I know a few farm town bankers. I’ll ask them about it and report back.Asking doesn't cost anythingSomeone just ask the bank and let us know
So, the risk then goes over to them.
Can you hedge real estate?
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Good call. That idiot honors me by blocking me.
Unlike residential real estate for which there is some emotional value at the microstructure level, commercial real estate is strictly valued on the PV of cash flows.
If it’s priced for industrial development and your friend wants to use it for lower valued farm land, then he isn’t the right buyer of the land.
there’s no hedge. It’s all idiosyncratic risk.
If it’s priced for industrial development and your friend wants to use it for lower valued farm land, then he isn’t the right buyer of the land.
there’s no hedge. It’s all idiosyncratic risk.
All that's needed is the Volatility rate (%) of the object in question, or of similar objects. Then one can feed all the data, incl. time, into the Black-Scholes options calculator to calc the Put price (ie. the theoretical fair value).
Someone correct me, but I think the volatility for such REITs should be below 25.
A 5 year insurance then would cost about 22.02% of the inital value of the property, and would fully insure against all losses above that very percent rate (and partially for losses below that rate; see the PnL chart below). You can even profit from such an options contract agreement should the value of the underlying fall more, as can be seen in that PnL chart (here 1826 days means about 5 years):
https://optioncreator.com/stjbxos
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Quanto is a moron. You have wasted precious electrons responding to him.
Here's a hot tip for you:
A much cheaper insurance (actually an unbelievably $0 insurance!) would be this method:
take a loan on the property and then buy "something" in the regular stock market, plus sell its ATM Call options and buy its ATM Put options. It costs you net $0. This then locks (freezes) the initial value of the underlying. Ie. no loss possible at all, and everything is insured & secured!...
Enjoy!
The net cost of this method is of course not $0 but the interest to pay for the loan.
(But it theoretically really costs $0 when no loan is involved, ie. when insuring an existing stock position against any losses. But then interest for margin use could apply...)
This is similar to the above linked Armstrong method, but IMO much easier to apply in practice.
A much cheaper insurance (actually an unbelievably $0 insurance!) would be this method:
take a loan on the property and then buy "something" in the regular stock market, plus sell its ATM Call options and buy its ATM Put options. It costs you net $0. This then locks (freezes) the initial value of the underlying. Ie. no loss possible at all, and everything is insured & secured!...
Enjoy!
The net cost of this method is of course not $0 but the interest to pay for the loan.
(But it theoretically really costs $0 when no loan is involved, ie. when insuring an existing stock position against any losses. But then interest for margin use could apply...)
This is similar to the above linked Armstrong method, but IMO much easier to apply in practice.
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To clarify, I don’t know this person. I just found the question interesting as I’ve thought about purchasing a similar piece of property and had the same worries of a drop in land value after purchasing. I thought people here at EliteTrader might have another way of approaching the issue.
Also, he isn’t buying the land to farm forever but as an investment. Most undeveloped land in farming communities is farmed right up until construction starts. If the land owner isn’t a farmer himself he will rent it to a farmer to produce some cash flow while he waits for the land to rise in value. This is common practice.
A note regarding the above "5 year insurance" chart:
it might seem paradox that the more the value of the property falls the less the loss becomes
(and at some point even turns into a profit; ie. at below the Break/Even point).
The loss is highest if the change in the value of the property is >= 0.
But Put options are of course exactly for this very case.
The MaxLoss is of course the cost of the long Put, here the said 22.02% of the initial value of the property.
it might seem paradox that the more the value of the property falls the less the loss becomes
(and at some point even turns into a profit; ie. at below the Break/Even point).
The loss is highest if the change in the value of the property is >= 0.
But Put options are of course exactly for this very case.
The MaxLoss is of course the cost of the long Put, here the said 22.02% of the initial value of the property.
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The problem is that the put would be based on a specific piece of property, not a correlated instrument that has liquidity. If the market does crash he would be relying on the bank to acknowledge that the value has dropped and make good on the put. But…..if they do refuse to acknowledge the value drop they wouldn’t have a reason to recall the loan early. It could work well but 22% premium is too high to work for an investment property he plans to sell in the future at a profit. Especially since he will be financing it at todays rates.