelling longer-term stories, and I can’t disagree with the market’s assessments.
Q.5 Which cities might be experiencing a bubble? Why?
My answer here would be similar to Q3, with the added feature that even Nobel Prize economists have said that bubbles are only evident in hindsight. Further, if one defines bubbles as a risk of the 2006-2008 scenario, I’d say that I don’t see that kind of risk to any large city. I hate to rely on the “this time is different” mantra, but as of June 2021, I think that’s the case. Fundamental demographic factors (e.g., Millennials reaching home-buying age, lack of inventory, high costs to increase supply (e.g., lumber), low-interest rates, and lack of overleveraging (the bane of 2006-2008), all support the notion that a collapse in home prices is not likely.
My concerns are longer-term, e.g., sea levels flooding Miami Beach, a move away from oil as an energy source to Texas, pension liabilities bankrupting Chicago, smog impacting the Salt Lake basin air quality, the adequacy of water supplies to many places, such as Phoenix, and the possible redistribution of wealth via increases in real estate taxes, but each of these is beyond any timeframe considered a bubble.
Q.6 How has COVID 19 impacted the real estate market?
On the one hand, there’s been a transition to people wanting more space (e.g., to work from home). This impacted smaller regions (so somewhat lost within some intra-index moves (e.g., within the Case Shiller NYM region), but clearly apparent in a preference for second-tier cities. Time will tell how permanent is that geographical preference.
An angle that hasn’t gotten much press is whether this scare with one’s mortality might accelerate people’s life goals. Will they marry and have kids sooner? Will they travel more? There will be an explosion of post-Covid euphoria (like post-WWI), or will the lessons of post-WWII and the resulting baby boom be an outcome that would impact where people plan to live and regional home prices.
Covid has made people more aware of the role of uncertainty, and we should appreciate that while the outlook has improved (at least for now in the States), variations are a feature of viruses and that Covid could return in some other format.
Net, an increase in uncertainty should increase the range of possible scenario forecasts.
Q.7 What are some myths about home prices?
The key lesson learned from 2006-2008 is that no, they don’t always go up. They might have risen for much of my life, but some portion of that must be attributed to inflation, the forty-year decline in interest rates, and benefits (yes, it was good) from securitization. The last two are late in their cycle. However, securitization is relatively new in other parts of the world and may lead to higher home prices there.
One “myth” that I believe is that home prices are a function of the local economy. If you can figure out future population trends and income per capita, you’ve got a great start toward predicting home prices. Demographic flows and better-paying jobs drive up home prices.
I think that there is a myth that home price gains are universal, but I’ve been following home prices in Paris for years (first with futures and later with an attempt to offer OTC agreements) and I’d note that the Paris home price index (and my forward quotes) are quite flat.
Q.8 Home prices are at an all-time high, what is your long-term outlook on them?
Well, I’d start by reminding people that they’ve been at all-time highs each of the last 12 months, and all forecasts over the previous year to suggest that they were too high then were wrong. When trading, it’s equally painful to be early as wrong. Also, home prices tend to have momentum, and (as I noted above) I can see little to change that over the next six months. Net, they may be high, but they will likely head higher. (At least that’s what the contract prices suggest). Net, it’s too soon to call a top.
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