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Making the difficult move into residential

The residential real estate derivatives market is significantly smaller than the commercial market at an estimated £2 billion since trading began in the 1990s, despite the physical market being six times larger. One of the main reasons for this is the limited exposure of institutional investors to residential property, says Guy Ratcliffe, head of property derivatives at Abbey Financial Markets in London.

Property derivatives: Market at last begins to fulfil its promise

"As investors have no background in residential it can be difficult to make the move into derivatives."

Nevertheless, there is anecdotal evidence of appetite for residential real estate. "Most life funds have an interest in residential real estate for strategic reasons – it is great for diversification and it tends to match insurers’ liabilities – but it is difficult to get any physical scale and it is expensive to manage," says Paul McNamara, head of property research at Prudential Property Investment Managers.

The market for residential property derivatives is benchmarked off the Halifax House Price Index (HHPI ) index. This index does not include rent, just capital appreciation, and trades have been done off it for at least six years with many sold as structured products to retail investors. Trades are typically longer in duration than in the commercial real estate derivatives market with almost no trades shorter than three years and some going out to 30 years.

Abbey, owned by the Santander Group of Spain, is one of the largest participants with an estimated 80% of the market. Among its activities, it buys and sells exposure to the HHPI in order to hedge its own and others’ issuance of retail structured products, most of which have five year maturities.

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