Location: New York
Author: Ellen J. Silverman
Date: Wednesday, July 26, 2006
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An investment alternative that is growing rapidly is derivatives based on commercial property. Property derivatives offer real estate exposure through a swap based in an exclusive arrangement on the return of the National Council of Real Estate Investment Fiduciaries index.

The U.K. has had a going property derivatives market for several years. Trades are typically tied to indexes from Investment Property Databank, a London-based research and data provider. Industry observers estimate U.K. trading volume last year at $1.5 billion to $1.9 billion and estimate it could more than double this year as the market becomes more established and liquid. "The U.S. market for property derivatives is potentially huge," according to Jeffrey Altabef, managing director for real estate finance and securitization at Credit Suisse.

Investors can use property derivatives to gain relatively inexpensive exposure to real estate and to hedge risk. They could reduce relative exposure to apartments by adding it in retail properties. "The underlying asset class is by far the largest in the world. The application for derivative use in this market place can add value to property companies and pension funds, as well as banks and speculators, who traditionally use derivatives to manage and establish risk in other asset classes," notes Philip Barker, vice president of real estate derivatives at GFI.

Paul Ogden, who heads property derivatives development for a joint venture in London between commercial real estate consultant CB Richard Ellis and derivatives broker GFI Group, says that "What we need, and what we are starting to see, is the influx of big institutions with very large property positions. That will add more depth to the market." In the U.S., Credit Suisse's commercial real estate derivatives operation is the investment alternative right now. But New York-based GFI says it's close to establishing collaboration with a commercial real estate company to also offer property derivatives in the U.S., as it does in the U.K.

The downside is that the U.S. market is tiny and illiquid. That is "obviously" going to be an issue for investors, says Alex Dewey of the London capital markets group of U.S.-based real estate services firm Cushman & Wakefield. "But once you get to that point of critical mass with the derivatives market, liquidity becomes less of an issue," he argues. "I believe we've reached that point already." GFI's Barker is only a little more circumspect. "I sense that the next six to 18 months are going to have a very strong multiplier effect in terms of profile and participation," he says. "We think that the growth is going to be exponential." Not everyone, though, is convinced of that. "I like derivatives," says Kenneth Rosen, professor of real estate and urban economics at the Haas School of Business at the University of California, Berkeley, and chairman of Rosen Real Estate Securities, which runs a hedge fund. "The only problem is they are expensive. But as more and more people do it, the liquidity will be better and so will the pricing."

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