IPD: property derivatives still growing

The property derivatives business is still growing, with £10.6 billion in deals so far in the UK - although the market continues to be reluctant to make trades based on property sectors.

The three months to September 30 saw 96 trades totalling £1.66 billion notional, based on the UK all-property index produced by the Investment Property Databank (IPD). The UK still dominates the property derivatives market - France saw only £613 million notional in trades and Germany £109 million, with smaller volumes in Italy, Japan and Australia.

Discussing the results at a meeting of the Property Derivatives Interest Group (PDIG) in London this morning, Ian Cullen, head of systems and information standards for the Investment Property Forum (IPF) think tank, said: "There has been no significant growth in the sector indexes, whatever their theoretical advantages."

In theory, trades based on a sector of the market - for example, City of London office buildings - should be more attractive, as they provide a closer hedge to a property portfolio than the all-property index. But sector trades have failed to take off and are still less than 5% of each quarter's business, Cullen said.

Alex Dewey, co-head of the property derivatives team at Cushman & Wakefield BGC, commented: "It's got a lot to do with the end users currently in the market. They tend to be of such size that they don't have a specific sector requirement - it's real estate versus other asset classes, not specific sectors such as Manchester office space. It's less of an education hurdle for them to enter the property derivatives market, because they already use derivatives in other areas."

As smaller investors overcome their nervousness, the number of sector trades could increase, but it is likely to remain a small proportion of the overall volume, he added.

The derivatives market also makes better predictions regarding the property market than the forecasts by industry analysts, remarked Peter Hayes of real estate investment company Pramerica. "Forecasts of rent tend to be more accurate than forecasts of yield - rent forecasts are based on economic factors such as GDP growth, and yield forecasts are based on sentiment," he remarked.

The consensus of IPF member forecasts was for 8.1% growth in the UK index over 2007, while derivatives prices implied 0% – with two months left to go, the trend was closer to 0%.

"Derivatives pricing gives a much more realistic view," Hayes added.