A New Measure of the Housing Market

It could be the perfect investment instrument, at least for these times.

With housing markets roiling and tumbling across the country, debt markets in a tense and fragile holding pattern, and nervous but plentiful global capital waiting on the sidelines, a former investment banker, in partnership with some powerful investment banks and a rocket scientist, is preparing to launch the latest in real estate indexes in an attempt to break open the derivative market for residential property. It might actually work.

The Residential Property Index, or RPX, a creation of Radar Logic, will track owner-occupied housing in 25 metropolitan statistical areas (MSAs) nationwide. That's nothing new. What is new is that RPX will update its numbers daily, and, unlike other indexes, it will reflect about as simple a metric as real estate has to offer: price per square foot.

The data used by RPX will be drawn from public sources and will be provided in one-, seven- and 28-day snapshots for each MSA, along with a composite of all 25 cities. Although a beta version of the 28-day cycle can already be viewed at www.radarlogic.com, trading isn't expected to begin until September. That's when broker/dealers that have already licensed the index, including Morgan Stanley (nyse: MS - news - people ), Merrill Lynch (nyse: MER - news - people ) and Lehman Brothers (nyse: LEH - news - people ), will begin offering it to their institutional clients.

Radar Logic was founded more than three years ago by Michael Feder, a former Credit Suisse managing director. Feder says he initially "set out to solve the problem of enabling capital markets participants to trade values in markets that were large but not commodity-like"--in short, to create "a steady stream of spot price data." He also calls it a "surrogate" spot market for housing.

A reliable price benchmark has been a holy grail for real estate buyers and sellers, especially since transparency in real estate transactions began to creep into the marketplace in the early 1990s, with REITs and securitized mortgages requiring more accurate reporting. (In commercial real estate, the growth of the REIT market was just one embodiment of this trend over the past 15 years, and the return of REIT-owned properties to the private markets has caused some concern over the loss of transparency.)

In order to set the stage for what he calls "participation in value away from asset ownership," Feder and his partners have built a model that he says is "proprietary but not secret." Broker/dealers will not be allowed exclusive use of the information, he says. Thus, any partner that creates a new index based on RPX data--for example, one based on high-flying markets like New York, Los Angeles and San Francisco--will have to make that index available to other investment managers.

In light of the current housing market malaise, Feder is at pains to point out that RPX is not a market forecasting tool but instead offers a "following perspective." It is posted nine weeks, or 63 days, after closings have been recorded. The index will reflect "actual closing values from transactions involving homes, not securities."

Just how big is the market? Big, Feder believes. The Federal Reserve estimates the value of owner-occupied real estate in the entire U.S. at just over $22 trillion. In the 25 cities from which the Fed gets data, there is $13 trillion in value, with just under $2 trillion in annual turnover.
"Our expectation," says Feder, "is that if the capital markets want to trade equity value, this is likely to be a very large market."

He may not be far off. Robert F. Dall, a Wall Street veteran involved in the inception of the commercial mortgage-backed securities market, thinks the new vehicle will catch on. "There should be a lot of trading in that index," he says.

That's certainly what Feder & Co. hope for as they bring their creation up against existing vehicles like the Standard & Poor Case-Schiller home price index, the current industry standard for residential real estate pricing. Case-Schiller is thinly traded, primarily on the Chicago Mercantile Exchange (nyse: CME - news - people ). Feder says that his index will reflect more information, including sales of new single-family homes and condominiums, and the sales of homes out of foreclosure.

"Case-Schiller is an econometric Index," he says. "Ours is a spot price index reflecting every arm's-length transaction" in the markets it covers.

The mathematical wizardry behind the RPX formula comes from Ventana Systems, a Massachusetts-based designer of dynamic systems whose clients include NASA.

To select the MSAs for RPX, Radar Logic considered the top 50 U.S. cities with estimated residential values (according to U.S. Census data) of $1 trillion or more.

"The top 35 capture a huge majority of the value," says Feder, noting that some states employ nondisclosure laws that prevent the collection of accurate data. One of those state is Texas, where, he says, all property sales are recorded with a residential value of one dollar
Another partner in Radar Logic's growth is Jonathan Miller, the CEO of Miller Samuel, a leading New York residential appraisal firm. Miller will provide research related to the RPX data.

Along with predicting that more MSAs will be added to RPX in the future, Feder also hopes to develop an index for the commercial property industry. It may not have the total volume that the residential market offers, but numerous derivative products have already been launched or are in development. And that price per square foot metric is, if anything, even closer to the valuation question of commercial property.

That suits Feder fine. "A trade is a trade," he says, "and a market is a market."

Source: Peter Slatin, Forbes/Slatin Real Estate Report

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