Today's insight is tomorrow's investment

A new exchange for an age-old problem

Published on April 18th, 2017

There have been many attempts to provide liquidity to what is an essentially an illiquid asset class, and the latest is attempting to merge technological disruption with deep-rooted tradition.

The International Property Securities Exchange (IPSX) is looking to launch in the first half of this year, and if it catches on it will create a genuinely new and innovative way to invest in real estate.

Put simply, it is a stock exchange for individual buildings, where the owners of an asset can list some or all of a building, and investors buy shares in it, just as they would a company.

The founders of the exchange are hoping to receive regulatory approval from the Financial Conduct Authority imminently, in a move which would make it one of only seven regulated exchanges in the UK, alongside centuries old institutions like the London Stock Exchange and London Metals Exchange. This would give it a stamp of authority and trust that would undoubtedly reassure potential investors in what is an both a new asset class for listed exchanges, and an untested method of trading property.

IPSX as a platform has already won the backing of some blue chip investors – British Land, M7 and the directors of Tritax have all invested in the company, and British Land is likely to be one of the first companies to list one of its assets on the exchange, with an asset valued at around £70m mooted.

Among the non-executive directors on the exchange’s board are for Trinity Mirror chief executive Sly Bailey, Sir Brian Ivory, former CEO of Highland Distillers, and form the property world, former GVA CEO Rob Bould.

Given the ambition to become one of only a few regulated UK exchanges, it seems apt that I should meet the company’s founder and chairman, former investment banker Anthony Gahan, and Bould at the Royal Exchange in the City of London. While Antwerp is the world’s oldest stock exchange, the Royal Exchange building counts itself as one of the oldest exchange buildings in the world.

While the platform could clearly be disruptive to the way that real estate is traded, and Gahan references fintech and disruption on a regular basis, the conversation centres more around real estate and ways of improving liquidity than the technology behind the platform.

“It’s the age old challenge of getting liquidity for commercial real estate,” he says. “Everything that has gone before has been created by the property world to fix a problem for them. What we are proposing is a regulated public market like the London Stock Exchange or Nasdaq, with a very high level of regulation, that will allow issuers to sell their shares to anyone around the world.

“We are hoping to get FCA approval in the second quarter of the year, and we will kick off with our first issuers shortly afterwards.”

In terms of how the process would work, as with a company, an initial public offering of a building would involve the asset owner producing a prospectus for the IPO which IPSX would approve. The IPO would need to be sponsored by an adviser, which could be an investment bank, fund manager or a property services firm.

A holding company would be created in which investors could buy shares, and that company would have a board, with the responsibility to manage the company in the best interests of shareholders, as with a company on the LSE.

An asset management fee would be paid to the manager of the building, which would normally be the company the previously owned the asset, and if shareholders didn’t like the strategy the asset manager was pursuing, they could pressure the board to remove the asset manager.  “You have a board that is responsible to the shareholders, and if they don’t like the strategy they get thrown out,” Gahan says.

As with the LSE, a minimum stake of 25% of the building must be sold, essentially the “free float” in the company. A particularity of IPSX is that the building’s listed would be permitted to have no leverage no higher than 40%. RICS valuations would have to be undertaken on at least an annual basis.

Gahan says that he expects the exchange to be a “mid-market” offering rather than huge assets being listed, with a minimum of £30m lot sizes and around £100m likely to be the top end of the scale.

When talking about the need for more liquidity in commercial real estate and the failure of vehicles that have gone before, Gahan and Bould are principally talking about REITs and open-ended funds, the latter of which were in the spotlight once again in the wake of the UK’s Brexit vote, when numerous funds closed for redemptions when investors asked for their money back in droves.

Gahan argues that REITs do not offer a true reflection of real estate performance, open-ended funds don’t offer enough liquidity.

“REITs are funds rather than a proxy for direct investment and haven’t worked as a perfect correlation for real estate because you have equity market noise inter alia. When the market adjusts, REITs follow it. But this would be a market solely for real estate assets, so you wouldn’t have that pollution, everything trades in line with the performance of the real estate.”

When I put it to Gahan and Bould that if a building were to be listed now investors might demand a discount, with many listed REITs trading at a discount, Bould points out that companies like PHP and Tritax are trading at premiums, and that different types of asset will be in demand at different times.

Gahan and Bould argue that IPSX will vastly broaden the spectrum of investors in property, and provide a vehicle for passive capital to invest in property for the first time. This latter point is slightly esoteric, but hugely significant. More and more capital is pursuing “passive” strategies – according to financial data firm Morningstar, 40% of the capital invested in US equities last year was passive rather than actively managed. But thus far there has not been a way for passive investors to invest in property, as there is no index that can be bought – until now.

“This will appeal to retail investors who want to put a few thousand pounds into property, but as you go up the pyramid, there are local authority pension funds, high net worth individuals and smaller institutions that at the moment can’t access property directly because of the lot sizes involved,” says Bould.

“If you look at the liquidity on various exchanges around the world, a major part of the investment is increasingly coming from passive money,” Gahan adds. “Passive managers like Vanguard could logically look at data that is updated regularly, and see a dislocation between the property performance and the performance of REITs, and it gives them an index they can invest in.”

But why would a seller choose to go through a process which, at least in the early days of IPSX until it is established, is more complex and less well understood than a traditional sales process. The answer comes down to liquidity and pricing.

“At the moment if you own property you have two options,” says Bould. “You either own it or you sell it. This gives you another option where you can sell a partial stake and bring in some liquidity, but also retain the asset management contract.”

“You have a lot of investors out there at the moment, both institutional and retail, who have a lower cost of capital than traditional property investors,” says Gahan. “If a building is providing a 3% net yield, for a private equity firm or property investors that might not be an attractive return, but for private investors or small institutions they might find that perfectly acceptable. The exchange should be able to offer access to investors willing to invest at attractive valuations based on their alternative investment strategies.”

As a result of both these factors, Gahan believes that the index would increase the frequency with which properties are traded.

“It automatically renews itself,” he says. “Buildings have a finite life, so at the end of their life cycle they may become targets for takeover by private equity firms or other buyers, just as companies might.”

In terms of the potential ambitions and applications for IPSX, they are far from limited. If the UK launch a success and the concept is proved, the plan is to set up a similar platform in Continental Europe, in a country still to be decided.

And Bould adds that again, if it is a success, it could be extended to include infrastructure assets.

“It could be a way to fund local authority or national infrastructure assets,” he says. “It has huge potential in terms of offering a way to keep control of the operation of an asset but providing a source of capital.”

One potential problem I raise is that given the notoriously “chatty” nature of the property world, there is the issue of the normal gossip about buying and selling assets, under the rules of the Takeover Code to which companies on IPSX would be subject, being deemed insider trading. Perhaps a spate of brokers being jailed would be an unintended consequence, a suggestion that is greater with a laugh but dismissed.

Beyond this, the platform does seem to offer a system that could provide that holy grail of property performance combined with increased liquidity. It will have to persuade the notoriously slow moving real estate world to trade assets in a different way, but if this can be achieved, it will be a valuable addition to the property world.

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