Bet to win if your house price falls

Up or down? Few questions have caused more discussion in recent months than the direction of house prices. The trouble is, investing in property has until now been a one-sided affair.

When prices have gone up, homeowners have been winners. But when prices have been set to fall, there's been little you could do to guard your investment, bar selling up and moving into rented accommodation.

Enter investment bank Goldman Sachs, which has just launched a series of covered warrants traded on the Stock Exchange that are designed to offer investors exposure to the residential property market without having to buy more of their own bricks and mortar.

As well as offering the chance to profit when prices go up, they also allow bears the opportunity to profit when prices fall, and provide people with a hefty investment in their property a means to hedge against any fall in value.

Warrants are financial instruments that give you the right to buy (a 'call' warrant) or sell (a 'put') an underlying asset at a set price, within a given time. Certificates are a sub-species which enable you to track the value of that asset directly. In this case, the underlying asset is the Halifax index of house prices: you can take a bet on house prices across the UK, or only in London, whichever you fancy.

According to Goldman Sachs, there are a number of reasons people might want to make such speculative investments, without actually venturing inside an estate agency.

'Examples of trading strategies include using certificates to gain long exposure to the UK average house price, or using put warrants on the Greater London average house price to hedge the downside risk of owning property caused by a fall in house prices,' it says.

Mark Valentine, executive director of equities, says: 'If you are out of the property market, but keen to get back in, this could be a way to keep a foothold in the market. Equally, if you are a money manager wanting to allocate part of the assets of a fund into residential property, this is an easy means to get exposure.'

So far, so good. The first warning to be sounded is that warrants are not for the faint-hearted or the innumerate. With a conventional warrant, if you make the wrong judgment on which way house prices will go, you lose your investment: a call warrant on the UK average house price was quoted at £1.24 on 16 May ; if the Halifax index for June 2004 were less than £124,000, your investment would be worthless at maturity.

Even if prices move in the direction you predict, the index has to go a certain distance before you hit break-even. Beyond that point, your profit rises much faster than the underlying asset grows or shrinks, because there is an inherent gearing built in.

If you bought put warrants against the UK average house price index, (last reported at £127,557 in April), you would only break even when the index fell to £116,400, but if the average house price fell to £102,800 (a fall of 19 per cent), you would double your money.

There is no point, in other words, in buying these warrants if you think that prices are only going to move up or down by a few percentage points. And to buy with confidence, and work out your potential returns, you need to master jargon such as strike prices and ratios as well as the basic arithmetic.

Certificates, much more like an index-tracking fund, are both safer and simpler to understand. Your investment rises and falls in proportion with the index, so that if you invested £10,000 in a put on London house prices and the corresponding index falls by 10 per cent, you make a gain of £1,000.

The prices of both types of product, which can be bought via stockbrokers, fluctuate in value daily so they can be expected to reflect the monthly trend in house prices reported by the Halifax and other indices.

If you want to sell before the maturity date (4 August 2004) you can do so, but there is a spread between buying and selling prices.

Compared with buying and selling real property, there are both pluses and minuses. On the positive side, there is no need to pay stamp duty, which can be as high as 4 per cent for a prop erty worth more than £500,000; and stockbrokers' dealing charges are relatively low.

Moreover, you can gain a high level of exposure for a fraction of the investment that buying a home would involve. And unlike spread betting options, which also allow you to bet on the housing market, you cannot lose more than your initial stake.

Howeever, your profits are liable to capital gains tax as these warrants cannot be held in an Isa. And unlike owning bricks and mortar, you do not benefit from occupying a property, or receiving rent.

There are also inherent risks with using warrants as part of a hedging strategy: if the index rises but your own property falls in value because it does not reflect the overall trend, you lose out both ways.

Goldman Sachs has found an innovative way to tap into people's growing interest in property investment, but whether it will be picked up by the public remains to be seen.

Stuart Grennan, head of advice at IFA Torquil Clark, says: 'To me, this type of product is more about speculation than investing in property, and although it may be useful for fund managers, I don't think it is very suitable for retail investors.'

But Ray Boulger, technical manager at mortgage broker John Charcol, is more positive: 'If you have a strong view that the market is going to fall, but you don't want to sell up and move, this gives you an opportunity to back your view on the market.'