Beyond commercial property loans

Beyond commercial property, the second current initiative for property derivatives in the US considers owner-occupied residential housing. This market, estimated to be more than US$ 21 trillion, is much larger than its commercial counterpart. However, large institutions have shown little appetite to trade derivatives on residential property indices, consisting of privately owned houses. Institutional investors focus on commercial property, and do not trade residential property in volumes needed to encourage growth in a derivatives market.

Several derivative products based on a housing index have been proposed to hedge housing exposure in academic literature. To improve the possibilities to pool and share housing investment risks, Case, Shiller and Weiss (1993) propose a market in futures contracts tied to regional house price indices. Englund, Hwang and Quigley (2002) suggest that there are large potential gains from policies or instruments that would permit households to hedge their lump investments in housing. Case et al. attribute the failure of the London FOX contracts in 1991 to the public’s lack of appreciation and understanding of such markets. Whether such appreciation for housing markets now exists remains an open question.

The US market is still looking for a common benchmark. Multiple public exchanges or platforms try to promote housing derivatives for builders, developers, lenders and professional investors with large positions in real estate based on different index families. Although the platforms have many differences, they all operate in a similar way to an ordinary stock market.