Together with a growing band of property sector professionals, bankers are working to kick-start the fledgling property derivatives market. Natasha de Teran explores the market’s current development and its future potential.

In mid-September, the UK’s Investment Property Forum sprung a new arm. The Property Derivatives Interest Group (PDIG) was born out of the real estate industry body – a special interest forum, representing those keen to see a property derivatives market take off. The PDIG’s birth was accompanied by the first real attempt to measure the extent of UK investor appetite for property derivatives – and the timing, for both, could not have been better.

The PDIG’s debut survey revealed strong support for the emerging property derivatives market from existing property investors. In total 100 property market investors were canvassed, representing just over £58bn of UK property investment. A large majority of them claimed to be interested in using the instruments, already having put mandates in place to begin using them.

Of the remainder, 91% were willing to recommend the use of the contracts, and 70% were intending to seek authority to begin using them by 2007.

Lacking in confidence

The strong levels of appetite were not, somewhat unfortunately, matched with strong levels of confidence in using the instruments. Among the deterrents respondents cited, were concerns about the accounting and fiscal treatment such derivatives would receive, the Financial Services Authority’s regulations on derivatives usage, their system requirements and actual levels of competence.

A good, though not overwhelming, amount of respondents also expressed concern over the index commonly referenced by property derivatives: the Investment Property Databank’s All Property index, a benchmark that references the UK commercial property market. Some 6% of those surveyed were concerned about the integrity of the index itself, while a further 13% wanted to see solid sub-indices emerge.

These would reference segments of the commercial property market and enable investors to engage in specific hedges and tactical asset management.

  James Adam: ‘only one index being referenced’   Bankers and brokers agree with this verdict. James Adam, head of the property derivatives team at ICAP, says: “One issue that will perhaps stall the market for a bit yet, is that there is only one index being referenced – the Investment Property Databank (IPD) All Property Index. The All Property Index is attractive to asset allocators that are looking for broad-based exposure to property, but the property sector specialists are much more interested in managing their exposures to subsectors of that market – just retail or office space, for instance.

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