When all is rosy, with interest rates benign and property prices rising, house-builder stocks tend to be major holdings in most UK-focussed share portfolios. But when sentiment begins to change, as the Bank of England raises rates and the Sunday papers are full of house-price scare stories, investors understandably think about hedging their exposure to house-builder shares.
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One way to do this could be to invest in a falling housing market - but how?
The answer is a spread bet - betting that the spreads offered by the market makers (the spread bet indices) are either too conservative or too bullish in their forecasts. Those taking the pessimist's view on house prices would bet down low, beneath the spread. As Matthew Brief, housing specialist at IG Index explains, business volumes have been high as investors have been speculating on the downturn in the housing market. 'We are seeing a lot of people having a punt on house prices and I would say that there is a fair degree of hedging, too, for those who own house builder shares. You have to bear in mind that as the spread bet is based on average house prices, it is not a perfect hedge. But that said, the principle is similar.'
Brief adds: 'We have seen a sharp discount on prices. September 2005 prices are significantly down on September 2004 quotes. For September 2004, the average house in London was being quoted at £244,000 but predictions for September 2005 are down to £225,000. Realistically, you are looking at predictions of a 10% fall, which is higher than many market commentators have been suggesting. The vast majority of business from clients is from a selling perspective, by which I mean they want to get on the back of a crash in the property market.'
The spread bets offered are based on the HBOS price index. Of the big spread bet indices, only IG Index currently offers spreads on the housing sector. Though spreads are based on the HBOS official figures, IG also takes into account figures from Nationwide. Since HBOS breaks down its figures on a regional basis, the firm also allows spread bets based on regional prediction, for instance the south east or north west. In terms of prices offered by the spread-bet index, if most clients are negative, all quotes will be adjusted downwards. This has currently been happening.
All costs to the client are in the spread - there are no hidden charges. Spread betting is a quick and versatile way to take a position in the housing market without incurring stamp duty or capital gains tax or tying up funds. Profits from spread betting are tax-free.
Brief adds that while the property market is perhaps seen sometimes as a difficult call, from an historical data perspective it is a lot more predictable than the FTSE and for that very reason had its own distinct attractions. The housing market is also one of the most highly publicised areas of the UK economic landscape, so it is always easy to keep fully informed. Historical data showing trends and prices is available free on the HBOS website*.
Rival spread betting firm City Index stopped offering spreads on house prices because in its view there was a lack of suitable indices. But Ashley Tatham, senior trader at City Index, says there are other options open to investors. 'When we offered spreads we based it on the Land Registry Index, which reflects all transactions in the market,' he says. 'However, because it is seasonal, there is a lag with regards to the figures coming through.
With the HBOS index, the problem was that it failed to take account of cash transactions. This is significant given the number of house buyers downsizing and buying smaller properties outright.
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Tatham says City Index likes the principle of spread betting on the housing market and using it as a hedge to protect against a fall in house builder shares. 'We will certainly look at it again in the future if a more reliable index comes along.'
But in the meantime 'there are other options open to people looking to hedge exposure to house builder stocks or just for those looking to spread bet on this sector full stop. 'For example, we offer sector trades. This means you are spread betting on moves in the house building sector rather than on the house price index.'
But for those who do want to spread bet on a housing market fall, it does not necessarily follow that if house prices take a major hit house-builder stocks will be hammered too. Brief at IG Index maintains: 'It is perfectly conceivable that those betting on a fall in house prices could still hold on to their house-builder shares without having their fingers severely burned'
There are a number of reasons for this - firstly, there is still a shortage of new-build houses in the UK and as a result many house builders have very healthy order books for building projects over the next four years. Secondly, while some of the UK's big fund managers are less enthusiastic than they were on house builder stocks, they are still not too bearish.
Andy Brough, manager of the Schroders Mid 250 fund, sees predicted merger and acquisition activity as a further reason not to abandon the sector. 'We expect to see consolidation in the sector and as such have been selling out of larger stocks such as Wimpey and Taylor Woodrow - the likely predators - and buying those likely to become the targets, for example Wilson Bowden and Crest Nicholson.'
Brough adds that house builder stocks should be subject to a kneejerk reaction at the first sign of pressure. 'In recent months we have reduced our exposure to house builders, booking some profits. However, despite the strong run that these stocks have seen in the past couple of years, we still believe we can generate strong returns from the sector through a selective approach.'
Like Brough, investors with house builder shares still on attractive valuations and with solid earnings may be loath to sell stocks that have performed well for them and could have a distance left to run. Without a crystal ball it is impossible to gauge the full extent of house-price falls in the next 12 months and beyond, especially with so many conflicting stories in the media and with such a regional bias in pricing. Against this backdrop, the argument for hedging via a spread bet is compelling.
For the spread better, there are a number of possible attractive scenarios. You bet low on a housing market fall, the market collapses and this covers any losses from house builder stocks that have taken a pounding (effectively a hedge). Alternatively, the market falls in the south east as you predicted, you gain on the spread bet but the housebuilder stocks you hold remain buoyant, as much of their order book is safe and predominantly in the UK regions where prices have held up.
The ability to spread bet on regional house-price averages (as well as national), allows much greater room for manoeuvre. London, for example, has a unique and excessively volatile market dynamic. IG therefore offers quotes for a full range of locations (see box).
Remember also: any bet that the market will fall heavily, if it proves wrong, may well be cancelled out by any increase in your own property's value (as well as the added boost that house builder stocks hold up).
For instance, you may think a recent shift by the Bank of England in the base rate will cause prices in the south east to tumble. You place a 'sell' bet with the market maker at £500 per point. If you're wrong you lose £500 for every point the average house price in the south east rises (but this may be more than compensated for by the rising value of your own holdings). But if you're right you make £500 per point while the market falls.
It is July. The latest HBOS figures show an average UK house price for June of £129,000. The IG Index price for the September monthly survey (in £1,000s) is 129.5/130.5.You believe house prices will continue to rise and decide to 'buy' £1,000 per point at 130.5.
The housing market roars on. When the Halifax Survey is published at the beginning of October, it reveals that the average UK house price over the course of September was £132,700. Your bet therefore settles at a level of 132.7. Profit closing level 132.7; profit opening level 130.5 The difference is 2.2. So the total profit for the spread bet is 2.2 x 1000 = £2,200.
It works in exactly the same way for those predicting a fall in house prices. If you believe house prices will go up you go long and 'buy'; if you take the view that prices will go down, then you go short and 'sell'.
Regional rather than just national houseprice spread bets can be placed. The areas are split as follows:
East AngliaAngus Campbell, head of sales at spread betting firm Capital Spreads, says: 'There are a number of stocks that can give investors exposure to the property market - from the big real estate companies such as Hammerson, Land Securities and British Land, to the smaller stocks that focus on the residential market, such as Savills and Rightmove.
'Some clients have made a killing from shorting the likes of British Land in the last year, with many of these real estate stocks seeing their share price fall 40 percent.'
The risk is, however, that if the punt goes the wrong way, the losses can be significant, and the prices of some property-related shares have remained buoyant.
'Rightmove's share price has been remarkably resilient, actually posting a small gain in 2007 and doing well so far in 2008,' says Campbell. 'These sorts of shares could benefit from the possibility of increased market activity if property prices start going into a tailspin.'
'If the property market slows down, developers will be under pressure to shift their developments for less than anticipated and that will put further pressure on their balance sheets.
'That's likely to see investors go short on these stocks as they look to capitalise on any downward movement.'
Investors can 'go short' of listed property businesses and funds, such as real estate investment trusts (REITs), property sector indices (an index of, say, UK construction firms) or individual companies, such as housebuilders, developers and landlords.
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