With the Real Estate Put Option (Selling price decline insurance) investor can sell an option thus investor underwrites price decline insurance. Property owner, who buys the option, is protected against price decline of the property. Let us walk through a specific example.

Property Owner Motivation

As an example, let us take a homeowner who lives in La Jolla, CA and the price of his or her home is $1 million, from the last sale date and sale price of the property.

Further, the homeowner believes that the price of the home in 5 years might decline below $0.8 million and he wants to insure the downside in any price decline below $0.8 million.

Investor Motivation

On the other side, an investor believes that price of that specific property will not go below $0.8 million in 5 years and is willing to insure a price decline below $0.8 million. In exchange, the investor receives money today from the property owner who wants to insure against any price decline below $0.8 million.

Put Option Contract

To create a contract based on the above example, the homeowner buys a put contract for a specific term of 5 years, with an expected future price of $0.8 million, which is called a strike price. IRESE can price such an option given data about price volatility and risk-free investment return rate by using binominal trees or Blacks-Scholes methodologies. Investor can use pricing tools provided to price an option. In our example, the homeowner should pay $3,062 today for the insurance against a price decline below $0.8 million. This position can be demonstrated with the graph.

Property Owner Payoff

In 5 years, the homeowner payoff is based on the observed price of the property, which is determined from publicly available price index data.  Learn how property price is derived. If the observed price is below $0.8 million, the homeowner gets the difference between $0.8 million and the price decline. In our example, if the price is $0.6m, the homeowner receives $0.2m ($0.8 less $0.6).

Investor Payoff

On the other hand, if the observed price is above $0.8m, the homeowner gets nothing. Investor received the money for the insurance which expired worthless.

• Here are a few examples of property owner payoff
• What if the property owner sells the property before the contract expires?

Put Options Benefits

This position reduces exposure to broad property market price declines that is beyond the control of property owners, specifically:

• Insures the price of the real estate against a price decline, thus “hedges” against a real estate market exposure
• Reduces relative holding exposure to real estate price changes in a mixed-asset portfolio, without selling a physical property