Back in July I wrote about a really clever investment vehicle for speculating on hedging home prices – the Macroshares Major Metro Housing shares. Created by Robert Shiller, one of the creators of the Case Shiller home price index, these shares allowed you to profit or lose based upon the value of their index. However, as I pointed out, this investment had a lot of nuances. In the end these nuances left the shares neglected in the market. There was very little interest in them; the volume died; they traded at a discount; authorized participants were able to profit by buying them at a discount and liquidating them; the operating expenses were spread over a dwindling number of shares; one of the 13 early termination triggers was activated; and they no longer trade and are being liquidated.

It’s really a shame because it was a great idea: being able to easily trade what is otherwise an extremely illiquid investment. I personally made 42% since July on a small investment that I made in the up shares as I realized they were underpriced at the time. (Yeah, I should have bought more.)

Robert Shiller had created similar investment vehicles for taking positions in oil but these vehicles also died a premature death – in one case because oil prices moved much faster than anyone had predicted. (I made some nice dough on that one also since they were really, really misunderstood in the market.)

Despite this string of failures Robert Shiller is still a genius as far as I’m concerned. He correctly predicted both the stock and housing market bubbles and his data saved me a lot of money by pointing out that the stock market was overvalued in July 2007. I just think the guy is way ahead of his time and maybe too smart for his own good.

In a CNBC interview today, banking analyst Meredith Whitney cautioned that home prices could drop another 25%. Her argument is based upon the fact that unemployment, currently at 10%, is now driving foreclosures and she doesn’t see it getting any better any time soon.

Meredith Whitney is a force to be reckoned with because she accurately predicted problems at Citigroup in October 2007, long before anyone else did. However, her current prediction seems a bit pessimistic even for me – and I’ve been a die hard housing bear.

Let’s start by looking at where Chicago housing prices have been. The graph below plots the Case Shiller index for Chicago (blue line) along side a trend line (red). That trend line was conservatively based upon the first 12 years of the historic data. As you can see the bubble took off in early 1999 and has actually dipped below the trend line in the last 6 months. In fact, we are currently 9% below the trend! On this basis Chicago homes are a bargain and not likely to drop much more. Also note that the index has turned up in the last couple of months.

Furthermore, let’s look at what trading in the Macroshares Major Metro Housing Up Shares is telling us about the future direction of housing prices. As of today this instrument is implying an 8.35% price increase between today and August 2014. OK…so in theory housing prices could still drop 25% in the short run and still end up 8.35% higher than they are now – but that’s a stretch.

One other thing to consider is that with all the money that has been pumped into the system over the last year or so we could be heading for some serious inflation. We’re already seeing the dollar drop and oil and gold prices surging. When inflation hits you want to be owning non-financial assets and owe lots of money that you can pay back with cheaper dollars.

Hmmm. Have I turned into a housing bull? I really don’t like sounding like all the other realtors but I have to call it like I see it.

As of last Tuesday there is a way to trade houses just like you would stocks – sort of. A company called MacroMarkets has created two instruments that allow people to take positions that bet on the price of houses going up or down in 10 markets that comprise the Case Shiller 10 City Composite Index. The motivation for creating these instruments (aside from MacroMarkets collecting fees) was to permit homeowners to hedge their exposure to housing prices. These instruments are similar to ETFs in that they trade on the exchanges and their value is (loosely) tied to an index value, that being the 10 City Composite Index. The way MacroMarkets created these instruments is that they deposited money into two trusts – one of which represents an interest in the underlying index going up and the other representing an interest in the underlying index going down. Under the terms of the trusts, assets are passed back and forth between the trusts based upon whether the index goes up or down – i.e. when the index moves up money is transferred from the down trust to the up trust. Macromarkets then issued shares in each of the trusts – the MacroShares Major Metro Housing Up shares trade under the symbol UMM and the MacroShares Major Metro Housing Down shares trade under DMM.

Unfortunately, nothing in this life is simple. The devil is in the details. First you need to understand what comprises the Case Shiller 10 City Composite Index. It’s a weighted sum of the index for 10 cities as follows:

Composite-10 Market	Weights
› Boston:	0.07412188
› Chicago:	0.08886762
› Denver:	0.03682453
› Las Vegas:	0.01480245
› Los Angeles:	0.21161961
› Miami:	0.04986164
› New York:	0.27239040
› San Diego:	0.05513356
› San Francisco:	0.11787881
› Washington, DC:	0.07849949

As you can see it’s largely influenced by New York City, Los Angeles, and San Francisco – not exactly representative of the nation as a whole. Second, the trusts fluctuate in value based upon 3X the percentage change in the index – i.e. if the index moves up 1% the up trust benefits by 3%. Third, the benefit or detriment to the trusts is based upon the cumulative percentage change from the Starting Level of the index, which was somewhat arbitrarily set on February 24, 2009 when the index was 162.17. This level of the index corresponds to both the up shares and down shares having an underlying value of $25 each. Since the most recent index value was 150.34 the underlying value of the up shares is now $19.53. Fourth, the trusts terminate on November 25, 2014 when a payout is made to the shareholders based upon the underlying value of the trusts at that time. Consequently, the up and down shares will trade based upon investors’ expectations of the index value on the termination date – i.e. they will trade at a discount or a premium to the underlying value today. What that means is that in order for you to profit from these securities the index will have to move by more than what the market expected on the day you purchased them and it will have to move in a favorable direction. For example, if you buy the up shares the Case Shiller index will have to move up by more than what was implied in the price on the day you bought the shares. More on this later.

But wait, there’s more! The trusts can terminate early for any of 13 different reasons, including if the index drops below 108.11 or if the amount on deposit in the up or down trusts falls below $10 MM (someone at MacroMarkets explained that it is really based upon the combined value of the two trusts being below $20MM). Well, an index level of 108.11 corresponds to a further 28% decline in the index, which would put it back at June 2000 levels. So maybe that’s not that likely to happen. However, the trusts currently have only $20.5 MM on deposit between the two of them and there are two ways that it can fall further. One is through the redemption process, which is one of the mechanisms that is used to keep the two classes of shares priced reasonably (the other mechanism is the creation process which would increase the assets). The other way the value can fall is through a gradual erosion of value from the very high fee structure, which is 1.25% of assets plus $600,000 per year for each trust. Well, with only $20.5 MM on deposit this thing is on the hairy edge of termination. The last investment vehicle that MacroMarkets created like this, the up and down oil shares, recently died a similar death. And before it died the shares lost about 1% in value per month just due to expense erosion.

So what if the trusts terminate early? Well then, instead of your time horizon being November 2014, it suddenly shrinks to a much closer timeframe. While you might expect the index to move higher by 2014 you might not be as confident of that occurring in the next 3 months. So your entire investment thesis gets discombobulated.

If you can deal with all these nuances there might be a play in here for you. At the very least we might get some insight on what the price of these instruments tells us about expectations for the future. As of today the last trade for the up shares occurred at $14.00, which implies an index value of 135.6 at termination – another 10% drop from current levels. Only thing is we can’t really tell if that is a forecast for November 2014 or a forecast for an early termination before then.

Not many real estate brokers will tell you what I am about to tell you:

1. Most of the data you’ve been fed about housing price changes is grossly misleading
2. Housing is not the great investment that the NAR (National Association of Realtors) wants you to believe

Let me give you some typical examples of the information that is out there on the subject of housing prices and the problems with this information. While the information is usually true in some way it is often misunderstood, and sometimes that is the intention.

Example #1

Two days ago the Tribune ran an article, “Home sales, prices decline statewide; city not as bad”, which stated that the median Chicago condo price in March rose 8% over last year. So what do you think that means? That condos in the city have appreciated 8% in this lousy real estate market? I don’t think so.

All it means is that the median price of a condo which sold in March was 8% higher than the condos that sold a year ago. But that doesn’t mean that the value of condos went up. More than likely it means that the mix of condos which sold this March is skewed more towards expensive condos. Maybe this year there are more 3 bedroom condos being sold and fewer 2 bedroom condos.

Example #2

According to the Tribune’s Real Estate Market Pulse, in Lakeview between 12/1/2002 and 2/28/2003 the median home sales price was $320,000 vs. $245,500 one year prior. Some people would look at the Lakeview data and conclude that housing in Lakeview appreciated by over 30% in one year. However, this is that median problem again.

Example #3

In late 2006 and early 2007 the NAR ran an ad campaign that stated, among other things, that “Housing is a great investment, with average home valuations increasing 88 percent in the last 10 years”. That works out to 6.5% per year on average (keep that number in mind for later). Of course, this 10 year period just happened to coincide with the most outrageous 10 year period of housing appreciation in the nation’s history, for which we are now paying the price. Unfortunately, they’re implying that home buyers can expect that appreciation going forward, which is absurd. This self-serving information appears to be intentionally misleading. But isn’t that the point of advertising?

Example #4

In late 2005 the Tribune published a map showing home price appreciation for each of the Chicago communities and some of the surrounding suburbs. One of the communities they highlighted was Uptown, where they claimed home prices had appreciated on average by 9% per year over 10 years, which is huge. In addition, they showed the 1996 price of a home (presumably the average?) as $121,918 and the 2005 price of a home as $265,000.

This example is interesting because not only does it suffer from the median or average problem that I’ve already addressed, but it also suffers from a math error that seems to recur throughout this map. The percentage change is wrong. For Uptown, given those home prices the average appreciation rate (if you can call it that) actually works out to 8.1% per year.

The Correct Way to Analyze Housing Price Trends

Fortunately, there is a more robust way to track housing prices. The S&P/Case-Shiller home price index tracks repeat sales of homes so that they can really tell if homes are appreciating and by how much. This index has been calculated for 20 metropolitan areas and Chicago is one of them, going back to January 1987. For each metropolitan area they calculate the index for low, middle, and high price tiers, along with a composite index.

The Chicago metropolitan area is defined broadly to include the counties of Cook, DuPage, McHenry, Kane, Kendall, Lake, and Will. In this area the pricing tiers are defined as:

• Low – Under $227,766
• Middle – $227,766 – $348,054
• High – Above $348,054

Here is what the data shows:

There are several points to note in this graph:

• Data for the individual tiers are not available prior to January 1992
• The lower priced tiers have appreciated more rapidly than the higher priced tiers. This makes sense in light of the “innovations” in subprime lending that spurred growth at the lower end of the market.
• The Chicago housing market peaked in September 2006, right around the time that the NAR came out with their great investment campaign. Since then prices have declined 9.1%. I guess it wasn’t such a great investment after all.

Speaking of investments, how has Chicago real estate performed as an investment? Case-Shiller provides comparisons of various asset classes such as stocks, bonds, commodities, and housing over the last 10 years, which has been a stellar time period for housing. I won’t bother to show you how Chicago real estate compared to stocks because we all know that stocks haven’t done that well during this time period. However, comparing Chicago real estate to bonds is a different story:

Basically, over this time period, you would have ended up slightly better off had you invested in bonds vs. Chicago real estate. However, there is a bit more to the story:

• The average appreciation of Chicago real estate from January 1987 to December 1998 was 3.7% per year.
• Starting in 1999 people thought they were rich (remember the tech bubble?) and they went on a home buying spree. In addition, this is approximately when subprime lending really took off.
• From January 1999 through the peak in September 2006 the growth rate jumped to 8.3% per year.
• To put all these percentages in perspective Robert Shiller (of the Case-Shiller Index) analyzed home prices going back to 1890. For the first 100 or so years of that time frame his data shows that the average appreciation of homes, after adjusting for inflation, was….are you ready for this? Zero!

Nevertheless, someone will always say “But I’ve owned my house for 3 years and my equity has doubled”. OK…but that has to do with leverage, and in the good ol’ days that leverage was 5:1. Since then it has sometimes been infinite. So if your house appreciates by 20% and you are leveraged 5:1 then your equity doubles. Of course, leverage works both ways. If your home depreciates by 20% then you are wiped out, and this has happened to a few people lately. It happened to me in New Jersey in 1993 (actually, I lost double my equity). However, if you like leverage, you can leverage investments in stocks, bonds, or commodities as well. It’s a great way to lose your ass.

OK. So why is a real estate broker telling you all this? Shouldn’t I be convincing you to buy, buy, buy? For one, I am sickened by the self-serving analysis of the real estate industry and I want to set Lucid Realty apart from this madness. Secondly, I want to make a really important point: Your house is not an investment. It is a place to live. Don’t buy a home primarily because of some perceived investment opportunity. You may or may not realize it. Of course, I’m not suggesting that you shouldn’t try to find the best value when shopping for a house. After all, that’s where we come in. It’s just that some people make the mistake of letting the perceived investment opportunity overshadow other considerations. Let me put it another way: what kind of investment is your car? And before answering that remind yourself that you don’t (normally) sleep there at night.

If you want an investment, there are plenty of much simpler ways to invest your money. And if you want a real estate investment then look to income producing property that you subject to rigorous financial analysis. In the meantime, if you want a place to tuck your kids into bed at night or have a group of close friends over please give us a call.