Derivatives open door to trading on house prices

Opportunities are emerging for investors to increase their exposure to the housing market without having to pay high taxes and fees or go through the process of buying a property.

A number of private banks are offering clients the chance to trade property derivatives – investments that allow them to speculate on rising or falling house prices without having to purchase a house. In another development, CityOdds, a financial betting service, has started providing bets on UK house prices for retail customers from as little as £5.

Richard White, head of derivatives at Knight Frank, said demand for residential property derivatives is growing fast.

“Demand has increased exponentially as the market has grown in size, from around £300m in 2005 to £2bn in 2008,” he explained.

While the residential property derivatives market is less developed than the commercial equivalent, it is set to play an increasingly important role in portfolios.

White said that derivatives offer property exposure without the burden of stamp duty and management and maintenance fees, and for smaller sums. These investments are also quite liquid – investors can buy and sell them easily – and they can offer protection against falling house prices.

Access to residential property derivatives is limited to sophisticated investors – typically those with at least £50,000 to invest – but is expected to become gradually more mainstream. White believed high street mortgage lenders could eventually introduce investments for homeowners, which would protect them against falling house prices.

Coutts, Royal Bank of Scotland and Morgan Stanley are among the private banks that offer customers exposure to house prices through derivatives.

Philip Ljubic at RBS said property derivatives had been a growing area and have a “broad-based appeal and acceptance” among pension funds, property funds, hedge funds and private clients. Private banks typically offer capital-protected structured products that allow investors to benefit from any rise in property prices but give some insulation from further falls.

Similar products have already made an appearance on the high street. Abbey, for example, offers a guaranteed growth plan that protects the investor’s capital and pays up to a maximum of 50 per cent of the growth in the Halifax house price index over a five and a half-year term.

Ljubic said a popular feature of these investments is their flexibility. Banks and other institutions are able to offer products tailored to specific client demands.

Knight Frank can therefore liaise with banks to agree a price for certain bespoke investments. An investor could ask for a product that would pay out three times any upside in house prices over the next three years with some capital protection, for instance.

Derivatives also provide a way for investors to speculate on house prices falling further, or hedge their own exposure to the property market. Those hoping to protect themselves against the recent sharp price falls may have missed their chance but those who believe the recent recovery may be short-lived can insure against another drop.

White said it is a cheap time to do this as there has been a shift in sentiment in recent months. “While the property futures market had originally predicted a sharp decline in the short term, new forecasts suggest that the fall will be far less severe than initial expectations,” he said. “Market stability and growth are expected to arrive sooner than the original pessimistic forecasts had suggested.”

The derivatives market is based on the Halifax House Price Index, which showed a 1.1 per cent increase in average house prices in July, the second rise in three months.

White said that, at the beginning of 2009, the futures market was anticipating a further 32.5 per cent fall in prices. However, the 2010 price is now trading at an average house price of £161,606, a 2 per cent increase from the December 2008 level.