The UK is a nation obsessed with property prices. But while opinion remains divided over the fate of the housing market, traffic in the property derivatives markets is decidedly one-way.
With so much money tied up in bricks and mortar, it is understandable why property prices have become such an emotive issue. Headlines in the national press claiming meltdown in the housing market have upped the ante by playing on the fears of homeowners. The only question now seems to be whether property prices are in for a hard or soft landing. According to the Halifax, average house prices fell 1.1% last October, though as this figure is based on mortgage approvals it gives a rather lagged picture of the market. Perhaps the best leading indicators are the various property derivatives that have emerged in the last few years.
Specialist spread bets, CFDs and covered warrants on the Halifax house price index enable people to back their views on the housing market - whether positive or negative - without the expense and upheaval of actually buying or selling property.
A pretty clear picture of a decisive shift in sentiment is emerging. John Austin, head of proprietary products at IG Index, says that because of this the firm's house price markets are currently suspended and it is only accepting bets to close existing positions. 'There has been such a run of stories in the press talking of meltdown in the housing market that the volume of sell-side business left us with no choice but to close our book to new business for the time being,' he explains.
The problem is that there is no easy way for spread betting companies quoting these products to actually hedge their exposure to the house price index. The flipside is that there is a huge degree of interest in these bets. 'We are very eager to get back into the house price market,' acknowledges Austin. 'We have a large exposure to the prices next March and would anticipate that once these figures have been released and the bets settled we will be back taking new positions again,' he adds.
IG normally offers bets on the average house price for the UK as a whole, as well as the average house price in London and eleven other UK regions. The company makes continuous two-way quotes in each of these markets, the difference between them - the spread - being the only cost of the transaction. In making the prices Austin explains that IG starts with a forecast that is then pushed around by the forces of supply and demand.
House price bets are available for the next four quarters with the prices given in points per £1,000. For example, the last settled national bet was 162.7 - representing an average house price across the country of £162,700. IG's current quote for December 2004 representing the average price for the month of December is 161.5 to 163.3. Looking further ahead the equivalent price for September 2005 is 148.3 to 151.7. Spreadbetting prices give a true measure of sentiment in the property market. 'The national average house price to September 2005 represents an 8% discount to the last settled price which is just about the most aggressive fall that we have seen,' says Austin. 'This may not seem that excessive but the Halifax index is less volatile than the property market as a whole because it tends to be skewed towards lower value houses.'
There is no easy way for spread betting companies quoting these products to actually hedge their exposure to the house price index. The flipside is that there is a huge degree of interest in these bets
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When these markets were open to new bets, someone who believed that the Halifax index would fall by more than 8% by next September could have sold the spread at 148.3. If the market were to fall more sharply so that the average price of a house next September as recorded by the Halifax is £142,000, the bet would settle at 142. This would give a profit of 6.3 points, which if betting £500 a point would equate to a tax free gain of £3,150.
For the regional bets the settlement price is the published average for the whole contract quarter, so a September London house price bet concerns the London average for the quarter up to and including September. The last settled price for London was 243, equivalent to an average property value of £243,000. IG Index is currently quoting December 2004 at 240.3 to 243.3, and September 2005 at 226.5 to 231.5. 'The discount in London to next September is lower at around 6%,' observes Austin. 'This is unusual in that London normally leads the country, but we have seen quite a lot of buying recently to close out positions and this has raised the price.'
IG is the first company to offer contracts for difference or CFDs on property prices. Like the spread bets, the CFDs are currently suspended for new business as IG's overall exposure to the house price index reflects the positions taken in both of these markets. 'In economic terms the property spread bets and the CFDs are the same,' explains Austin. 'The only difference is in the tax treatment, since if you win with a spread bet the gain is tax free, while if you lose the loss cannot be offset against other chargeable gains.'
The first company to offer spread bets on property prices was City Index, though it no longer does so today. Their spreads were based on the Land Registry figures, which reflect the prices of all property transactions completed in the previous quarter.
'The main problem with the Land Registry figures is that it looks as though there are some seasonal variations, with prices not moving at all in some quarters,' explains Ashley Tatham, a senior trader at City Index. 'For instance, prices invariably seemed to rise in the quarter to September and then not move in the following three months.'
Tatham also says that as the Land Registry figures are based on a simple average, they can potentially be distorted by the mix of properties changing hands. This is not the case with the Halifax figures, because the index is standardised. The Land Registry does, however, reflect all of the transaction - including those not involving a mortgage. 'The problem with the Halifax figures is that they are only based on a small share of the market, as HBOS may only account for around 10% of the mortgage market now,' says Tatham. 'They also fail to take into account properties bought for cash, which is becoming a more significant factor.'
The danger for the spread betting companies is that these limitations create a problem of perception. 'Clients who were spread betting on property prices saw that the house price index wasn't moving in line with the actual house prices around them,' explains Tatham.
One alternative is to indirectly spread bet on property prices using proxies such as the house builder sector or interest rate futures, but while there is certainly a correlation it is not particularly close. 'The problem with the house builder sector is that it is much more volatile than a house price index as the profits are highly geared to interest rate changes and the value of the land bank,' explains Tatham. 'With interest rate futures people will find there is a lagging factor between interest rates and house prices. It is perfectly possible for interest rates to go nowhere in the next two years and yet for house prices to drift off by 20%.'
With the spread bets on house prices currently suspended for new business, the one way left for traders to hedge or speculate directly on property values is the covered warrants market. Goldman Sachs has issued a series of six warrants and certificates linked to the future level of the Halifax House Price index for June 2006.
Warrants and certificates are listed and traded on the LSE. A warrant is much like an option and gives investors the right - but not the obligation - to buy (in the case of a call warrant) or sell (with a put warrant) the underlying asset at the specified strike price on or before the expiry date. In return for this right, investors pay an upfront price or 'premium' for the warrant, which is a fraction of the cost of the underlying asset, giving them a geared exposure to the market.
'With a warrant, people know the price they are getting in at and how and when it settles,' says Mark Valentine, an executive director at Goldman Sachs. 'The property products are not really for the very active trader, someone with say a one-month view on house prices, since the lengthy time to expiry makes them less sensitive to short-term influences.'
Traders can sell their warrants on the LSE via their broker at any time before the instrument matures. 'The value of these products reflects the supply and demand in the market as well as the intervening monthly house price index levels,' explains Valentine. 'These warrants track an estimate of where the index will finish in June 2006.'
One of the brokers to accept warrants is Comdirect. Neil Jamieson, head of marketing at the company, says that warrants are a niche product and the property warrants are very much a niche within a niche. 'It is pretty much one-way traffic at the moment with people speculating on a fall in prices,' he says. 'These products are a very good way to hedgean exposure to the property market, but for most people hedging the full value of a typical property would be prohibitively expensive.'
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