What is a 'Property Derivative'

A property derivative is a financial product that fluctuates in value depending on the changes in value of an underlying real estate asset, usually an index. Property derivatives provide investors with exposure to a specific real estate market without having to buy and sell tangible properties.

BREAKING DOWN 'Property Derivative'

Property derivatives are a variety of financial derivative, which is a structure that takes its value from an underlying entity such as an asset, an index or an interest rate. Examples of derivatives include futures, options, swaps and property index notes. Derivatives are frequently used to hedge against price movements or to gain access to assets or markets that are otherwise hard to trade. 

Property derivatives typically replace real property with the performance of a real estate return index such as the National Council of Real Estate Investment Fiduciaries Property Index (NPI). The NPI is the accepted index created to gauge the investment performance of the commercial real estate market. As of the fourth quarter of 2017, the index is worth approximately $559 billion, across all U.S. regions and real estate land uses. An index is used because individual real estate assets can be hard to price accurately and efficiently. A real estate index gathers information across the broad real estate market in an attempt to accurately approximate the value of underlying assets.

The benefits of property derivatives

Using property derivatives, investors can move in and out of all four quadrants of the real estate market, private equity, public equity, private debt and public debt. Doing so allows them to manage risk and potentially increase returns to their existing real estate asset allocation. An active derivatives market enables an investor to reduce upfront capital requirements and to shelter real estate portfolios on the downside while providing risk management strategies. 

One method of using property derivatives is to make a total return swap of the National Council of Real Estate Investment Fiduciaries index, broken down by property sector. The swap allows investors to take a position in an alternate property sector in which they may not already own properties. Investors can then swap the returns from different sub-sectors, such as exchanging office-related real estate for a retail real estate. Swaps allow investors to tactically change or rebalance their portfolios for a specific period, usually up to three years. Additional methods include “going long,” or replicating the exposure of buying properties, and “going short,” or replicating the exposure of selling properties.

RELATED TERMS
  1. Real Estate

    Real estate is property made up of land as well as anything on ...
  2. List Price

    The list price, in the real estate world, is the suggested gross ...
  3. Personal Property

    Personal property is a type of property which can include any ...
  4. Commercial Property

    Commercial property is buildings and land that are intended for ...
  5. Underlying Security

    An underlying security is a stock, bond, currency, or commodity ...
  6. Property Tax

    Property tax is an ad valorem tax assessed on real estate by ...
Related Articles
  1. Investing

    A Guide to Real Estate Investing

    Investing in real estate is a popular choice for good reasons, but it's more complicated than owning your typical stocks and bonds.
  2. Investing

    Real Estate Vs. Stocks: Which One's Right For You?

    There are ups and downs for both real estate and stock investments, so before diving in, know the differences between the two.
  3. Investing

    Simple Ways to Invest in Real Estate

    Owning property isn't always easy, but there are plenty of perks. Here are some ways to invest in real estate.
  4. Investing

    The Risks Of Real Estate Sector Funds

    Discover the risks and rewards of investing in real estate funds, as well as some of the best and worst performers.
  5. Investing

    10 Habits of Successful Real Estate Investors

    Make a plan, develop a niche and the other key behaviors it takes to grow a successful, long-term career in real estate.
  6. Investing

    Exploring Real Estate Investments

    Discover how owning properties can give you a roof over your head or a check in your pocket.
  7. Investing

    How to Make Money With Real Estate Options

    Buying real estate options is one way to invest in real estate at a lower entry cost.
  8. Investing

    How Much Money Do You Need To Invest In Real Estate?

    Here's a rundown of how much investors need to get started in real estate investing.
RELATED FAQS
  1. The Role of an Asset Manager in the Real Estate Market

    Find out what role asset managers play in the real estate markets. Learn how real estate portfolios are selected and why ... Read Answer >>
  2. What are the main segments of the real estate sector?

    Understand what the three primary segments of the real estate sector are and the metrics used by investors and analysts to ... Read Answer >>
  3. How do real estate hedge funds work?

    Understand what a hedge fund is, how it differs from a mutual fund, and the function of real estate hedge funds. Read Answer >>
Trading Center