Synthetic real estate – going nowhere fast
For those looking to gain broad exposure to the property market, the attractions of property derivatives are obvious. Instead of having to find physical properties to purchase, the investor simply buys a product whose returns are linked to the performance of an established property index. The cost of buying or selling physical property might be as high as 7% of notional value. The cost of taking the exposure via a property swap is more like 0.5%, and it does not require putting forward any capital at the start of the deal. Also, the economics of a property swap are simple. The buyer agrees to pay a spread over Libor and in return the investment bank originating the swap agrees to pay the annual change in whichever index is being tracked.
Those touting property derivatives also say they have many advantages over property funds and buying the shares of property companies, not least the transparency of the underlying indices used, which are highly visible and follow fixed rules and methodologies. Meanwhile, a property derivative can be tailored to give the buyer whatever maturity they find optimal.