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Risky Realty

Real estate professionals and institutional investors see benefits in housing futures. But Dick and Jane homeowner, use caution.

Housing futures, peddled by the Chicago Mercantile Exchange and the Chicago Board Options Exchange, are the new thing in finances this year. It's not surprising, given the increasing real estate share of the typical American's net worth and the recent attention to housing prices. But how useful are these futures for individual investors or homeowners? "They'll sell you hamburgers that clog your arteries, cigarettes that cause emphysema and now housing futures that add unmanageable risk to your lifestyle," says Tampa, Florida, financial consultant Michael Zmistowski. You're better off with Real Estate Investment Trusts focused on high-quality commercial properties, he suggests.

For the majority of investors and homeowners, he's right. The CME and the CBOE are selling slightly different products, but both are intended for institutional investors, real estate developers and high net worth homeowners in limited circumstances. Say you're planning to sell a $1 million home in Las Vegas, one of the 10 metro areas where the CME offers housing futures. (The 10 are also aggregated to create a national contract.) It could take months to find a buyer, during which time real estate could fall. You might not want to assume that risk if, for example, you've already bought a $1.5 million house elsewhere.

To hedge, you'd need to sell about 17 of the CME's contracts. (Each contract is worth about $250 times the index level, which was recently around 234 for Las Vegas.) By the time you buy back the contract, you'd receive about $4,300 for each point the index falls, compensating you for a presumably lower home price. Conversely, you'd be obligated to pay $4,300 for every point the index rose, which, you hope, would be offset by a higher sales price. The CBOE program works much the same, except that it uses a cross-country index and four broad regional indexes calculated by the National Association of Realtors.

For professional traders and real estate types, the contracts could be useful. But for Dick and Jane Homeowner, at least in the early years, it would be like using hand grenades to remove moles from your backyard. It might do the job, but the risks are simply too high.

Scott Bernard Nelsonis a newspaper editor and freelance writer in Portland, Oregon.

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This article was originally published in the October 2006 print edition of Entrepreneur with the headline: Risky Realty.

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