Residential property derivatives and the structured product market

The market for derivatives on residential property has had comparatively less publicity recently than commercial property derivatives, but nevertheless it is a significant existing market.Well in excess of £1 billion worth of derivatives trades have been executed based on the Halifax house price index, of varying maturity and type.The contacts range from short-dated futures to 30+ year swaps.The type of swap and option contracts executed include put, call,Asian and basket options.

For residential property there are a number of indexes available, produced by banks, building societies, estate agents and government bodies. It was important to use only one index to encourage market growth, one that is understood, has substantial historic data and is expected to have a long-term future.For this reason the market standard has become the Halifax House Price Index.There are a number of reasons for this, including the fact that Halifax has always held a high share of the mortgage market – this is very important because it is the mortgage valuation process that drives the data for the properties that comprise the index.

The Halifax Index also has a long history, having been produced since 1984, so there is in excess of 20 years of data that proves its reliability and to back-test investments. Of other indexes available, the Nationwide Index has a longer history, but a smaller sample size and the new ODPM (Office of the Deputy Prime Minister) index,which is an amalgam of mortgage data across the industry, has a broader base, but only a short history.

Last year there were 24 House Price Index investment products launched into the retail market-place.The issuers ranged from retail banks and building societies, through private banks, to bespoke independent product providers.The most common type of product that has been offered is the relatively simple capital guarantee plus upside, which are now standard issue products.The construction of these products mirrors that used historically in equity-linked products, in the purchase of a zero-coupon bond (or swap) and an at-the-money call option on the Halifax House Price Index.These products have been issued for periods of between three and 15 years, with the most successful issues being around five years in term. Extending the term of the product reduces the cost of the capital guarantee and therefore allows an increase in the level of gearing on the index.One recent issuer launched a suite of products simultaneously with the following terms:

■ 100% return of the HPI for 5 years
■ 150% return of the HPI for 7.5 years
■ 200% return of the HPI for 10 years

These products were all capital guaranteed at maturity, which is obviously a significant feature that is not available when investing in direct property holdings. In addition to being index-based, they offer a diversified portfolio for investors. In terms of product construction, the Halifax Index is a capital based index, not a total return based index, and so HPI structured products are comparable in style to FTSE-based structured products.

The availability of derivatives on residential property has enabled further products to be structured whose payouts could not be achieved with direct property investments.These include:

■ A CPPI style fund that invests in HPI call options and cash
■ Investment accounts whose payout increases as the House Price Index declines
■ Multi-asset products combining HPI with any of gold, cash and equities
■ Basket products combining HPI with FTSE returns
■ UK HPI quantoed into euros for European investors

All of these products allow the investor to access returns from the residential property market,without the expense and complexity attached to direct investments, including rental yield risk, void periods, maintenance costs, agency fees, stamp duty fees on acquisition, estate agents costs and all the general hassle involved with direct ownership.


Guy Ratcliffe, head of property derivatives
t: +44 (0)20 7756 7124

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