Real estate is a fickle beast. People always need places to live, and businesses always need offices, warehouses, and storefronts, so demand for buildings—whether residential or commercial—is unlikely to diminish altogether.
That being said, the real estate market is complex, and like other asset categories, it tends to be cyclical and experience both booms and busts. Factors like inflation, interest-rate changes, recessions, wages, and even evolving workplace norms all have the potential to shake up demand for homes, offices, and other types of real estate.
If you expect demand to rise, investing in real estate companies, REITs, construction equipment manufacturers, mortgage providers, and other real-estate-adjacent assets may seem like a no-brainer. But what if you think real estate is overvalued and you expect the value of the housing and real estate market to recede? What are some practical ways to bet on the real estate industry losing value?
While real estate—just like healthcare, industrials, and technology—is a cyclical asset category that gains and loses value over time, timing any market is notoriously difficult, and winning big on a well-timed bear bet like Michael Burry is usually the exception and not the rule. When speculating, always proceed with caution, avoid putting all of your eggs in one basket, and never invest more than you can stand to lose.
1. Short (or Buy Put Options on) a Specific REIT
REITs (real-estate investment trusts) are publicly traded companies that own or finance income-generating real estate and distribute most of their profits to shareholders as dividends. Many of these specialize in a particular type of real estate (e.g., hotels, rental properties, storage facilities, or student housing).
If you expect a certain segment of the real estate market (as opposed to the entire sector) to lose value, your best option may be to short a specific REIT that specializes in properties in the real estate sector you’d like to bet against.
For instance, if an investor’s analysis has led them to believe that the travel-accommodations industry might see a decline over the next year or two (perhaps due to wages not keeping up with inflation or pandemic-related travel restrictions), they might choose to short one or two REITs that invest specifically in hotels, resorts, or vacation rentals.
It's important to note here that in order to short an REIT (or any stock, for that matter), you’ll need to have a brokerage account that allows you to borrow shares. First, identify one or more REITs you’d like to short. Next, determine how long you think it will take for these companies to fall in value. Borrow the shares for an appropriate term, then sell them at market value—if your analysis proves correct, the companies will lose value before you are required to buy shares back at a lower price and return them to your broker, pocketing your gains.
Keep in mind that if your analysis (or your timeframe) proves inaccurate, you’ll still have to buy shares to return to your broker, and they may cost as much as (or more than) you sold them for.
If your brokerage doesn’t allow you to borrow shares, you may still be eligible to trade options, in which case you could buy put options on the REIT you think will lose value. When doing so, be sure to carefully consider expiration dates, as you can only profit if the price of the REIT falls below your strike price by an amount larger than the premium you paid for the contract before its expiration date. If this occurs, you can resell the contract for a profit.
2. Short (or Buy Put Options on) a Specific Stock
Alternatively, you could short a specific stock (or a few) that is involved in the real estate market (e.g., major homebuilding companies like D.R. Horton or NVR).
It's important to keep in mind here that traditional stocks tend to be more volatile than REITs because REITs are valued primarily for their high and regular dividends, so their stock prices don’t tend to swing as dramatically. This means that shorting an individual homebuilding stock could offer more potential upside but also higher risk.
If an investor noticed that housing starts were falling during a period of high inflation and slow wage increases, they might be inclined to bet that homebuilding stocks would suffer as a result. They could borrow shares of one or several homebuilders from their broker, sell them immediately at market value, then buy them back once their prices fall before returning the borrowed shares to their broker.
Alternatively, they could buy and resell put options on the same companies in the same way described in the REIT section above.
3. Short (or Buy Put Options on) an Real Estate ETF
If you’re bearish on real estate in general and want to mitigate risk by shorting a more diversified array of real estate-related assets, you could also consider shorting (or buying puts) on a real estate ETF. Some of these include only REITs and are more dividend-focused, while others include REITs along with homebuilding firms, mortgage lenders, material companies, and the like.
If your time horizon is relatively long, it may be best to choose the latter, more diversified sort of real estate ETF, as different components of the real estate space may fall at different times, and the decline of one category (like homebuilders) could have a cascading effect that later shakes up other categories (like building-material suppliers or mortgage providers) due to falling demand.
4. Invest in an Inverse/Bear Real Estate ETF
If you want exposure to what you hope will be a declining real estate sector but you don’t want to bother with the hassle of using derivatives or borrowing shares, you can also invest in an inverse or bear ETF. These are pooled investment vehicles that, instead of investing directly in a themed array of securities, use derivative and shorting techniques to profit when that same themed array of securities loses value.
For this reason, investing in a real estate bear ETF is probably the simplest way to bet against the housing and building market with a traditional brokerage account.
Beware, however, that many inverse ETFs are highly leveraged in order to multiply returns, which means any losses are multiplied as well. The ProShares UltraShort Real Estate ETF, for instance, is leveraged 2X, meaning that if the assets it’s short on lose 1% of their value, it gains 2%. Alternatively, if the assets it’s short on gain 5%, it loses 10%.
Leveraged inverse ETFs are extremely risky and should be approached with caution and diligence. For risk real estate bears with lower risk tolerance, a non-leveraged inverse ETF may be a better option.
Another thing to consider here is that inverse ETFs aren't the best long-term shorting instruments. Inverse fund managers buy and sell derivatives daily, so bear ETFs don't necessarily inversely mirror the sector they track over the long term. That being said, they can be a great way to profit off of short-term drops.
The Bottom Line
Real estate tends to become overvalued on a somewhat cyclical basis, but it’s also inextricably tied to factors like inflation, wages, and the actions of the Fed, so trying to time its booms and busts is no easy task.
The above are just a few ways to try to expose your portfolio to a possible decline in the sector if you’re feeling bearish, but as with any speculative investment decision, be sure to do your research and consider the risks involved and the importance of maintaining a balanced and diversified portfolio so that inaccurate predictions don’t end up draining your savings.