This post talks about a thought exercise and simplifies several complicated concepts. More detailed assessment and research is advised before following any of the below.

For most expats, rental expenses will likely be the biggest single expense that they have to budget for in any financial planning.

Many countries, such as the Philippines, have restrictions on foreign citizens owning real estate which forces expatriates into the rental market. Whilst other expats, even when the legal system permits, shy away from property ownership outside their country of citizenship and continue to rent often owing to feelings of mistrust in the local legal system, or the often temporary nature of expat residency.

It is little surprise then that the vast majority of expat workers around the world find themselves in the rental market and often beholden to the demands of landlords demands for higher rental payments.

Some countries, such as Germany, have very favourable legal systems for tenants that outline rental increases, eviction requirements, etc. Others, such as some Asian nations, have far fewer protections for tenants and allow the rental market to conduct itself with all parties seeking to act in their own best interests.

In theory, a region with no legal control over rental increase caps, the rental market is controlled entirely by "invisible hand" of the free market supply and demand forces.

In such a free market, the rental price of an apartment would be the convergence point between what a tenant is willing to pay, and what a landlord is willing to accept, in an "arms length" transaction.

The same forces that dictate the rental price will also dictate the property value.

To understand this we need to understand the "Cap Rate" or "Capitalization Rate" of an investment property.

If an apartment is for sale today at $500k and has a rental yield of $20k the apartment's capitalization rate is 4%

The 4% can be assumed with the CAPM (Capital Asset Pricing Model) to show the implied risk of the investment.

REIT Futures Options

Provided that you can find a REIT that is specific to your local market, and is traded on a public exchange, there should then be the option to purchase futures options on that as a way to lock in the future price of the real estate market and therefore any rental payments.

Futures "call options" give the investor the option, but not the obligation, to buy a specific item in the future at a pre-agreed price.

For example:

Let's say our investor, Nick, lives in Hong Kong and signs a rental agreement for 1 year at a cost of $20,000.

Nick finds a Hong Kong specific REIT that trades as an ETF on the Hong Kong public exchange, and currently trades for $20 a share.

Nick enters into a futures options contract to buy 1,000 shares at $20 each one year from today.

For the contract, Nick pays a premium of $900.

A year later, the Hong Kong property market has risen by 10%.

Nick exercises his futures contract to buy 1,000 shares of the REIT at $20 a share, and then sells them at the market price of $22 a share.

Nick takes a profit of $1,100:

$22 - $20 = $2 $2 * 1,000 shares = $2,000 $2,000 - $900 Contract premium = $1,100

By using a futures option on the REIT, Nick was able to cap his rental payment at $20,900 even though his rent increased up to $22,000.

The main issues with this as a hedging strategy are:

- The REIT will likely not track the value of your individual apartment accurately, and gives a fairly large margin of error. - Finding a REIT that tracks only real estate in your market may be difficult or even impossible - Trade volumes on the futures options of a specific REIT will be very low and the premiums thus very noncompetitive - Premium prices may well be prohibitively high and thus negate any potential hedging

However, REITS are gaining in popularity and speciality.

There are already REITs that cover Hong Kong (The Link REIT), a Selection of Japanese REITS (Also known as J-REITs), and a UAE specific REIT (Emirates REIT)

However, it seems that while the viability of using REIT call options is far from perfect, the idea may provide at least some level of hedging against rental price increases.

As always, you should be sure to do thorough research before making any such investment decisions.

I hold no positions in any of the securities mentioned in this article