It is possible to make a credit funded investment
Alternatively to an unfunded swap or CFD, it is also possible to make a funded investment. Rather than paying LIBOR plus a spread quarterly and receiving property returns, the investor pays the notional amount of cash upfront and receives property returns net of the spread. For example, on a two-year swap an investor could choose, rather than paying LIBOR plus 1% on the swap, to pay 100% of the notional amount and receive the property return minus 1% each year and 100% redemption after two years.
The basis for property derivatives documentation is the International Swaps and Derivatives Association (ISDA) documentation. Just as for other derivatives, ISDA has prepared standardized documents for property swaps, in order to facilitate trading. The Property Index Derivatives Definitions were published in May 2007. Standardization aims to reduce transaction costs, legal risk and transaction time, to increase transparency and confidence in the market, and to improve efficiency and liquidity. In addition to the definitions, ISDA provides confirmation templates for forwards and swaps in the US (Form X) and in Europe (Form Y), as well as an annex that describes the indices on which the trades are based. By September 2007, the Association has included the Standard&Poor’s/Case–Shiller Index, the Office of Federal Housing Enterprise Oversight (OFHEO) Index, the National Council of Real Estate Investment Fiduciaries (NCREIF) Index, the worldwide Investment Property Databank (IPD) Indices, the UK Halifax House Price Index, the FTSE UK Commercial Property Index and Radar Logic’s Residential Property Index (RPX). The definitions booklet covers issues such as disruption events on these indices. More indices, as well as confirmation templates for options and basket trades, are likely to follow.
Derivatives to manage house credit and price risk
On the side of residential owner-occupied housing, Hinkelmann and Swidler (2006) are sceptic as to whether the market can take off. Mentally, homeowners tend to treat their home just as a consumption good rather than as an investment that involves price risk. Moreover, they would always be subject to a huge tracking error risk when hedging their homes with derivatives based on house price indices. This limits the effectiveness of hedging, and individuals may not use derivatives to manage house price risk. Ultimately, a lack of hedgers in the marketplace may lead to failure of residential housing derivatives such as the Chicago Mercantile Exchange (CME) housing futures contracts. It remains to be seen whether the involved challenges and hurdles can be successfully addressed.
History shows that the buildup period of a new market is very fragile. Property derivatives were launched in the early 1990s and actually failed. The debut on the London Futures and Options Exchange (FOX) crashed in a combination of bad timing and scandal over false trades designed to create the impression of higher activity (see experience in property derivatives).
Today, liquidity in the property derivatives market has a good chance of being increased. In 1981, the first interest rate swap was done. Although people were sceptic at the time, it is now a trillion dollar market. The property market could experience a similar sort of growth in derivative instruments.
Payday loans as a new solution to invest
GFI and Colliers claim they are working with the National University of Singapore to create residential indices for Singapore’s housing market. The main issue is that there are fewcountries that have an adequate amount of transparency to develop credible and robust indices on which to trade.
The first property derivatives in Switzerland were launched by the Zuercher Kantonalbank (ZKB) in February 2006. The bank issued two structured products that were offered to institutional as well as retail investors as a new solution to invest into the asset class of real estate.
One of the products was capital-protected while the other was structured as a discount certificate. The products could be subscribed in small denominations and the bank guaranteed a daily secondary market. The two products were based on the “ZuercherWohneigentumsindex (ZWEX),” which tracks owner-occupied house prices in the Zurich greater area. The index is calculated and published quarterly and is based on transaction prices. The bank says that demand exceeded expectations, especially for the product with capital protection.
In September 2007, the first swap on commercial property was transacted. ZKB and ABN Amro traded the IPD Switzerland All Property TR Index against Swiss LIBOR plus an undisclosed spread.
