The Wall Street Journal just published an article titled, “Don’t Bet Against Your House.” The article talked about how the problem with real estate is that diversification is impossible, and while there are ways to hedge losses, they are only realistic for big players. I wanted to correct them on these statements and open some eyes to a few products on the market right now that can help homeowners defer some of this risk.
First off, there is a reason why these products are in existence: the owners and investors of these companies believe that the chances of home values crashing further is less than the chances of home prices regaining their historic levels. While purchasing one of these products can potentially limit your losses, it is essentially a bet against these companies.
The first product is offered from EquityLock Financial. This company provides homeowners with a hedge against falling home prices through use of price protection contracts. Basically, they use a housing index for a given area and if the index has dropped when you sell, then EquityLock Financial pays out that difference. If the index fell 10 percent between the beginning of the contract and the time of sale, assuming a home price of $200,000, you would get a $20,000 check from EquityLock. Since this is tied to an area index, and therefore is not neighborhood specific, it is also possible to sell for a gain and still get paid out, or sell for a loss and get nothing. For more information check out our article: EquityLock Financial Allows Homeowners to Hedge Their Home Equity.
Another creative product that allows homeowners some level of protection is the debt-free home equity plan, also known as the REX Agreement. What this does is allow homeowners to get a lump sum payment upfront (up to 13 percent) in exchange for giving up a portion of the home’s future appreciation. It is not a loan, so there are no payments. When you sell your home, a portion of the proceeds, above and beyond the initial contract valuation of your home, goes to the company as payment. If your home loses value, they get nothing and you get to keep your lump payment. They only get paid if your home appreciates. This option gives homeowners an opportunity to diversify a bit. They can take this money and invest it elsewhere, thereby spreading risk around. The downside to this plan is that if home prices start seeing improvement, you will be giving up a sizeable amount of that gain. In addition, there are certain rules that must be followed. For example, the home must remain a primary residence and must be properly maintained. This agreement also includes a clause that requires you to stay in the home for a minimum of five years before selling. If you sell prior to that time, you have to pay an early exit fee. For the right person in the right situation, this tool could offer a great opportunity to spread risks without immediate cost.
I want to stress again that these programs are not for everyone, but for the right person in the right situation, they might make sense. I wanted to show that there are creative solutions out there for people who are scared about declining home values. If you fall into that category, it might make sense to look at them a little closer, but know that it is possible to hedge and diversify out of real estate without being one of the “big players.”