RED-SIG | FAQ

Frequently Asked Questions (FAQs)

These questions represent common questions that either the RED-SIG members have sort answers to or have been raised by others for answer by the RED-SIG network. If you have a question you would like RED-SIG to try to address, please email it to info@red-sig.org.

The answers below are for guidance only, before committing to a trade you should seek your own formal advice.

If you have an answer or comment regarding an existing answer please email to info@red-sig.org.

The FAQs have been divided into themes, please select one:

Theme 0 - Derivatives 101

What is a property derivative?

The role of a broker
What is ISDA?

What is the ISDA Master Agreement?

Who is a counterparty?

Who is a Total Return Swap (TRS)?

Theme 1 - Taxation & Accounting

How applicabe is FIRPTA (Foreign Investment in Real Property Tax Act)?

What are the differences in tax treatment for - (a) US vs non-US investors (b) taxable vs non-taxable investors (b) income vs capital gain?

Does (can) where the trade is booked or "domiciled" have consequences for taxes?

Are there any UBTI (unrelated business taxable income) issues for US tax-exempt investors relating to real estate derivatives?

What are the standard accounting practices for swaps, in particular equity-index linked swaps?

What is hedge accounting and when does it apply? What limitations, if any, exist on the types of instruments used in order to qualify for hedge treatment?

What are the potential conflicts or inconsistencies between accounting treatment of derivatives (whether hedges or not) and real estate and/or fund accounting?

Theme 2 - Valuation

What is standard valuation practice for swaps?

How are swaps marked-to-market?

Theme 3 - REITs

What derivative transactions (if any) are OK for REITs (private or public) to enter into?

What transactions might generate non-qualified earnings for a REIT?

Can a taxable REIT subsidiary house real estate derivative trades?

Theme 4 - Other Matters

FAQs follow:

Theme 0 - Derivatives 101

Question	What is a property derivative?
Raised by (optional)	N/A
Answer Summary	Property derivatives derive their value by reference to an underlying asset, a bundle of assets or benchmark. Parties to a derivative agreement have differing views as to the future value of the reference item. The parties can document their differing views in a negotiated over-the-counter agreement based on a notional balance (no principal is exchanged). There are two legs to the agreement: a return leg and a floating rate leg. The parting paying the return of the referenced item is the return payer. The party receiving the return is the return receiver. The return receiver pays the return payer a periodic floating rate of return (Libor) plus a spread in exchange for the performance of the referenced item. The return leg embodies ownership such that the return receiver will enjoy gains and suffer losses (in which case the return receiver pays the return payer). The return receiver is going long the referenced item and the return payer is going short the referenced item (relative to the floating rate leg).
Answered by	RED-SIG
Additional Documentation	Merrill Lynch Derivative Handbook (ML_RED_Handbook.pdf)

Question	The role of a broker
Raised by (optional)	N/A
Answer Summary	Brokers have no affiliation to any bank or counterparty, and are therefore able to source deal interests from all aspects of the market, matching buyers and sellers. Brokers are independant and unbiased, providing pricing and information intended to enhance client perspectives and lead them towards the best course of action. Brokers play a big role in educating the market, which helps expand the diversify the underlying client base. Typically, brokers speak to a vast array of market participants - enabling the entry of non-traditional participants, such as hedge funds, banks and other interested financial players.
Answered by	CBRE Melody / GFI
Additional Documentation	N/A

Question	What is ISDA?
Raised by (optional)	N/A
Answer Summary	ISDA - "International Swaps and Derivatives Association". ISDA is the standards setting association of the derivative market. Of note, on May 4, 2007 the International Swaps and Derivatives Association published the Property Index Derivatives Definitions. At the same time, ISDA also published new confirmation forms for Total Return Swaps and Forwards.
Answered by	RED-SIG
Additional Documentation	See ISDA's Website and RED-SIG Useful Documents

Question	What is the ISDA Master Agreement?
Raised by (optional)	N/A
Answer Summary	Documentation that needs to be in place between counterparties conducing over-the-counter (OTC) derivative transactions, clarifying the legal and financial relationships.
Answered by	RED-SIG
Additional Documentation	See RED-SIG Useful Documents

Question	Who is a counterparty?
Raised by (optional)	N/A
Answer Summary	One of the parties on one side of a specific transaction.
Answered by	RED-SIG
Additional Documentation

Question	Who is a Total Return Swap (TRS)?
Raised by (optional)	N/A
Answer Summary	An agreement between two counterparties – the first party pays the total return of a specified underlying asset (index, for example) in return for receiving LIBOR-based cash flows over the period of the contract. The second party receives the total return and makes a LIBOR (plus a spread) payment to the first.
Answered by	RED-SIG
Additional Documentation

Theme 1 - Taxation & Accounting

Question	How applicabe is FIRPTA (Foreign Investment in Real Property Tax Act) for US derivative investments?
Raised by (optional)	RED-SIG Advisory Group
Answer Summary	[investigating]
Answered by	[individual & organisation]
Additional Documentation	[investigating]

Question	What are the differences in tax treatment for - (a) US vs non-US investors (b) taxable vs non-taxable investors (b) income vs capital gain?
Raised by (optional)	RED-SIG Advisory Group
Answer Summary	[investigating]
Answered by	[individual & organisation]
Additional Documentation	[investigating]

Question	Does (can) where the trade is booked or "domiciled" have consequences for taxes?
Raised by (optional)	RED-SIG Advisory Group
Answer Summary	[investigating]
Answered by	[individual & organisation]
Additional Documentation	[investigating]

Question	Are there any UBTI (unrelated business taxable income) issues for US tax-exempt investors relating to real estate derivatives?
Raised by (optional)	RED-SIG Advisory Group
Answer Summary	[investigating]
Answered by	[individual & organisation]
Additional Documentation	[investigating]

Question	What are the standard accounting practices for swaps, in particular equity-index linked swaps?
Raised by (optional)	RED-SIG Advisory Group
Answer Summary	[investigating]
Answered by	[individual & organisation]
Additional Documentation	[investigating]

Question	What is hedge accounting and when does it apply? What limitations, if any, exist on the types of instruments used in order to qualify for hedge treatment?
Raised by (optional)	RED-SIG Advisory Group
Answer Summary	[investigating]
Answered by	[individual & organisation]
Additional Documentation	[investigating]

Question	What are the potential conflicts or inconsistencies between accounting treatment of derivatives (whether hedges or not) and real estate and/or fund accounting?
Raised by (optional)	RED-SIG Advisory Group
Answer Summary	[investigating]
Answered by	[individual & organisation]
Additional Documentation	[investigating]

Theme 3 - Valuation

Question	What is standard valuation practice for swaps?
Raised by (optional)	RED-SIG Advisory Group
Answer Summary	[investigating]
Answered by	[individual & organisation]
Additional Documentation	[investigating]

Question	How are swaps marked-to-market?
Raised by (optional)	RED-SIG Advisory Group
Answer Summary	[investigating]
Answered by	[individual & organisation]
Additional Documentation	[investigating]

Theme 4 - REITs

Many private funds often incorporate private REITs within their structures, so this section relates to both public and private REITs.

Question	What derivative transactions (if any) are OK for REITs to enter into?
Raised by (optional)	RED-SIG Advisory Group
Answer Summary	[investigating]
Answered by	[individual & organisation]
Additional Documentation	[investigating]

Question	What transactions might generate non-qualified earnings for a REIT?
Raised by (optional)	RED-SIG Advisory Group
Answer Summary	[investigating]
Answered by	[individual & organisation]
Additional Documentation	[investigating]

Question	Can a taxable REIT subsidiary house real estate derivative trades?
Raised by (optional)	RED-SIG Advisory Group
Answer Summary	[investigating]
Answered by	[individual & organisation]
Additional Documentation	[investigating]

Theme 5 - Other Matters

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