Hedging a Housing Crash

Two books I have read recently:


Put together these books paint a pretty dire picture of the future here in Calgary. Peak demand for oil happened in 2007 and with the Saudi’s pushing prices even lower the supply side meeting up with a domestic boom in the USA for natural gas and oil production it doesn’t look good for the high cost oil sands production here in Alberta. The market seems to want to push out the high cost producers and it will do that by maintaining low prices until companies here ramp down their existing sites.

The oil company perspective on this couldn’t be worse. During the $100/bbl days many of the companies secured debt to finance the growth into oil sands and now at the lower price of oil they have to service those debts with the cash flow from production. Stopping production would mean bankruptcy.

Housing prices here in Calgary are largely inflated due to the number of high paying oil and gas jobs. These jobs are quickly disappearing as the oil companies in Alberta have already cancelled $200B in capital expenditures.

Meanwhile nationwide house prices are extremely over-valued relative to median household income. This value has been inflated to Canadians taking on record amounts of debt. In fact, values are well above where the USA was before the crash in 2008, when houses lost up to 40% of their value.

It is fundamentally impossible for house prices (in aggregate) to increase (beyond inflation) without regulation changes that allow for home owners to take on more debt. If home owners can only bear to commit 40-50% of their income to mortgage payments then that puts a cap on how much the values of houses can change (they have to keep pace with income growth). Gains beyond these rates would be from speculation and over-confidence in the stability of house prices.

Recent regulation changes in Canada have been made to reduce prices in an attempt to soften the risk of a crash. Early in Harper’s government they extended mortgages to 40-year and zero-down, this resulted in a housing price boom. However, these policies were later reverted due to a growing concern that Canadians were taking on too much debt risking a collapse. Terms have been reduced to a max of 25 years thereby limiting how much new buyers can afford to pay. Zero-down options have been removed after seeing how much of a disaster that was in the USA. These changes will cause prices to drop, but over-confidence in house price increases have yet to see that happen.

Canadians are currently in a tight spot. If the Bank of Canada needs to raise interest rates, or if the current recession hits hard it could be enough to trigger enough foreclosures that the supply of houses for sale would snowball into a dramatic price reversion back to the mean.

Hedging against this risk is not so easy.

For my house in Calgary there is a definite correlation to the price of oil. ie. if the price of oil drops significantly so does the value of my house. It’s possible to counter act some of this by investing in the inverse oil ETF $DWTI. Hedging against the broader crash is trickier.

During the 2008 crash in the USA there were very few clear winners. Discount stores and firms that handle foreclosures saw a boost in profit and positive returns on their stocks. Government T-bills were a pretty good hedge to the US crash. With that in mind I will allocate more of my portfolio towards government bonds/treasury bills if foreclosures start to pick up. I will be allocating more of my investments into other currencies as well – a drop in the value of the Canadian Dollar makes USD denominated stocks more valuable.

Fingers crossed a crash doesn’t happen any time soon. But it’s good to have a strategy in place just in case.