The UK property derivative forward curve suggests that we have seen the bottom in valuations, writes Michel Heller of CBRE-GFI. Over August, the curve has continued to price in higher-than-expected total returns for the short term.
Year to date, the IPD estimate of annual return has recorded -10% for 2009, but the derivative curve closed the month pricing in -6% for the year -a 4% risein valuations from July’s figure to the year end -and it is factoring a drop of only -3% at the moment.
The 2009 contract gained 450bps over the month, primarily as a result of strong buying interest, buoyed by strong data points as well as the stock market rally. The 2010 contract also rallied, gaining 4% on the month to close at 9.5% total return.
Despite this rally in the front end of the curve, the market is not pricing in a significant rally going forward, with net initial yields expectedto tighten by only 30bps over the next five years. Derivatives are pricing in a net initial yield of 7.55% for December 2009 and 7.25% for December 2014. Arguably, this is to be expected, due to the higher capital base than was previously being priced in. However, the 2011-14 contract is still pricing in a significant premium to the long-term historic IPD average at 11.25% total returnpa.
There is now an opportunity to hedge at premiums to current valuations and at a premium to the long-term IPD average. Some funds are looking to use derivatives to hedge-beta risk.
Source: CBRE-GFI
Prices at 31 August 09
Dec 09 -6 -6.00
Dec 10 9.5 1.00
Dec 11 11 4.20
Dec 12 10.5 5.60
Dec 13 10.5 6.50
