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Puts On Your Personal Residence

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Puts On Your Personal Residence

Huh? Wha'd he say? OK, show of hands. . .who remembers the late 1980's and early 1990's when housing prices across the country fell apart as a result of the S&L crisis? I remember quite well since I was the lucky recipient of a 30% haircut on the value of my home during that period of time. Lucky? Yes, many others lost more; 50% or more in some cases. Thank God, those days are over now. Yet history has a way of repeating. What I would have given then for the opportunity to protect myself from price erosion. But no such thing existed.

According to a recent Forbes article, more than 50% of homebuyers in the early 1990's experienced value declines in their markets over the next five years. The best we could hope for then was to sell to someone and let them take the value hit, rent the place out to minimize the negative cash flow, or stay put for a while until the financial storm blew over. But there is a way for a few fortunate souls to protect their investment against falling home prices.

Making matters worse, there is the issue of leverage. When we buy stocks, we can do so using 50% margin - 2:1 leverage - and must maintain at least 35% leverage or face margin calls. In these heady days of 25% annual price appreciation induced by practically free money, a 1% down payment means 100:1 leverage, and in the case of zero down or 125% loan to value, the leverage is infinite. Now that's a housing bubble! Ratios like this make the stock market look like the bastion of fiscal health!

Say that back in 1990 we bought a home with 20% down for $100,000 - now a myth in California's coastal cites (L.A., or San Francisco Bay area) and most major metropolitan cities nationwide. But for the sake of argument assume that's true and that over the next five years, our community or neighborhood, including our house, declined in value by 20%, thus wiping out our down payment, leaving us only with the loan value - or worse, "upside down" owing more than the house is worth. That's a big hit. We can't move and we can't refinance.

As Fundamentals Guy, and with a background in a prior life in the commercial real estate business, I've always wondered how I might protect myself against that kind of loss. Lo and behold, there is now such a way. It's normal for us to insure against fire, our health, our cars, etc. It's normal for us to even insure against our stock portfolio with put options. But until now, we've never been able to buy a protective put on our home values. That's right, a protective put or insurance for loss of value on our homes!

OK, the bad news first: It is currently only available in Syracuse, N.Y., but through use of data pooling on the Internet, is likely to expand to other cites next year.

That said, here's how it works. Instead of protecting against loss for our individual home, it protects against loss of an index for a particular zip code. For a one-time fee of just 1.5% of the estimated home value, which can be financed over four years, we can get an "insurance policy" or a European-style protective put with a maturity of three years, but appears to never expire thereafter until we sell our home. After three years, and IF we sell our home thereafter, if the index of home values in our zip code index has declined, we are paid that percentage decline of our stated home's value.

Say, we buy a $100,000 home today with 20% down payment. The down payment really doesn't matter because we are buying protection against the stated value of the home, not the hard cash investment. Again, it's like a put on a margined stock. It insures against the value, not the margin. For a 1.5% fee of $1500, we price-protect the home for $100,000. The property's "protected value" goes into effect three years after the purchase. Thereafter, if we sell the home, whether for a loss OR a profit - it doesn't matter, we will be paid for the loss of the index value consistent with our zip code.

Let's take the example used above. We've bought a $100,000 home in the 99999 zip code (I just made that up, but it might be a real zip code). We spend our 1.5% or $1500 for our value loss policy. Three years later, we can collect if we sell thereafter. Say then that we sell the house for $115,000 - yes, a profit, perhaps because we've fixed it up. Yet the zip code index, based on other selling prices in our area, shows an 18% decline in value. $100,000 "protected value" multiplied by an 18% decline equals a paper loss of $18,000. Thus, we would be paid $18,000 for our "loss" - the loss in value of the index, not the loss in value of our home, which we obviously didn't have thanks to our expert skills as a home remodeler .

Even if we had sold our home for a loss at say $94,000, we would still collect $18,000 on the policy since the index, and not the home, declined by 18%.

Pretty cool, eh? Certainly I have some questions in which I still need answers. . .such as, in what window of time after three years must I sell in order to cash in? I can't imagine they'd be willing to wait for six years or more thereafter to pay off when I actually sell. Does that mean I must purchase another put after three years? Etc.

OK, assuming we're interested in a protective put on our home, how do we get one? Realliquidity.com is the developer or the product. We can get the address and phone number from the web site. That's the place to start. There is an on-line form there to register your interest. However, I did not personally complete it since I don't want to volunteer that much information until the program expands and can pull its own weight - nothing worse than having your insurance firm turn out the lights after you've paid the premium. But in fairness, the FAQ section says that it carries the equivalent of an A or AA rating. Check out a detailed list of questions here:

http://www.nw.org/network/communityDev/homeEquity/fAQ.html

Additionally, there's a "soft" advertising pitch at equityhq.org, which is the non-profit group providing the service in Syracuse.

My personal take: An interesting and potentially viable start to a worthwhile service. Only in operation for two months now, it's too early to tell how the Syracuse pilot program will work. The program is far from complete and there are many questions that simply can't be answered until it is tried. That is the purpose of the Syracuse pilot.

Furthermore, in the interest of full disclosure, I have absolutely nothing to do this operation. It caught my attention because of my real estate background and my belief that housing is in a bubble on par with that of the stock market in late 1999. It just struck a chord in me!

With that, make a great weekend for yourselves. Questions always welcome.

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