The National Council of Real Estate Investment Fiduciaries and Credit Suisse First Boston LLC are attempting to create the first domestic real estate derivatives market, which would give institutional investors another way to invest in real estate and rebalance their real estate portfolios.
Real estate derivatives also would provide an opportunity to invest in equity real estate right away, at a time when many institutions are faced with long waits.
The new instruments — to be created by CSFB under an exclusive two-year contract with NCREIF — also would allow real estate investors who believe the real estate market is overvalued to short it, something they are unable to do now.
NCREIF and CSFB executives also anticipate that investors will be able to reduce their real estate risk or swap into other types of real estate without the expense of selling the underlying property and giving up its income stream.
A year-old real estate derivatives market in the United Kingdom, benchmarked to the Investment Property Databank Index, has been slowly gaining acceptance. Officials in Sweden and the Netherlands also are considering real estate derivatives markets.
In the U.K., more than £600 million ($1.09 billion) in real estate derivative contracts have been written since December. One of the first transactions, in January, was a £40 million real estate swap in which Prudential Assurance Co. Ltd., London, decreased its exposure to the property market by £40 million and British Land Co. PLC, London,and another property company increased their exposure by £20 million. In February, TD Securities, Toronto, the trading arm of Toronto Dominion Bank, completed £70 million in property derivatives in three-year swaps with counterparties that included two pension funds, a life company, a unit trust and Deutsche Bank, Frankfurt.
While most British derivatives are structured more like bonds, the U.S. ones would be rate-of-return or property-type swaps based on the NCREIF Property index.
Few U.K. pension funds have taken advantage of so-called property derivatives, but an informal poll at a conference in November showed they would allocate an average of 14% of their real estate portfolios to property derivatives in the future.
So far, U.S. institutional investors have taken a wait-and-see approach, saying a real estate derivatives market needs to be of significant scale before they would become involved.
Among those monitoring the situation are the $123.5 billion California State Teachers' Retirement System, Sacramento; the $50.6 billion Public School Employees Retirement System of Pennsylvania, Harrisburg; and the $8.2 billion Los Angeles City Employees' Retirement System.
"We would be interested … but it would have to be proven in the marketplace before we would get into it," said CalSTRS spokeswoman Sherry Reser.