UK Property Derivatives Report
By Michel Heller, CB Richard Ellis/GFI.
With the physical market grinding to a halt as buyers and sellers fail to agree on values, property derivatives have featured prominently in the activity of derivative traders and property investors.
This is seen most evidently with the record volumes seen in the first quarter of 2008, with £3.5 billion being traded on UK IPD property indices. This amounts to 20% of all notional traded since the market started in 2004. Property investors are now getting more familiar with the benefits of using derivatives and are using them to hedge, forward hedge, reweight portfolios synthetically and outperform IPD indices.
Over the past three months, the market has recorded both yearly highs and lows. The collapse of Bear Stearns was the prime mover, traders being concerned that a liquidity drought would lead to an even more severe property downturn.
Prices for the year 2008 moved 300 basis points in one week in March, a dramatic move, implying capital falls of nearly 20% for 2008. But following JPMorgan’s purchase of Bear Stearns and a better than expected IPD Monthly number for February, the market has traded upwards. In fact, the IPD has been recording slowing capital falls, which has meant higher expected total returns.
Year to date, the IPD has recorded total returns of –3.97%, with current prices for the year 2008 priced at –10.5%. Some argue that this is too cheap. The fall in total returns has been slowing (April recorded –0.5% as opposed to the –3.7% seen in December 2007) and so it seems unlikely that the IPD will fall another 6.5% over the next eight months.
Others argue that the falls could be significantly worse, with concerns of a “double dip”. This is based on that fact that the IPD index recorded no rental growth for April, as well as fears that redemptions will increase towards the end of the year. This might mean forced sales at low valuations, with investors finding it difficult to get hold of debt.
The year 2009 is currently priced at 2.5%. Given a 5% income yield, this implies a capital fall of 2.5% in 2009 – a slowdown from the current 15.5% capital fall in 2008 implied by derivative contracts. The IPD All Property Equivalent yield was 6.1% in December 2007. Should current derivative expectations be right we can expect to see a yield of 7.2% for December 2008 and 7.4% for December 2009. Of course, investors who think otherwise can express this view with property derivatives, inexpensively and swiftly.
Looking further out, the derivatives market indicates that property will recover in 2010, with expectations of a 6% total return for the year, with 2011 and 2012 expected to return more than 8% total returns annually.