Real estate is a capricious beast. People still need places to live and businesses still need offices, warehouses and storefronts. It is therefore unlikely that the demand for buildings, whether residential or commercial, will drop completely.
That being said, the real estate market is complex and, like other asset classes, it tends to be cyclical with ups and downs. Factors such as inflation, changes in interest rates, recessions, wages and even changing workplace standards all have the potential to disrupt demand for homes, offices and other types of real estate.
If you expect an increase in demand, investing in real estate companies, REITs, construction equipment manufacturers, mortgage loan providers and other property-adjacent assets might seem like a no-brainer. But what if you think real estate is overvalued and you expect the value of the housing and real estate market to decline? What are the practical ways to bet on the loss of value of the real estate sector?
While real estate, like healthcare, industrials and technology, is a cyclical asset class that gains and loses value over time, it is notoriously difficult to time any market, and Winning big on a well-timed bear bet like Michael Burry is usually the exception, not the rule. When speculating, always proceed with caution, avoid putting all your eggs in one basket and never invest more than you can bear to lose.
1. Short (or buy put options on) a specific REIT
REITs (Real Estate Investment Trusts) are publicly traded companies that own or finance income-producing real estate and distribute most of their earnings to shareholders as dividends. Many of them specialize in a particular type of real estate (for example, hotels, rental properties, warehouses or student accommodation).
If you expect a certain segment of the real estate market (as opposed to the entire industry) to lose value, your best option may be to short a specific REIT that specializes in properties in the real estate industry against which you would like to bet.
For example, if an investor’s analysis has led them to believe that the travel accommodation industry may experience a decline over the next two years (perhaps due to wages not keeping up with the inflation or pandemic-related travel restrictions), he might briefly choose one or two REITs that specifically invest in hotels, resorts or vacation rentals.
It is important to note here that to short sell a REIT (or any stock, for that matter), you will need a brokerage account that allows you to borrow stocks. First, identify one or more REITs that you want to sell short. Next, determine how long you think it will take for these companies to lose value. Borrow the shares for an appropriate term and then sell them back at market value. If your analysis turns out to be correct, the companies will lose value before you are forced to buy back shares at a lower price and return them to your broker, pocketing your winnings.
Keep in mind that if your analysis (or your timeline) turns out to be inaccurate, you will still need to buy stocks to return them to your broker, and they may cost as much (or more) than you sold them for.
If your brokerage doesn’t allow you to borrow stocks, you may still be eligible to trade options, in which case you can buy put options on the REIT that you believe will lose value. When doing so, be sure to consider expiration dates carefully, as you can only profit from them if the price of the REIT falls below your strike price by more than the premium you paid for the contract before its expiry date. If this happens, you can resell the contract for a profit.
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2. Sell (or buy put options on) a specific stock
Alternatively, you can short a specific stock (or a few) that is involved in the real estate market (eg, large residential construction companies like DR Horton or NVR).
It’s important to keep in mind here that traditional stocks tend to be more volatile than REITs because REITs are primarily valued for their high and regular dividends, so their stock prices don’t trend. to oscillate so dramatically. This means that shorting an individual homebuilding stock could offer more upside potential, but also higher risk.
If an investor noticed that housing starts were falling during a period of high inflation and slow wage growth, he might be inclined to bet that homebuilding stocks would suffer. They could borrow shares of one or more homebuilders from their broker, resell them immediately at market value, then buy them back once their price drops before returning the borrowed shares to their broker.
Alternatively, they could buy and resell put options on the same companies in the same manner described in the REIT section above.
3. Short (or buy put options on) a real estate ETF
If you’re bearish on real estate in general and want to mitigate risk by shorting a more diverse range of real estate-related assets, you might also consider selling short (or buying options). sale) on a real estate ETF. Some of them only include REITs and are more dividend-oriented, while others include REITs as well as homebuilders, mortgage lenders, materials companies, and more.
If you have a relatively long time horizon, it may be better to choose the latter, more diversified type of real estate ETF, as different components of the real estate space may fall at different times, and the decline of one category (such as builders of houses) could have a cascading effect that then shakes up other categories (such as building material suppliers or mortgage providers) due to the drop in demand.
4. Invest in a real estate inverse/bear ETF
If you want exposure to what you hope will be a declining property sector but don’t want to worry about the hassle of using derivatives or borrowing stocks, you can also invest in an ETF reverse or bearish. These are pooled investment vehicles which, instead of investing directly in a thematic range of securities, use derivative and short selling techniques to profit when that same thematic range of securities loses value.
For this reason, investing in a bearish real estate ETF is probably the easiest way to bet against the housing and construction market with a traditional brokerage account.
Beware, though, that many inverse ETFs are heavily leveraged in order to multiply returns, which means losses are also multiplied. The ProShares UltraShort Real Estate ETF, for example, has 2X leverage, which means that if the assets it is short on lose 1% of their value, they gain 2%. Alternatively, if the assets it is short on gain 5%, they lose 10%.
Leveraged inverse ETFs are extremely risky and should be approached with caution and diligence. For risky real estate bears with lower risk tolerance, an unleveraged inverse ETF may be a better option.
Real estate tends to be overvalued on a somewhat cyclical basis, but it’s also inextricably linked to factors like inflation, wages, and Fed actions, so trying to time its ups and downs doesn’t hurt. is not an easy task.
The above are just a few ways to try and expose your portfolio to a possible downside in the sector if you are feeling bearish, but as with any speculative investment decision, be sure to do your research and consider the risks involved and the importance of maintaining a balanced and diversified portfolio so that inaccurate forecasts do not end up depleting your savings.