Real estate as an asset class

The real estate market as a whole is an aggregate of many submarkets such as owneroccupied housing, offices or land. Usually the performance of a submarket and not the overall market is the focus of an investor. It is important to take indices as underlying instruments that have a large community of potential users. Primary users are generally institutional investors, but private investors should also be able to understand and benefit from property derivatives.

While investors see real estate as an asset class that must generate a return as high as possible, homeowners see their house as a consumption good with some price risk. The submarkets for the two are completely different. The choice of an index as a suitable underlying instrument for derivatives depends mainly on the criteria of the region, property type and data base (rents, transaction prices or appraisal values). Types with a potential volume that is sufficiently large for a reasonable derivatives market include offices, residential properties, retail space and industrial space. It is doubtful whether more special property types such as hotels or even land would find a big enough market.

Owner-occupied housing is treated very differently around the globe. While homeowners borrow relatively moderately and stay for decades in their home in central Europe, households in the UK and in the US are much more sensitive to property price movements. Often, they are ready to realize gains by selling their home or they increase the mortgage once prices have appreciated.

Only the latter mind-set may lead to a broadly supported desire for protection against falling house prices. The market for owner-occupied housing is huge, and the sufficiently large number of transactions make indices more reliable.