Real estate is the last major asset class without liquid derivatives markets. The reasons for that are not fully known or understood. Therefore, the aim of the current research is to better understand the main factors that influence the propensity of commercial real estate investors in the U.K. to employ property derivatives.Design/methodology/approach
The research methodology that was chosen for the current research is grounded theory which, in its original form, goes back to Glaser and Strauss (1967). A total of 43 interviews were conducted with real estate professionals from property investment management firms (investing directly and indirectly in property), multi-asset management firms, real estate investment trusts (REITs), banks, and brokerage and advisory firms, among others.Findings
The research results show 21 influencing factors, in addition to eight factors that were discussed in the literature and tested, as to their influence on the propensity of real estate investors to employ property derivatives. Three reasons have been identified as the sources of investor reluctance to trade in property derivatives. The first and main reason is related to a mismatch between motivations of property investment managers and what can be achieved with the instruments. The second reason which ties in with the first one is a general misunderstanding as to the right pricing technique of property derivatives. Finally, the third reason is a general lack of hedging demand from the investor base owning to the long investment horizons through market cycles.Research limitations/implications
The research contributes to the literature on property derivatives in various ways. First, it extends the literature on market hurdles in property derivatives markets by testing and extending the hurdles that were proposed previously. Second, the research shows that the existing price models need to be extended in order to account for the risk perception of practitioners and their concerns with regards to liquidity levels.Practical implications
For both theory and practice, the research has shown some limitations in using property derivatives for purposes such as creating index exposure or hedging. Another contribution, in this case to practice, is that this study provides a clearer picture as to the reasons that keep property investment managers away from using property derivatives. Furthermore, it has been shown that liquidity per se is not a universal remedy for the problems in the market. In addition, practitioners should give more thought to the notion of real estate market risk and the commensurate returns that can reasonably be expected when they take or reduce it.
Property derivatives, real estate derivatives, illiquid markets, index-based derivatives, property index futures