Property holders opt for derivatives amid uncertainty
The roller-coaster ride taken by financial markets in Asia in the wake of the United States subprime mortgage crisis is likely to stir interest in Hong Kong property derivatives, says the brokerage behind most of the deals done to date on the market, GFI Colliers.
'The primary purpose of the derivatives, and the reason they will prove increasingly popular in the present climate, is to provide a hedge for holders of property who are concerned that the value of their holdings may fall,' GFI head of property derivatives Stephen Moore said.
And with a cloud of uncertainty hanging over property prices as global economic growth slows and the effects of the US subprime crisis continue to rock financial markets, more Hong Kong developers could turn to derivatives to limit losses on their property portfolios, he said.
Mr Moore was commenting after the announcement last week that Goldman Sachs and Lehman Brothers Global Real Estate Group had signed the first long-dated Asian OTC (over the counter) option written on Hong Kong property price movements.
Neither the size nor the tenor of the option was revealed in the joint announcement by the two investment bankers.
But market talk is that it was the largest property derivative deal done in Hong Kong thus far, which would put it at HK$180 million plus.
It was also a longer-dated swap than deals so far done, which would put it at longer than two years.
The put option was bought by the real estate group of Lehman as a hedge against a fall in property prices as captured by movements in the University of Hong Kong, Hong Kong Island Residential Price Index (HKU-HRPI).
Goldman Sachs, which is believed to have paid a comparatively modest single-digit percentage of the contract value as a premium from Lehman, effectively bought an exposure to the property market by entering into the deal, without taking transfer of physical property.
If prices fall, Lehman will be able to exercise the option and collect from the seller, or Goldman, a payment calculated as a percentage of the fall multiplied by the contract value. If prices rise, Lehman will simply not exercise the option and in this case would have limited its losses to the premium that it paid Goldman, while benefiting from the rise in the value of its property portfolio.
The size and the longer tenor of the contract represented the 'next phase' of the property derivative market in Hong Kong, Mr Moore said.
The market's debut contract was a simple short-dated swap brokered by GFI Colliers between developer Sun Hung Kai Properties and Dutch investment bank ABN Amro in February last year. 'That was the first property derivative transaction in the Asia-Pacific,' said Mr Moore.
Since then '15 to 20' deals with contract values of about HK$2 billion had been done, but Mr Moore said the potential for the market was huge.
In the Hong Kong short-dated swap markets all contracts have so far been linked to the HKU-HRPI and have involved institutional investors holding large property portfolios or big landlords buying the swap options to protect their asset values from declining.
The uncertain outlook for property prices as well as the present volatility in the market represented an opportunity for investment banks to package more derivatives to sell to big institutional investors, including hedge funds and pension funds, said Mr Moore.
But he also believed that retail banks might extend investment opportunities to high-net-worth investors.
'We have seen lots of wealthy Chinese industrialists come to Hong Kong and buy properties on the Peak,' he said.
'A property derivative contract might provide them with an exposure to the Hong Kong residential market of up to HK$100 million through a buy contract that might cost them just HK$8 million,' he said.
By comparison, added Mr Moore, transaction costs incurred by buying a luxury property on the Peak would include stamp duty of up to 3.75 per cent, legal fees of an additional 1 per cent, and another 1 per cent for agent's fees.
'If you bought as an investment and wanted to sell again in a year or so, the round-trip costs could be near 10 per cent,' he said.
'Besides these advantages, a mainland buyer could do a deal through a broker on the phone and get instant exposure within minutes.'
