Property Derivatives

Property Derivatives

A property derivative is a financial derivative whose value is derived from the value of an underlying real estate asset. In practice, because real estate assets fall victim to market inefficiencies and are hard to accurately price, property derivative contracts are typically written based on a real estate property index. In turn, the real estate property index attempts to aggregate real estate market information to provide a more accurate representation of underlying real estate asset performance. Trading or taking positions in property derivatives is also known as synthetic real estate.

Property derivatives usually take the form of a total return swap, forward contract, futures, or can adopt a funded format where the property derivative is embedded into a bond or note structure. Under the total return swap or forward contract the parties will usually take contrary positions on the price movements of a property index.

The most common benchmarks used for writing property derivative contracts in the UK are the various property indices published by the Investment Property Databank ("IPD") and FTSE UK Commercial Property Index Series. The IPD Annual Index covers approximately 12,000 directly held UK property investments, market revalued in December 2006 at just over £192 billion equivalent to 49% of the UK investment market. IPD indices are also used in a number of other countries such as Australia, France, Germany, Italy, Japan and Switzerland as the basis for commercial property derivatives. In the United States commercial property utilizes the National Council of Real Estate Investment Fiduciaries (NCREIF) property index the NPI. There are two main residential real estate indices in the United States which trade - Radar Logic's RPX, and the main index - S&P/Case-Shiller Home Price Indices (see Case-Shiller index).

The FTSE UK Commercial Property Index Series currently covers £16bn of prime investible property assets directly held in the UK. The FTSE UK Commercial Property Index Series is valued daily, on a T+2 basis.