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Property Swaps: They’ll be in Australia before 2010 cont'd...
There are derivative markets for all asset classes including commodities, equities, interest rates – but not property, until now.
News from abroad is the first full time property derivatives trading desk has commenced operations in Britain and writing business. Currently the market is between a handful of investment banks typically for STG10m 2 year contracts.
In plain terms, a property gives an investor a total return via capital gains (future value) and income (rental). The property based swap contracts are based on total returns, as reflected in a nominated property index. In Australia this would most likely be derived from the Investment Property Databank, which monitors incomes and returns of 800 Australia non-residential properties valued at $66.7 billion.
Buying a $10 million contract would be like buying a $10 million property. Just as an investor takes out a loan to finance the purchase and pay interest for the facility, so the property swap investor also has exposure to a $10 million asset and interest payments. The major difference at this stage of the market development is that swap transactions are mostly unfunded, meaning investors need to pay only for the interest on the contract amount.
In Britain, the price of a contract is based on the 90-day bank bill swap rate currently 5 per cent plus the spread - the price of the derivative contract, which is currently at 4 per cent for a two-year contract. The buyer would pay a total of 9 per cent on the $10 million to own a contract. The spread or price was determined by market forces, such as expectations of growth in the market. At maturity of the swap the counterparty would pay the investor the total return as reflected in the Investment Property Databank Index.
Advantages of the property derivatives are as follows:
- Buyer can invest in a property risk asset and not be up for transaction costs which may represent over 5% of property costs.
- Offer property managers flexibility to rebalance portfolios or unwind positions.
- Depending on the market situation, managers could switch from office to retail or industrial.
- Allow investors to take a position in the market in the absence of physical assets.
*Metfund acknowledges source material published by The Australian.
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