Property Derivatives
The man from the Pru: Paul McNamara expects growth in derivatives
Paul McNamara is director and head of research at Prupim and he was writing exclusively for Property Week
Politics and economics will dictate property’s fortunes in 2010 As a long-term property investor with investment horizons measured in years rather than months, Prupim expects the pace of capital growth in the UK market to lessen noticeably in forthcoming quarters.
Although an accurate forecast of the Investment Property Databank return for the next 12 months would be of interest, it is not our main concern. Our focus is on establishing whether, at current prices, the market is likely to be able to provide us with fair or better returns.
The exact timing of the delivery of those returns, within reason, is a secondary issue.
This is especially the case given the raging uncertainties in the economic and financial spheres.
New statesmen This year the state of the investment market will be determined by factors that are beyond the narrow scope of economic forecasters.
The result of the general election will need to be watched closely.
The policy decisions taken by the winning party — or parties, if the result is a hung parliament — and their subsequent impact on key variables such as the value of the pound are likely to have a considerable impact on a property market that remains dependent on overseas cash.
Similarly, the policies and behaviour of the banks, and how they intend to manage their exposure to commercial property, will be significant.
Overall, the UK commercial property market still offers good value.
Despite some clearly excitable bidding on some properties, the UK still represents fair value or better.
If we choose our markets well, we can buy at today’s prices and still achieve our required returns, even if cycles turn out to be volatile in the short term.
With so much uncertainty elsewhere, we can be reasonably sure that investors will continue to focus on quality.
The appetite for prime buildings with long-term, secured tenants will lead to some aggressive bidding contests. Investors will also start to return to overseas markets, particularly in parts of Asia-Pacific.
However, even here, value needs to be assessed market by market.
We also expect further growth in the commercial property derivatives market.
Trading on different sectors or subsectors is an essential development for property investors, to help them manage their portfolios more efficiently and effectively.
Prupim has continued to explore these types of trades, and we expect others to follow.
Despite the non-binding nature of the Copenhagen talks on tackling climate change, sustainability will remain centre stage for investors.
There remain good reputational and economic reasons for investors, managers and developers to address buildings’ sustainability credentials.
These are only likely to increase in importance as the property industry comes under renewed political pressure to help tackle climate change.
Large sections of the property sector have bought into the principle of sustainable investment and management. As the worst of the economic storm passes, they will focus more on how best to provide this difficult but laudable ambition.
Residential Market - failed to produce any meaningful moves
Like commercial property, many of the concerns overhanging the market are weighing on residential investors minds despite the well documented lack of supply.
Consequently the market failed to produce any meaningful moves.
Alistair Darling, the Chancellor of the Exchequer, proposed giving the FSA more powers to police the UK mortgage market, such as requiring Hedge funds and private equity firms, who bought distressed mortgage portfolios, to abide by the same rules as banks when it comes to dealing with customers.
He also announced other measures to clamp down on risky loans, which may curb demand for home loans.
Paragon the buy-to-let mortgage specialist signalled that lending markets are improving by announcing that they are poised to resume lending again for the first time in two years.
Market Commentary - another week stuck in the headlights unsure which way to turn
The Property Derivative market spent another week stuck in the headlights unsure which way to turn as more property funds report commercial property is back on their radar, Mervyn King the governor of the Bank of England reiterated that the Bank is going to maintain QE for as long as necessary and in contrast concern is continuing to grow about the refinancing of real estate debt over the next few years, not to mention escalating sovereign debt and the overall health of the banking sector.
Standard Life is reported to be advising investors to consider increasing the proportion of money held in commercial real estate, whilst Mike Turner from Aberdeen Asset Management said, ’’The commercial property market compares with where stocks were about seven months ago.’’
This sentiment was also backed up by Ken Adams from Scottish Widows who added,’’ U.K. commercial property is cheap and cheaper than stocks and credit is, broadly speaking, close to fair value.’’
Fitch a leading ratings agency published a report this week warning of the difficulties of refinancing more than $98bn of securitised real estate debt maturing across Europe by 2014 and the Bundesbank told German banks to take advantage of renewed confidence while they can in order to prepare for likely loses of £81bn over the next year.
Residential Market - house prices could fall as much as 6.6% next year
Latest research from Savills last week said that UK house prices could fall as much as 6.6% next year as unemployment deters buyers and more property becomes available on the market.
Adding that values were unlikely to return to 2007 peak levels until 2014.
Cluttons LLP echoed this view predicting a 1.5% drop in 2010 and saying that they didn’t expect values to return to peak levels until late 2013.
Consequently the front end of the HHPI curve came back a little reflecting these concerns.
The Royal Institute of Chartered Surveyors, (RICS) reported that 34% more Estate Agents, reported seeing a rise in property prices during October, than those recording declines.
In September the number was 21%.more. They also reported that in Q3 the average number of sales per surveyor slightly rose to 19 from 18.5 in Q2.
World’s first property derivatives fund to be launched
Three former members of Bank of American’s property derivatives team plan to create the world’s first long-only commercial property derivatives fund.
InProp Capital’s Paul Ogden, Ricardo Pereira and Markus Wolfensberger intend to launch the InProp UK Commercial Property Fund early next year.
The fund will be open-ended and ungeared with a target initial equity of £50m.
It will give investors returns based on those of the Investment Property Databank UK Annual Index.The manager of the fund, InProp Capital, will achieve this by trading on the over-the-counter property derivatives market through swap deals.
It will buy the returns from the IPD index at the prevailing price in return for paying a fixed rate to the seller of the returns – a rate that is effectively equivalent to all the costs of buying physical property, such as financing costs, stamp duty, legal costs, and agent costs.
Both the buyer and the seller will then ‘cross’ their trade to the Eurex derivatives exchange so that neither has to worry about each other’s credit risk.
Eurex provides an automated and integrated ‘Clearing House’, which assumes the counterparty risk for both parties. “This fund has been designed to specifically address the issues surrounding commercial property vehicles that have been concerning investors for the last couple of years,” said Ogden.
“I believe that it can offer investors an efficient and liquid way of accessing the commercial property market’s returns without the liquidity problems and dealing costs that are usually associated with unlisted indirect vehicles or the poor tracking error and volatility seen in REITs.”
Residential Market
Residential pricing improved in the front end buoyed by good news from the house builders, with Barratt Developments Plc reporting that reservations had increased by 34% over the last 19 weeks and Persimmon has ruled out the need for defensive fund raising due to improving market conditions and also said that they have sold out of stock for 2009.
There was also a 5% rise in mortgage lending during October.
The latest Rightmove survey dampened spirits a little by reporting that house vendors reduced asking prices by 1.6% in November taking the average house price to £226,440.
Speculators were quick to point out that over the Christmas period one would expect a reduction in interest, whilst Rightmoves commercial director, Miles Shipside added, ‘’this months price fall proves that the market does not yet have the strength to buck seasonal trends.’’
According to the latest research from Lombard Street Research, housing affordability peaked in Q2 this year and is now deteriorating as prices rise again.
Market commentary - pricing nudged higher this week
Derivative pricing nudged higher this week at the front and tail ends as the market was struggling to find any directional indicators from the minutes of the MPC meeting held earlier in the month.
There was a 3 way split in the MPC camp, with the majority voting for a £25bn increase in QE, whilst one member voted for an additional £40bn and the other for no increase at all, citing that overly generous QE and low interest rates will create asset bubbles.
The MPC also unexpectedly discussed the idea of cutting interest rates on reserve accounts, in an attempt to stimulate the banks in to lending cash rather than hoarding it, but there appeared to be no firm outcome.
The Bank also announced full details of it’s growth forecasts. For 2010 they expect GDP to grow by 2.2% rising to 4.1% in 2011, which is much higher than the Treasury’s own forecasts.
Don Robert, chief executive of Experian, the worlds largest credit checking company said that banks in the US and on the continent are recovering but those in the UK are more challenged than in any other market.
He went on to say that he is not convinced that defaults have peaked yet.
Market Commentary - continued improvement
The UK Property Derivative market shook off the previous weeks set back and pushed ahead across the entire curve this week with activity continuing to improve.
The story this week is still very much that the property funds have more cash to place in the market, with a shortage of prime physical assets still underpinning the market.
Mervyn King delivered the latest Inflation Report which has been billed by the press as dovish but latest research suggests that UK economic output is unlikely to return to the £1.4 trillion level it peaked at in early 2008 for two more years and he warned that ‘’The UK faces an arduous struggle as it attempts to rebuild and rebalance its economy.’’
He also hinted that interest rates may rise or QE may be withdrawn in the coming months.
Mr King later confused markets by apparently leaving the door open to more QE and more importantly the report warned that if the Bank followed market expectations and raised interest rates to 1.5pc by the end of next year and more than 3pc by late 2011, inflation would be pushed significantly below target.
Mean while over in the US, Randall Zisler, CEO of Zisler Capital Partners LLC said ‘’A crisis of unprecedented proportions is approaching in the US commercial real estate market.’’
He estimates that $500bn-$750bn of mortgage debt will be defaulted on, estimating that this is equal to 54% of the $1.4 trillion of loans due over the next 4 years.
Residential Market - uncertainty continues
The uncertainty surrounding the recovery in the UK residential market continues, whilst the market awaits the Nationwide housing survey to see if the upward trend in prices has continued during October, however the Land Registry did report that house prices have risen by nearly 4% since April.
The recovery in UK mortgage approvals continued with September recording 56,215 new home loans compared to 52,970 in August, the highest level for 18 monthsThe British Property Federation, (BPF), welcomed Tory ‘Localism’ proposals aimed at boosting house building and improving the planning system.. The main idea being to give local authorities greater decision making powers along with bonus payments equal to the tax income generated by newly built homes and commercial properties.
Market Commentary - property pushing on
As equity markets pause for breath and slip back among growing concerns about the state of the economy the property market along with derivative pricing pushed on and even the Dec 09 contract finally clambered out of the negative pricing range!
RICS reported that Inquiries and new lettings activity in the UK commercial property market rose for the first time in 2 years in Q3 2009. Surveyors reported a rise in new inquiries of +11 up from -3 in Q2 2009, and +8 from -13 in new sales and lettings for the same periods.
The good news continues as Germany’s Deka, Commerz AG & Union Investment RE GmbH lead a revival in European acquisitions. Latest research suggests that German money managers have 7.5bn euros to spend and have spent 1.05bn euros in Europe during Q3 2009, 22% more than in H1 2009.
On the flip side the UK failed to emerge from recession in Q3 prompting renewed calls for a continuation of the Bank of England’s QE program, which should be discussed at the next MPC meeting in early November.
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