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How to hedge against a real estate crash
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beanpole
Posted 12/3/2023 17:36 (#10508523)
Subject: How to hedge against a real estate crash


I’m considering a land purchase that is on the edge of town so developers have the appraisal pretty high. I can afford the payment easily with my current income but I’m concerned about a drop in real estate values. The current interest rates make a downward adjustment of land value a real possibility and could change that appraisal figure substantially. If the lands appraised value was to drop by 50% a lender would likely ask that the principal be paid down to get the balance below the new valuation. This would pull the brakes on my other ventures pretty hard and I don’t know if I could stomach it. Is there a way to hedge land value after a purchase? An insurance policy? Some financial market option I’m not aware of?

Edited by beanpole 12/3/2023 17:38
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Aaron SEIA
Posted 12/3/2023 18:10 (#10508589 - in reply to #10508523)
Subject: RE: How to hedge against a real estate crash


Ask the bank for some language in the contract. As long as you can make the payment, my simple mind doesn't understand why or how they could force a principle payment so they weren't upside down on paper. The obvious and easy way is to pay it off fast.
AaronSEIA
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beanpole
Posted 12/3/2023 18:45 (#10508663 - in reply to #10508589)
Subject: RE: How to hedge against a real estate crash


You’re probably right but it doesn’t address my scenario. All loan contracts leave the bank with the ability to call the loan in at any time. If there is a substantial drop in the real estate market a banks entire book will suddenly have negative equity and they will be forced to get it off their books one way or another. They will first ask for you to pay it down, if you can’t they’ll ask for a lien on other property. If you can’t do either they’ll be forced to foreclose. Doesn’t matter if you can make the payment as negative equity is frowned on in the banking world. I’ve been googling and there are some index options that could be used but I don’t think they would be correlated closely enough with a small farm town real estate market. If you know of a bank that will commit in a loan agreement to not foreclose due to negative equity caused by market fluctuations please tell me who they are.

Pay it off fast. Definitely my plan but I’ve been reading a lot about all of the commercial real estate loans that are fast approaching renewal that will have to refinance at the new high rates or sell. This could drop land values on paper easily. I would be buying with only 10% down so a 10% drop in valuation would take all of my equity. A 20% drop would put me negative. A 50% drop would no doubt put a banker at my door explaining why he has to ask me for early principal pay down.

Edited by beanpole 12/3/2023 19:01
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JRosenberger
Posted 12/3/2023 19:20 (#10508734 - in reply to #10508663)
Subject: RE: How to hedge against a real estate crash


Milford, IL		This is an opinion only - I have been fairly risk averse at times and that has lead to missed opportunities - 10% down is not enough. Unless we are talking about a steep family discount or some other extenuating circumstance.

I re-read your post. Are we talking about corn and soybean farm land or something you would develop into houses or apartments?
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beanpole
Posted 12/3/2023 20:23 (#10508857 - in reply to #10508734)
Subject: RE: How to hedge against a real estate crash


It would be investment property with an intention to sell for development in the future. If I bought it I would grow grain in 2024. I’m looking for a higher return crop for after that. My down payment of 10% is just a scenario and probably not what I would actually use.

My point of the post was to find out if there is a hedge vehicle that would protect me if there is actually a substantial real estate drop in the next 5 years, I currently believe that it’s possible. I could maintain S&P puts to cover a catastrophe like 2008 but they may not be well correlated with real estate during a less severe correction.
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moon1234
Posted 12/4/2023 23:17 (#10510580 - in reply to #10508663)
Subject: RE: How to hedge against a real estate crash



De Forest, WI

beanpole - 12/3/2023 18:45 You’re probably right but it doesn’t address my scenario. All loan contracts leave the bank with the ability to call the loan in at any time. If there is a substantial drop in the real estate market a banks entire book will suddenly have negative equity and they will be forced to get it off their books one way or another. They will first ask for you to pay it down, if you can’t they’ll ask for a lien on other property. If you can’t do either they’ll be forced to foreclose. Doesn’t matter if you can make the payment as negative equity is frowned on in the banking world. I’ve been googling and there are some index options that could be used but I don’t think they would be correlated closely enough with a small farm town real estate market. If you know of a bank that will commit in a loan agreement to not foreclose due to negative equity caused by market fluctuations please tell me who they are. Pay it off fast. Definitely my plan but I’ve been reading a lot about all of the commercial real estate loans that are fast approaching renewal that will have to refinance at the new high rates or sell. This could drop land values on paper easily. I would be buying with only 10% down so a 10% drop in valuation would take all of my equity. A 20% drop would put me negative. A 50% drop would no doubt put a banker at my door explaining why he has to ask me for early principal pay down.


Have had multiple real-estate loans.  None have had language that allows the bank to call the loan at any time.  Usually you have to DO or NOT DO something to allow them to take action.  You either miss a payment, etc. As log as you honor the terms they can not call the loan at any time.  That was outlawed many decades ago.

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jdironman
Posted 12/5/2023 05:25 (#10510646 - in reply to #10510580)
Subject: RE: How to hedge against a real estate crash


Nw Iowa		Some definitely have it.
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beanpole
Posted 12/5/2023 19:22 (#10511725 - in reply to #10510580)
Subject: RE: How to hedge against a real estate crash




”Have had multiple real-estate loans.  None have had language that allows the bank to call the loan at any time.  Usually you have to DO or NOT DO something to allow them to take action.  You either miss a payment, etc. As log as you honor the terms they can not call the loan at any time.  That was outlawed many decades ago”.



It’s called an acceleration clause. It’s very unlikely to happen but it’s possible. If there is a substantial drop in real estate values it could be very bad for a banks books and they would have to remedy it somehow. Or even worse, the new asset values could make the bank insolvent and be forced to liquidate. Banks are so levered up it won’t take a 50% drop to do this.

Edited by beanpole 12/5/2023 19:23
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moon1234
Posted 12/6/2023 09:32 (#10512456 - in reply to #10511725)
Subject: RE: How to hedge against a real estate crash



De Forest, WI
beanpole - 12/5/2023 19:22



”Have had multiple real-estate loans.  None have had language that allows the bank to call the loan at any time.  Usually you have to DO or NOT DO something to allow them to take action.  You either miss a payment, etc. As log as you honor the terms they can not call the loan at any time.  That was outlawed many decades ago”.



It’s called an acceleration clause. It’s very unlikely to happen but it’s possible. If there is a substantial drop in real estate values it could be very bad for a banks books and they would have to remedy it somehow. Or even worse, the new asset values could make the bank insolvent and be forced to liquidate. Banks are so levered up it won’t take a 50% drop to do this.


Looked at the last several loan contracts, no language like this exists in them. They were within the last 10 years, so if it’s something brand new maybe it just didn’t exist until then? I sent a message to an attorney relative asking about this. He replied that acceleration clauses are illegal without some type of qualifier happening first, such as missing a payment or breech of some other terms of the contract. The bank can not just call the loan due to changes in the market. That is illegal.

Edited by moon1234 12/6/2023 09:40
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beanpole
Posted 12/10/2023 21:26 (#10519108 - in reply to #10512456)
Subject: RE: How to hedge against a real estate crash


That’s good to hear. I haven’t had any experience to test the theory, just heard stories from the previous generation about things like this in the early 80’s.
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billybob
Posted 12/3/2023 18:45 (#10508665 - in reply to #10508589)
Subject: RE: How to hedge against a real estate crash


68340

Banks always have any business dealing with their best interest first.  Knowing this is knowing part of the meaning of bank.  Shaking hands, smiles, being very nice.  Just the sugar on the cookie is all.  Don't take it to mean anything else.  

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barren
Posted 12/3/2023 20:13 (#10508835 - in reply to #10508523)
Subject: RE: How to hedge against a real estate crash


Glasgow, Ky		Don't have an answer to your question but the lender I have always dealt with requires enough collateral to cover a 50% or so decline in real estate values. I experienced that in the early 80's.
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jdironman
Posted 12/3/2023 20:39 (#10508882 - in reply to #10508835)
Subject: RE: How to hedge against a real estate crash


Nw Iowa		Here 50% is pretty common. I don’t think it matters how much money you have. Banks will lend 50% of value. You have a lot of money you get a better rate.
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Rowcropcattleman
Posted 12/3/2023 21:19 (#10508941 - in reply to #10508523)
Subject: RE: How to hedge against a real estate crash


Missouri		All I can say is know your lender. Dad bought a farm in 81’ $1200 an acre, had half the money to out down. The next year it was worth $400, the lender stayed with dad.

Dad said during 80’s lenders pulled loans of guys that could’ve worked through it and made it. They didn’t pull loans of guys that had no assets to get.
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Boone & Crockett
Posted 12/4/2023 03:45 (#10509111 - in reply to #10508941)
Subject: RE: How to hedge against a real estate crash


Well, could use Tbills on futures contracts. If rates continue higher, will most certainly exacerbate the decline in real estate. Over the years, gold and land have pretty much been joined at the hip in their rise and fall. Could again use futures to short the gold market. Now before somebody gets their panties all in a knot, I never said there’s a 100% certainty or direct correlation, but generally speaking,pretty good chance that if rates rise, or gold falls significantly, land values will have dropped also.

Edited by Boone & Crockett 12/4/2023 03:47
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beanpole
Posted 12/5/2023 18:56 (#10511688 - in reply to #10509111)
Subject: RE: How to hedge against a real estate crash


I think rates are done rising but they’ll be at this level for a year or so. Any commercial real estate that has a variable rate loan is seeing the payment increase substantially. Lots of talking heads are predicting a commercial real estate bubble because of this.
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barren
Posted 12/4/2023 04:55 (#10509130 - in reply to #10508941)
Subject: RE: How to hedge against a real estate crash


Glasgow, Ky

Part of the pulling loan's resulted from not making their payments.  Not in all cases but in some.

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jdironman
Posted 12/4/2023 06:11 (#10509170 - in reply to #10509130)
Subject: RE: How to hedge against a real estate crash


Nw Iowa		Barren, I wonder how banks will react today, they are getting squeezed for margin, will they use that call feature fairly liberally if land values even correct slightly like 25%? I could sure see that if interest rates stay up and corn price stays down. I think we are seeing overall 5-10% lower than high here.
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Rowcropcattleman
Posted 12/4/2023 07:17 (#10509262 - in reply to #10509130)
Subject: RE: How to hedge against a real estate crash


Missouri
barren - 12/4/2023 04:55

Part of the pulling loan's resulted from not making their payments.  Not in all cases but in some.




Yes in both cases but the couple guys locally that had nothing to go after for the balance they didn’t call.
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beanpole
Posted 12/5/2023 19:00 (#10511695 - in reply to #10509130)
Subject: RE: How to hedge against a real estate crash


These days it’s worse. Fractional reserve banking means that the banks are lending out way more money than they have in deposits. This puts them at the mercy of auditors and regulators. If asset values fall they will be forced to clean up the books as quickly as possible. You won’t be safe just because your friendly with your banker and still making payments.
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beanpole
Posted 12/5/2023 18:51 (#10511680 - in reply to #10508941)
Subject: RE: How to hedge against a real estate crash


Unfortunately I don’t have a relationship with a lender like that
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DPx2
Posted 12/4/2023 06:15 (#10509174 - in reply to #10508523)
Subject: RE: How to hedge against a real estate crash


NW MO		Another option is to not use a bank to finance. There are other ways to finance these days that may have more favorable terms.

https://www.investopedia.com/articles/investing/021016/complete-guid...
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tmrand
Posted 12/4/2023 07:51 (#10509327 - in reply to #10509174)
Subject: RE: How to hedge against a real estate crash



Southeast Colorado		Can't say as though that article seemed like much help.

Any option to conventional financing looks pretty pricey.
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beanpole
Posted 12/5/2023 19:02 (#10511698 - in reply to #10509174)
Subject: RE: How to hedge against a real estate crash


That’s a good point. I’ll have to look into it.
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plowboy29
Posted 12/4/2023 19:33 (#10510233 - in reply to #10508523)
Subject: RE: How to hedge against a real estate crash


Minnesota		Really no way to hedge against a real estate crash except have it paid for,but then that’s just losing your own money instead of the banks.
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GleanerCase
Posted 12/4/2023 20:34 (#10510355 - in reply to #10508523)
Subject: RE: How to hedge against a real estate crash


This is nothing personal and I’m not trying to be a jerk but the question indicates that in row crop agriculture anymore there’s just an expectation that there must be some sort of safety net.
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beanpole
Posted 12/5/2023 19:08 (#10511703 - in reply to #10510355)
Subject: RE: How to hedge against a real estate crash


I don’t have the expectation of a safety net but I was hoping that there might be a savvy way to limit my downside. I mean it’s 2023 isn’t it?

Maybe I’ll just take my down payment and buy bitcoin. Then after a couple months I can pay cash for the ground.
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plowboy29
Posted 12/5/2023 19:47 (#10511759 - in reply to #10511703)
Subject: RE: How to hedge against a real estate crash


Minnesota		Sounds like you figured it out, it’s just that easy!
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