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Over
the last couple of decades, the pattern of investing in asset
classes such as currency, bonds, equities and commodities
has transformed with the emergence of derivative markets.
But, only the property markets, which are the biggest asset
class among all, have failed to follow suit. The US housing
market, which has $21.6 tn dominating the entire investment
classes, has now found a way to hedge against the falling
property prices. The US has started applying modern finance
techniques to hedge the risks associated with its housing
market. Andrew Baum, Principal and Chairman, Oxford Property
Consultants (OPC) says, "Lack of acceptable index and
domination of real estate industry have delayed introducing
property derivatives". But all this is going to change
shortly as the Chicago Mercantile Exchange (CME) is planning
to introduce index-based futures and options linked to property
in the month of May, a new way to bet on the booming housing
market.
Certainly,
the booming housing market has been the driving force behind
the introduction of derivatives. Investors and households
believe that the US housing markets are experiencing the bubble
due to low mortgage rates. Over the past few years, the median
single family home value and ownership rates have been increasing
sharply. According to the National Association of Realtors,
the median value for existing single-family homes was $206,600
in 2005, up from $170,000 in 2003. Consequently, concerns
are mounting that the present housing bubble burst will result
in home owners' financial distress.
The
property derivatives offer a number of advantages to the investors
such as gaining exposure to property without owning it, offsetting
the risk in the existing portfolios, reduced transaction costs,
benefits of price discovery. The property derivatives allow
the transfer of property risk without the need to buy or sell
physical property. Accordingly, the investors who want to
hedge risks and speculate on housing prices indices across
10 cities can as well trade on the national index. With the
transaction costs at an estimated 0.5% for buying a derivative,
compared to 8% of trading in property, the ability to buy
exposure to property markets without the risks and expense
of choosing and managing buildings is highly attractive. |
