Constructing the Real Estate Derivatives Market
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Our March 9, 2007 post about real estate derivatives created a buzz, at a time when the financial industry grapples with the usual fits and starts of developing a new product. This post looks at where things stand. Expect more news in the aftermath of the upcoming March 28-29 conference of the Pension Real Estate Association (PREA) in Boston.
Creating a new market for any financial instrument requires sufficient interest. People have to be willing to buy and sell in large enough numbers to keep the bid-ask spread somewhat "low". Otherwise, participants will likely struggle to unwind a position. Additionally, too few actors result in excessively "high" costs that could destroy the economic rationale for trading in the first place. The burgeoning market for commercial property derivatives is no exception. According to Jim Clayton, PREA's Director of Research, there are two types of swaps being developed. The total return swap takes a LIBOR versus real estate index structure. The second version is a swap of total returns on two respective NCREIF (National Council of Real Estate Investment Fiduciaries) property sectors. Carter adds that "index return swaps allow investors to adjust exposure to real estate without buying or selling properties, thereby creating flexibility for portfolio management while eliminating the required physical delivery of the asset."
While true that more than a few pension funds now invest in commercial properties outright, obstacles remain. Valuation challenges, relatively high transaction costs, long lead times, difficulties in selling short and oft-encountered illiquidity are a few factors that influence the asset allocation decision. For a review of market development activities in the UK and US, click here to read "Commercial Real Estate Derivatives: They're Here ... Well, Almost" by Jim Clayton (PREA Quarterly, Winter 2007, pages 28-31).
Click here to link to a long list of real estate industry associations, courtesy of the Pension Real Estate Association. According to their website, the Pension Real Estate Association is a "nonprofit organization whose members are engaged in the investment of tax-exempt pension and endowment funds into real estate assets." Another resource is the University of Connecticut's Center for Real Estate and Urban Economic Studies. Headed by Dr. C.F. Sirmans, the Center provides "professional and practical assessment of real estate issues in Connecticut, the region, and the nation."
