Derivatives: Contract pricing edges up as capital value growth slows

Pricing for 2011 contracts rose 30bps in April, while IPD Q1 2011 figures showed capital values still growing, albeit more slow

The IPD quarterly figure for  Q1 2011, released in early May, revealed a rise in capital values for the seventh consecutive quarter, writes Sam Whitham. Capital values growth was positive but weak, at 0.83%. Combined with income, this equated to a 2.34% total return, slightly lower than the 2.82% Q4 2010 figure.

IPD All-Property returns have outperformed both the fixed income and equity markets. Five- to 15-year gilts offered -0.67% total returns in Q1 2011, incorporating a 2.45% fall in capital values. Equity markets fared a little better, with FT All Share capital growth of 0.19% and total returns of 1.06%.

The IPD All-Property Annual Estimate for April showed capital values rose just 0.11% during the month. Capital value growth, which was strong in February and March, appears to be slowing down, with the potential for a shift into negative territory.

Surprisingly, no sector showed falling capital values, but retail and industrial property were almost flat at 0.03% and 0.01% capital growth respectively. Offices were slightly stronger, at 0.29% growth, but again were propped up by central London, which itself weakened in April. Outside London, offices’ decline continued, making the general outlook more bearish.

IPD UK swap trading volumes for Q1 2011 rose by roughly 140% from their Q4 2010 levels, reflecting strong interest from end users in property derivatives. But the market was quiet in April. Derivative pricing has hardly moved in the past month. With fewer business days and a very quiet period between the two bank holiday weekends, activity was somewhat abridged.

Pricing for all annual contracts pushed a touch higher. The 2011 contracts rose the most, by 30bps in the past month, most recently pricing at 5.3%, while 2012 contracts rose 5bps to 4.05%. The 2013, 2014 and 2015 annual contracts all finished the period 10bps higher, at 5.25%.

So far this year there has been greater interest in structured notes that mimic property returns, and not just at an All- Property level, but also for sector and sub-sector notes. Industrial and central London office notes have been sought after by investors unable to gain desired exposure through direct property or quality indirect funds.

Halifax House Price Index non- seasonally adjusted prices have now risen 0.5% so far this year. April data revealed a marginal increase in average house prices, following the trend of the past two months. One-year HHPI contracts are priced at around 94.5%, implying house prices will fall 5.5% by the end of 2011.

Front-end HHPI contract pricing for Q1 2011 has risen since the end of 2010. One-year contracts, which closed at 88% in 2010, are now priced 6.5% higher; three-year contracts, which closed 2010 at 92%, now have a 94.75% mid price; and five-year contracts are pricing 3% higher at 101%. At the back end of the curve, pricing for longer-dated contracts initially dipped at  the start of the year but had recovered to the same level by the end of Q1.

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