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What type of investment is inversely correlated with real estate?

The real estate market has been receiving some negative press, signaling a housing bubble in the last couple of months, leaving many  people wondering if there is a way to hedge oneself properly against such an event.

The legendary investor Michael Burry, aka. The “Big Short”, was one of the only investors who called the housing market collapse in 2008 and positioned himself properly for that event. Knowing that he did it, we know that it is possible for someone to position himself against a certain market or industry. So, what type of investment is inversely correlated with real estate? We will discuss the two main ways to bet against real estate, which are mainly inverse ETFs on REITs and put options on REITs. But first, it may be wise to define what a REIT is.

What is a REIT?

A REIT stands for “Real Estate Investment Trust”. It is generally a company listed on the stock market and owns a large portfolio of real estate. This real estate can be commercial, residential, or more.

A publicly traded REIT allows anyone with a stock broker account to indirectly invest capital into the real estate market, even with a small amount of money. Some people might enjoy investing in REITs because of the dividends that the companies promise: the average dividend yield for REITs is currently at 4.3%, compared to the dividend yield on a benchmark ETF like the SPY, which is currently at 1.55%.

REITs generally manage to sustain such a high dividend yield as they can collect rent from their tenants consistently every month. Every shareholder of the REIT gets a small piece of the rent through dividend income. Now that we know what a REIT is, what it does and why people like it, we will look at the two main ways that exist to invest against the real estate market.

Related: Top REITs Stocks by Market Cap.

Which asset classes are inversely correlated with Real Estate?

REIT inverse ETFs

Inverse ETFs are funds that bet against certain stocks, or against a portfolio of stocks. This is useful for traders and people who may not be able to borrow shares in order to bet against a certain company stock. Inverse ETFs function by using financial derivatives, for example index swaps, to create an ETF that is always negatively correlated with the performance of a set group of REIT stocks. 

A huge reminder that inverse ETFs do have decay, meaning that over a long period of time the share price will gravitate towards zero. This is why you might notice that most inverse ETFs have done many reverse splits, in order to keep the share price from going down too low.

Inverse ETFs are meant to be used for short to medium term trading, and in general many think that it is not wise to stay in an inverse ETF for the long term. Before trading inverse ETFs, it may be wise to read the shareholders’ prospectus on the ETF. This is so that you fully understand what purchasing these inverse ETFs means, and how they are extremely high-risk investments.

Put options on REITs/shorting REITs

One of the most common types of investment that is negatively correlated with real estate is purchasing put options on REITs, or shorting REITs by borrowing shares of REITs, selling them immediately, and then purchasing them back at a lower price.

Some Wall Street investors exercise put options, as it allows them to leverage their money in a way that is not possible otherwise. A put option works as some sort of “insurance” that you will be able to sell your shares at a certain “strike” price on a certain date.

If the share price is lower than the strike price on the day that the option expires, then congrats! Your option is exercised and you get to sell shares at a higher price than the current price.

Keep in mind that options trading is not a common strategy among beginner investors: as options are temporary securities with expiration dates, the premium you are paying only works for a certain period, so most options expire worthless. The risk/reward is more complicated than buying shares as there are statistically higher chances of losing all of your money.  

Related: How stock correlation could help you make better investment decisions?

Bottom Line

There are investments that can be made to bet against the real estate market. However, nobody knows whether there will be a crash and when it will actually happen.

Historically, real estate has gone up over the long run. If you look at the median home price in the USA, you will notice that indeed over the long run real estate has only gone up. Therefore, any bet against the real estate market would need to be extremely calculated, and many experienced investors would advise to have a clear exit plan when shorting anything. Just like nothing can go up forever, the opposite is also true: nothing can go down forever. 

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