The Need for Real Estate Derivatives

Real Estate Derivatives are an $8 Trillion Opportunity‍

The global market for derivatives is a massive one, but real estate is underrepresented. There is a huge opportunity for a liquid market that allows users to gain exposure to real-time restate prices. The Parcl Protocol was created, in large part, to address this opportunity.

‍The Parcl Protocol is a venue for gaining derivative price exposure to high-value real estate markets from all over the world, leveraging digital assets and the power of the blockchain. Parcl is on the cutting edge of innovation in DeFi and Real Estate; bridging the gap between real-world real estate prices and synthetic digital assets.

‍Executive Summary

  • What are derivatives? Derivatives are financial contracts such as futures, swaps, and options, that derive their value from an underlying asset, commodity, currency, or benchmark index
  • What are the benefits of derivatives? Derivatives offer enhanced liquidity and an option to hedge instruments that don’t have a liquid spot market. Derivatives also allow for price speculation and synthetic investments on instruments where no spot market exists. Broadly speaking, derivatives can be an attractive tool for portfolio diversification and risk management.
  • Why Real Estate needs derivatives: Real Estate Derivatives are underrepresented relative to total real estate asset value — we think it’s at least an $8tr opportunity.
  • The massive opportunity for a Real Estate derivatives platform; The Parcl Protocol is an essential venue for accessing real-time liquidity within the residential real estate market. Users can hedge, trade, speculate, and invest in the prices of the most recognizable real estate markets from all around the world.

Overview of derivatives‍

Derivatives are financial contracts such as futures, swaps, and options, that derive their value from an underlying asset (stocks, bonds, etc.), commodity (gold, wheat, oil), currency, or benchmark index (S&P 500, Case Shiller, Parcl Price Feed). The price of a given derivative is a function of price movements of the underlying asset, commodity or reference price. Derivatives are usually leveraged instruments, which amplifies both risk and reward for market participants.

‍A real estate derivative, for example, is a contract between two parties in which they agree to exchange payments based on the future price of a real estate related property, security, or index (the underlying). The party who agrees to buy the underlying at the specified price is said to be “long,” while the party who agrees to sell it is said to be “short.”‍

Derivatives originated primarily as a risk mitigation tool, allowing producers of goods & commodities to hedge their exposure to factors outside of their control (weather, war, famine, etc.). Over time, the derivatives market has expanded immensely in size (>$500tr notional, >$12tr net globally), breadth of offering, and motives of participants.

‍The two primary derivatives market participants are hedgers and speculators. Hedgers often own or hold the underlying, and intend to transfer future price risk to another party. Speculators take on risk, initiating positions based on their view of future price movements of the underlying. Speculators can be both long or short, and may or may not have a position in the underlying (if it’s even possible to do so).‍

Photo by Dylan Calluy — unsplash.com

What are the benefits of derivatives?

  1. Hedging & Improved Liquidity

Derivatives offer a venue for market participants to hedge or otherwise receive liquidity for their interest in an underlying asset, good, commodity, currency, security, or index. If you own or otherwise have exposure to an underlying and are worried about it depreciating in value, you could enter into a derivative contract that will offset some or all potential losses. Often, derivatives add liquidity to an underlying that otherwise has low or sub-optimal liquidity in its spot market.

2. Speculation & Synthetic Investments

Derivatives also allow speculators to gain exposure to or invest in the price movements of assets, goods, commodities, or indices, that are otherwise difficult to gain exposure to, in a liquid manner.

3. Portfolio Diversification

Derivatives allow market participants to improve liquidity, improve portfolio diversification, and better manage risk. They also offer access to entire categories of assets, goods, or commodities that are otherwise difficult to access (high barriers to entry, external costs such as delivery & transport, etc.).‍

Real estate derivatives are underrepresented relative to asset value — we think its at least an $8tr opportunity

Notional derivatives exposure (the value of all underlying) is estimated to be over $500tr globally (some estimates as high as $1quadrillion), and net derivatives value (aggregate value of all derivatives contracts) is estimated to be greater than $12tr globally.‍

Global TAM: Real estate represents nearly $300tr of global wealth (as much as 75% or more of total global wealth!), with residential real estate representing over $250tr and commercial real estate representing over $35tr. The annual market size of real estate transactions is estimated to be >$10tr.‍

There is a market for real estate derivatives — including swaps on the National Council of Real Estate Investment Fiduciaries Property Index (NPI) and futures contracts for the Case Shiller Indices — but this market is niche & considerably underutilized relative to real estate’s share of global wealth.‍

Derivatives on real estate related debt, such as Mortgage Backed Securities (MBS) and Credit Default Swaps (CDS) represent a much larger market (well >$10tr in notional value), but these instruments largely represent exposure to borrower quality & credit health versus direct exposure to underlying properties or real estate market prices.‍

Several of these instruments were a critical point of failure in the 2007/2008 global financial crisis

This problem was amplified by a lack of a direct spot market for real estate (real estate borrower risk & credit health is strongly correlated to underlying real estate prices, however).

If the market for real estate derivatives were more robust & roughly matched real estate’s share of global wealth, the total addressable market (TAM) for real estate derivatives could be as large as $400tr in notional value or ~$8tr in net exposure.

The role of the Parcl Protocol

‍The Parcl Protocol is a newly launched venue for trading digital assets that provide synthetic price exposure to residential real estate markets via smart contracts or ‘Parcls’. Parcls represent derivatives on underlying price feeds that track real-time price per square foot/meter in a wide range of recognizable geographical areas (major metros, cities, and neighborhoods).‍

The Parcl Protocol is the much-needed arena for accessing real-time liquidity within the residential real estate market. Users can hedge, trade, speculate, and invest in the prices of the most recognizable real estate markets from all around the world.

‍Real estate derivatives such as Parcls can improve diversification and add stability (reduce volatility) within a portfolio. Financial Advisors suggest the optimal allocation of real estate within a portfolio is 5–10% of net assets.‍

Check out parcl.finance if you’re interested in leveraging derivatives to build your global real estate portfolio.

Original content shared on parcl.co

Shared content and posted charts are intended to be used for informational and educational purposes only. Parcl does not offer, and this information shall not be understood or construed as, financial advice or investment recommendations. The information provided is not a substitute for advice from an investment professional. Parcl does not accept liability for any financial loss or damages. For more information please see the terms of use.

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A Blockchain-based digital real estate protocol — delivering real estate to everyone.