RBS to offer house price derivatives

The Royal Bank of Scotland is preparing to launch residential derivatives products aimed at retail investors who are prepared to bet against the odds that house prices will rise.

The bank’s own residential lending exposure means it will act as the counterparty to the trades, which will be pegged against future increases in the Halifax house price index.

However, the forward curve for residential derivatives – the nearest thing to a property futures market – is pricing in a 10 per cent price drop to house prices in 2011.

Naomi Yarrow, RBS derivatives trader, believes investors could use the products as an alternative to buy-to-let, or as a diversifier for those who are looking to buy a house at a future point, perhaps for children.

“If house prices go down, the discount means you still get a bit of uplift, and house prices will then be cheaper for you to buy,”
she says.

Requiring a minimum investment of £10,000, the two products from RBS will launch in the new year and have either a four-year or an eight-year lifespan, tempting investors to gamble on medium-term house price growth.

The risk of launching a property derivative product in the current regulatory climate will be tempered by the fact that these notes are capital protected, meaning investors will get their initial investment back at the end of the term, with any house price growth on top.

The eight-year buy-to-let capital protected note is designed “to replicate an investment in residential property” without the hassle of property maintenance or finding a large deposit. Instead of the traditional rental yield, investors will receive a fixed annual coupon of less than 3 per cent through the eight-year term, plus capital growth linked to the house price index upon maturity.

The four-year product offers a separate zero coupon note, issued at a discount of about 10 per cent to the December 2009 house price index, and any positive growth from this point is paid out after four years.

On a quarterly like-for-like basis, the Halifax house price index has been in negative territory for eight months, with November showing a drop of -2.1 per cent, the biggest monthly fall since January. However, estate agents Savills predicts a return to house price growth in 2012, anticipating average UK prices will rise by 12 per cent in the next five years.

This means that, assuming the average house price index rises 40 per cent over the term of the eight-year product, allowing for the coupon, investors would receive a total return of 7.6 per cent per year. If it increases 10 per cent,
total returns would be 3.6 per cent.

But Neil Young, chief executive of residential property investor Young Group, warned: “The biggest attraction of buy-to-let property investments today is extremely strong rental growth, and these products won’t replicate that at all.”