Barely two years after the bank was rescued by the UK tax payer after exposure to sub-prime residential mortgage products caused its near destruction, offering a property derivative product seems to fly in the face of the current regulatory climate.
The bank’s own £87bn UK residential mortgage exposure means it will act as the counterparty to the trades, which will be pegged against future increases in the Halifax house price index. However, the forward curve for residential derivatives – the nearest thing you can get to a property futures market – is pricing in a 10 per cent price drop to house prices in 2011.
Requiring a minimum investment of £10,000, the two RBS products will launch in the new year, and have a four-year and eight-year lifespan, tempting investors to gamble on medium-term house price growth.
RBS anticipates writing around £50m of business, and started pitching to private banks and firms of wealth managers last week. It is anticipated that retail investors will access the products through intermediaries, though institutional investors are also being targeted.
FULL HOUSE
Risks are tempered by the fact that these notes are capital protected, meaning investors will get their initial investment back at the end of the term, with any house price growth on top. So if house prices fall through the floor, investors will at least get back what they’ve put in. But if house price growth comes back strongly in 2012-13, investors could be handsomely rewarded.
The RBS Buy-to-let capital protected note is designed “to replicate an investment in buy-to-let residential property” according to the bank. This will suit some investors, who can avoid the hassle and expense of property maintenance, or those who are unable to find a large deposit. Buy-to-let mortgage lenders typically insist on a 30 per cent deposit, and lack of competition in the market means interest rates are very high.
Instead of the traditional rental yield, investors in the RBS buy-to-let notes will receive a fixed annual coupon of less than 3 per cent throughout the 8-year term, plus capital growth linked to the house price index which is payable upon maturity.
RBS is also marketing a separate zero coupon note, which will be issued at around a 10 per cent discount to the December 2009 Halifax house price index, but does not pay an annual coupon. It also has a shorter term - any positive growth from this point is paid out after four years.
PRICES STILL FALLING
On a quarterly like-for-like basis, the Halifax house price index has been in negative territory for eight months, with November showing a drop of -2.1 per cent, the biggest monthly fall since January 2010. However, Savills predicts a return to house price growth in 2012, anticipating . This means that, assuming the average house price index rises by 40 per cent over the term of the eight-year product, allowing for the coupon, investors would receive a total return of 7.6 per cent per year. If it increases by 10 per cent over eight years, total returns would be 3.6 per cent per year.
RBS derivatives trader Naomi Yarrow believes investors could use the products as an alternative to buy-to-let, or as a diversifier for those who are looking to buy a house at a future point, perhaps for growing children. “If house prices go down, the discount means you still get a bit of uplift, and house prices will then be cheaper for you to buy,” she says.
Depending on your circumstances, this may seem an attractive investment proposition – but property experts are keen to point out that buy-to-let properties could actually perform better across the same timescale.
“The biggest attraction of buy-to-let property investments today is extremely strong rental growth, and these products won’t replicate that at all,” comments Neil Young, chief executive of residential property investor the Young Group. “As it’s 100 per cent cash, returns won’t show any benefit of gearing. It would be preferable in many ways if RBS would concentrate on lending money to property investors who could then buy real houses for people to live in.”
