The wider market now agrees with derivative pricing as to how far capital values will fall in this cycle , writes Michel Heller from CBRE-GFI.
October’s derivative prices were hit by a stream of negative news stories and the attendant downturn in sentiment, reaching new lows for the 2008, 2009 and 2010 contracts.
However, many people thought derivatives overshot on the downside. Coupled with a late bounce in equity markets, this meant we saw a recovery to the end of the month, but expectations were still worse than a month ago.
Total returns are expected to be -18.2% over 2008, a fall of 175bp for the month. In the year to date, the IPD montly index has fallen by 11%, so a total return fall of more than 7% for the last quarter of the year is expected. Assuming an income yield of 5%, this implies a capital fall of 23.2% for the year.
Returns for the 2009 contract were 3% in May, and fell steadily to -8% by the end of September. Pricing fell to an all-time low of -15.8%, before recovering to finish October at -10.6%. Assuming an income yield of 6.9%, this implies a capital fall of 17.5% for the year.
Equally dramatic was the pricing activity of the 2010 contract, which fell from +4% at the beginning of the month to a low of 0% for the year, before bouncing back and closing the month with a 1.6% total return expectation, an implied capital fall of 7.4%, assuming an income yield of 9%.
The 2011 contract gained in October, pricing in a total return expectation of 9% for the year, a 150bp increase, while the 2012 contract was static, expecting a 9.2% total return. Assuming income yields of 10% and 10.4% for 2011 and 2012 respectively, capital falls of 1% and 1.2% for the respective years are expected.
This equates to a peak-to-trough capital fall of 50%, with a net initial yield of 8.84% by December 2012.
Despite the cynicism over the derivative market’s mispricing, based on a lack of liquidity, it has been embraced as being the most accurate forecast of IPD total returns in the short term.
Prices at 31 Oct 08
Contract Expected Expected
Annual Period
Dec 08 -18.2% 18.2%
Dec 09 -10.6% -14.6%
Dec 10 1.6% -9.4%
Dec 11 9% -5.1%
Source: CBRE/GFI
