Real estate derivatives are destined to be either the latest hot investment or the next junk bonds, depending on whom you ask.
Still, a number of global investment managers, brokers and investment banks are developing real estate derivatives strategies, predicting the market could grow to $105 billion — from close to nothing now — in three to five years, Plus, new indexes are emerging in the United States to supply the statistical basis for them.
If the market takes off, derivatives could be a boon for money managers. The new strategy could also give investors a quicker way to invest their real estate allocations and to hedge the risk.
While the U.S. real estate derivatives market is in its infancy, the market in the United Kingdom ballooned this year to an estimated £3.7 billion ($7.26 billion) as of June 30, up from £927 million as of Dec. 31, 2005, according to a September report by data research firm Investment Property Databank, London.
Proponents say an active real estate derivatives market could help institutional investors reduce real estate portfolio risk, provide a new way of reducing or adding exposure to certain sectors and another way of investing in real estate without buying or selling buildings.
Not everyone is excited about the prospect of a new property derivatives market, though. Michael Dudkowski, vice president and consultant, Wilshire Associates, Santa Monica, Calif., argues that derivatives will be used for leverage on so-called "exotic debt structures," piling additional debt on instruments that could crash.