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Many investors dream of living out the scenario that was dramatized in the movie The Big Short and making it big by shorting the housing market. If you're one of them, keep reading. We'll cover the basics of what you need to know before shorting real estate investments, including what it means to short the housing market, the risks and benefits of making this financial move, and the most accessible ways to make it happen.
Before you can get into the details of how to short real estate, it's important to have a clear understanding of what it means to short the housing market. Below is an overview of how this process works. In investing, to "short" something means to bet against it. Where stocks are concerned, this means betting that the price of the stock will fall rather than rise. When done correctly, an investor can make money by short selling. The process of shorting a stock is fairly simple. First, you borrow shares of the stock that you want to short from someone who owns shares with the promise to return those shares at a predetermined date.
Then, you sell those shares on the open market and for cash. Then, in time, you rebuy the stock to replace the shares you borrowed. If the price of the stock falls in the way that you've predicted, you'll have the ability to buy back shares of the stock at a lower price than the amount for which you originally sold them, and you get to keep the difference as profit.
If however, you're wrong and the price of the stock rises, you'll lose money when you have to buy shares of the stock to replace what you've borrowed. A similar concept can be applied to the housing market. In this case, shorting the housing market means betting that home prices will fail. However, unlike with a particular stock, there is no direct way to short the real estate market, so investors will trade real estate investment trusts REITs and shares of companies within the real estate industry instead.
Over time, if housing prices fall in the way that the short seller suspects, the REITs and company shares will lose value, which will allow the short seller to benefit. In order to successfully short real estate, it's not enough to simply bet correctly that housing prices will fall. The other important ingredient is that other investors need to be unaware of whatever problems will ultimately cause housing prices to drop. This will leave real estate assets overvalued, which is exactly what happened in the subprime mortgage crisis.
Prior to the financial crisis , the vast majority of people believed that the housing market was rock solid, which contributed to the creation of a housing bubble. However, under the surface, an increase in subprime mortgage lending was also leading to a significant rise in the number of borrowers who were making time-limited, interest-only payments on adjustable-rate home loans.
As housing prices continued to rise, mortgage-backed securities MBS and other investment vehicles like the credit default swap became popular among investors, who were betting that the vast majority of borrowers would never default on their mortgages.
A handful of investors, namely those depicted in The Big Short and a few others like hedge fund managers John Paulson and David Einhorn, saw that the mortgage market was unstable, as was any collateralized debt obligation CDO that was built on mortgages. They began to short the housing market. Over time, once those low, introductory interest rates expired and the payments on those subprime mortgages began to rise substantially, millions of subprime borrowers began to default on their mortgages, leading to the collapse of the CDO market.
It's ultimately that fundamental disconnect between the instability of the mortgage market and the investors' belief in its solidity that lead Paulson and the others to make millions off of short selling the U. Billionaire investor Carl Icahn made waves in the first quarter of by predicting that the commercial real estate market will soon experience a meltdown similar to that of the housing market crash.
He also revealed that he's currently shorting the commercial mortgage bond market in "his biggest position so far," which has led many investors to wonder if they should do the same. The reality is that it's inherently risky to short real estate. Each investor and trader needs to weigh the risks and benefits of betting against the U. We've laid them out below for your consideration:.
The main benefit of shorting the housing market is that, since you're going against the grain, when you win, you often have the potential to win big. Other benefits include the ability to hedge your investments. Also known as "shorting against the box," this technique involves investing in a short position for a similar number of shares on an asset that you already own. That way, if something happens, the asset that you've shorted will rise by the same amount of any losses from your long position.
That said, there are also plenty of risks involved in shorting real estate investments. The ETF uses various real estate index swaps to provide bearish investors with a daily return that is -3x the daily performance of its index. The fund resets on a daily basis, which results in the compounding of returns over multiple periods. It is intended for short-term hedging and speculative purposes, and not as part of a buy-and-hold strategy. The comments, opinions and analyses expressed herein are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy.
While we believe the information provided herein is reliable, we do not warrant its accuracy or completeness. The views and strategies described on our content may not be suitable for all investors. Because market and economic conditions are subject to rapid change, all comments, opinions, and analyses contained within our content are rendered as of the date of the posting and may change without notice.
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