Property derivatives are financial instruments that can be used to take a position in a property market without having to buy or sell property.
These financial instruments are usually linked to broader property market indices, such as the IPD Property Indices and the S&P/Case-Shiller Home Price Indices.
Although derivative products have been used widely in the stock market as a means of hedging risk they have been used infrequently in the property market for hedging real estate risk, which is the risk of property value declines and negative returns. An example of how derivatives can be used to hedge the risk of negative returns in the real estate market are the total return swaps.
In using derivatives for hedging real estate portfolio risk a great deal of caution is needed in order to select the appropriate financial instrument (in terms of the property index that is linked to) that will provide the desired downside protection for the particular portfolio of properties held by the investor. This is not an easy task because real estate performance varies considerably across locations even within the same urban area, as well as across property qualities even within the same property type.
