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Falling Commercial Property Values Fuel TRS Mart

--Jeanine Prezioso

Commercial property owners and investors are increasingly using total return swaps on the National Council of Real Estate Investment Fiduciaries index, or NCREIF, to hedge against expected depreciation in the asset class.

The total notional traded on the index from its 2006 inception is around USD2.3 billion to date—with about USD500 million added in the last quarter, according to data from broker GFI Group. Pricing for a Dec. ’09 swap on the index is already in negative territory relative to last year at -8%, indicating the market’s view that property values will drop 25% in the next 15 months. "We are seeing investors taking advantage of this by buying swaps at this level, as an alternative to buying physical property," said Phil Barker, a property derivatives broker at GFI in New York. "[Minus] 25% for them may be acceptable for this time period...hedging at this rate may be the only option to liquidating their holdings in a very depressed market."

An investor can take a view that property values will increase more or less than where the index is trading and set a trade based on that view. It gets a payout if the index is trading higher than expected, based on the difference in the index prices at each end of the contract term.

One London-based hedge fund manager said he uses the index to play inefficiencies between the real estate equity and debt markets. The level of detail in the index as far as sectors, regions and dates allows for a lot of opportunity to play relative value trades, said Stephen Ashworth, a partner with Reech CBRE Alternative Investment Management who manages the Iceberg relative value real estate fund in London. "We’re more interested in looking at other real estate instruments and might consider for instance the relative value of U.S. real estate equities against the real estate swap contract," he said.

Barker declined to name who recently put trades on the index but said more parties have been calling to inquire. Goldman Sachs and Merrill Lynch are the two most active banks in commercial property derivatives, he added.

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