How to profit from falling house prices

My view on house prices is controversial to say the least.

Most people don't agree with me. In fact one kind soul went as far as to call me an idiot. But being in the minority is something I'm perfectly comfortable with.

And now it's not just me who's saying house prices are about to resume their down-trend, the markets are saying so too.

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UK House Price vs. FTSE 100

Source: IG Index

Here's a chart of UK house prices against the stock market since the financial crisis began in the summer of 2007. I've rebased both the FTSE 100 and the Halifax's house price to 100. The blue line is the FTSE. You can see how it tanked at the beginning of 2009 and then began the great come-back rally. House prices (the red line), didn't fall as sharply, but the recovery was pretty similar.

Now, I find most charts a little disconcerting, as they only tell you about the past.

However, you may notice that my chart goes into the future too. This is because I've downloaded data on where people are betting that house prices are going. That's the part of the red line on the right hand side of the chart.

IG index (the spreadbetting company), offers bets on the quarterly index published by Halifax. The latest data says that the average UK house price was £168,400 at the end of March. And right now, the spreadbet for the end of March 2011 is 163.8 166.6, indicating prices are going down to £165,200 (the mid price of the quote).

To arrive at the quote, they take off three decimal places from Halifax's data. So if you wanted to get exposure to 'an average UK house', then you can either sell (short), or buy (long) the quote at £1,000 per point.

These figures aren't screaming a warning... yet. At the moment it's pencilling in a gradual fade, rather than a crash. But bear in mind, up until recently, these futures were indicating higher prices, but with all the recent gloom, the curve has moved downwards.

But I reckon there's a bit more mileage in a down-bet. I reckon that prices will soon resume their down-trend...

So what about the UK economic recovery?

Up until recently, the markets have been basking in the warmth of the global economic recovery. The stock market is said to be a 'lead indicator', meaning it goes up before the economy does, as it's anticipating all those lovely profits from a recovery.

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But over the last month or two, that's all changed. The FTSE's begun to slide again... could it be that we're not going to get that economic recovery we've been promised?

Europe's gremlins are coming out of the closet. There are all manner of structural economic problems for nation states and we could well be heading into another downturn. So why am I still reading about house price recovery?

The stock markets react to news instantly and often violently, losing or gaining several percent in a day. Not so the housing market. As the chart confirms, if the stockmarket is the hare, then the property market is the tortoise. But don't think that this means housing doesn't react to the wider economy.

That's the mistake that much of the media is making now. I'm still reading about how house prices will continue to recover next year, but these guys are taking their cue from the past. They're looking at the traditional spring bounce we've just had and extrapolating it forwards.

I'm taking my cue from today's economic reality.

I'm looking at European-wide stagnation (at best), I'm looking at government cuts and I'm looking at rising unemployment. I'm looking at a stock market that's heading back into its down-trend and sapping confidence as it goes. And don't even mention the banks...

If the banks are about to get hit again, then they're hardly going to be in a position to increase mortgage lending.

So while the spreadbet prices are already bearish on housing I reckon they've got even further to fall. Property markets are cyclical and we're still on the down-curve.

How to take advantage

The most direct way is to short sell house prices using a spreadbetting account (you can compare the top twenty spreadbetting accounts, and apply for one online, here). So, if you sell the March 2011 quote at £163.8 at £10 per point and house prices fall say 8%, then the bet will close out at £155 and you'll pocket 8.8 points (163.8-155 = 8.8) times your stake. In this case we put on £10, so it would be £88.

If house prices go up, the maths goes into reverse. In fact, if you disagree with me and you think that house prices will go up then why not place an up-bet on the house prices?

This article was first published in the free investment email The Right Side on 26 May 2010.

Spread betting is not suitable for everyone - ensure you fully understand the risks involved and never risk more than you can afford to lose. Spread betting carries a high level of risk to your capital. Prices can move rapidly against you and resulting losses may be more than your original stake or deposit. Margin amounts vary between spread betting companies and the type of markets spread bet. Commissions, fees and other charges can reduce returns from investments. Tax treatment depends on individual circumstances and may be subject to change in the future. Your capital is at risk when you invest in shares - you can lose some or all of your money, so never risk more than you can afford to lose. Always seek personal advice if you are unsure about the suitability of any investment. Please note that there will be no follow up to recommendations in The Right Side.

Managing Editor: Theo Casey. The Right Side is issued by MoneyWeek Ltd. MoneyWeek Ltd is authorised and regulated by the Financial Services Authority. FSA No 509798. https://www.fsa.gov.uk/register/home.do