Real estate statistical arbitrage
Rocko Chen
December 15, 2008
Statistical arbitrage in real estate investments at this point remains possible in theory; it just requires some legwork and a complete understanding of the financial markets. It does not matter if the collective real estate market declines further or experiences unexpected growth, this could be doable.
This is all theory as I do not personally bet on real estate, so please keep in mind.
The 2-step entry
1. Bartering
As the media (especially here in New Zealand) rains down forecasts of drastic unemployment hikes and deteriorating property values for the coming year, it gives buyers leverage. Who cares if the TV people are right or wrong, as long as they make inexperienced property sellers weak in the knees, it is time to go in for the kill; demand steep discounts (40%+ in US, 20%+ in NZ) from the last bid, not offer.
I understand the above step requires one to find an incredibly naïve counterparty and seems incredibly challenging. Fear not, the market is full of them, egotistical, fearful, and unaware… who do you think created these bubbles?
2. Hedging
As soon as the long side deal closes, the investor takes a short position in a US listed REIT (Real Estate Investment Trust) of equivalent value. The discount, positive discrepancy, or potential profit becomes largely protected.
The Exit
Now that the position is hedged, it does not matter if the value increases or lowers. As long as the new buyer pays up at the bid or a smaller discount (before transaction costs), the investor covers the REIT short position, and a profit is made.
Main risks
The scheme transfers the original risk of speculative, directional loss into more manageable forms.
1. Opportunity cost. Obviously other forms of financial instrument trading could yield higher returns and less leg work or time. But then again, it all depends on what the investor knows and is comfortable with.
2. Credit risk of new buyer. If the new buyer fails to provide enough cash or get a mortgage from the bank, the investor risks the headaches of crazy paperwork and time I´d imagine.
3. Credit risk of clearing firm. If the clearing firm who the investor went through for the short position(s) falls, the amount could be lost or stuck for a while. This remains a very low probability event, and can be managed with further labor in monitoring credit conditions.
4. Exchange rate risk. This is possible for those with "long" real estate positions outside the US.
This is all theory as I do not personally bet on real estate, so please keep in mind.
The 2-step entry
1. Bartering
As the media (especially here in New Zealand) rains down forecasts of drastic unemployment hikes and deteriorating property values for the coming year, it gives buyers leverage. Who cares if the TV people are right or wrong, as long as they make inexperienced property sellers weak in the knees, it is time to go in for the kill; demand steep discounts (40%+ in US, 20%+ in NZ) from the last bid, not offer.
I understand the above step requires one to find an incredibly naïve counterparty and seems incredibly challenging. Fear not, the market is full of them, egotistical, fearful, and unaware… who do you think created these bubbles?
2. Hedging
As soon as the long side deal closes, the investor takes a short position in a US listed REIT (Real Estate Investment Trust) of equivalent value. The discount, positive discrepancy, or potential profit becomes largely protected.
The Exit
Now that the position is hedged, it does not matter if the value increases or lowers. As long as the new buyer pays up at the bid or a smaller discount (before transaction costs), the investor covers the REIT short position, and a profit is made.
Main risks
The scheme transfers the original risk of speculative, directional loss into more manageable forms.
1. Opportunity cost. Obviously other forms of financial instrument trading could yield higher returns and less leg work or time. But then again, it all depends on what the investor knows and is comfortable with.
2. Credit risk of new buyer. If the new buyer fails to provide enough cash or get a mortgage from the bank, the investor risks the headaches of crazy paperwork and time I´d imagine.
3. Credit risk of clearing firm. If the clearing firm who the investor went through for the short position(s) falls, the amount could be lost or stuck for a while. This remains a very low probability event, and can be managed with further labor in monitoring credit conditions.
4. Exchange rate risk. This is possible for those with "long" real estate positions outside the US.
Print
Email
