Is the IPSX a solution to the liquidity problem faced by real estate?
February 07, 2019
Early January saw a new exchange approved by the Financial Conduct Authority (“FCA”) - the International Property Securities Exchange (“IPSX”) making it the first regulated exchange dedicated to commercial real estate. The ISPX allows companies owning single commercial real estate assets to raise capital through an IPO or share issue on the exchange, with these shares being traded as equities, opening up further the public market option for real estate owners. Provided they list, investors on the exchange (including the general public) could potentially own shares in iconic buildings such as the Walkie Talkie, the Shard or Wembley.
It is envisaged this exchange will impact how investable real estate is as an asset class through improved transparency, real time valuation and accessibility. Improved accessibility is driven by reduced initial capital outlays, as investors can gain exposure to assets without having to acquire the whole building. However, the main benefit of the exchange is how it tackles one of the greatest challenges in the real estate market – liquidity.
Compared to equities (and relative to bonds), underlying real estate is highly illiquid. Most transactions involve a time lag between an asset/portfolio being put on sale - through to completion of this sale because of deals being privately brokered rather than transacted on an exchange.
This recently came to the fore in the aftermath of the 2016 Brexit vote, where there was a “run” on a number of open-ended property funds, with investors pursuing redemptions as they sought to withdraw capital from the UK / cash-out prior to a property crash. Funds under this pressure at the time suspended trading of their funds citing “exceptional market circumstances”.
This observed illiquidity could be improved upon through the IPSX as shares in assets are issued on the exchange and traded regularly. As a result, these property shares are more akin to traditional equity investments – highly liquid, as the bid-ask spread is always known.
As a result, there is also a debate to be had around valuation. In the instance where a publicly traded PropCo (Company A) decided to list an asset (Asset B) on the IPSX and continue to manage the real estate going forward, one would assume that investment in the shares of Company A and Asset B would be based on differing fundamentals. An investment in Company A would mean you are buying into the fundamentals and strategy of Company A, as well as their wider portfolio and pipeline, whereas with Asset B you are buying into the fundamentals of the asset itself (albeit managed by Company A - so with an appropriate premium / discount placed against perceived management capability).
However this may not be the case in practice. Listed real estate is subject to two different pricing checks – the trading level of shares and published asset values done by RICS valuers.
Extending the previous example further - When Company A decided to sell a minority stake of a trophy asset (Asset C e.g. the Shard) into the IPSX, there could be clamour from sophisticated and unsophisticated investors alike to acquire these shares, potentially pushing the share value of the asset above the RICS valuation.
If Company A were trading at a discount to NAV (as a number of the UK PropCo’s and REIT’s currently are), you would get a situation where, Company A could be trading at a 20% discount vs NAV, but a majority owned Company A building now trading on the IPSX at a 10% premium vs NAV. This begs the question, when looking to value Company A, which is correct? Does Asset C’s pricing trigger a re-rating of Company A?
Unless carefully managed, this could ultimately lead to Company A using the IPSX price as a clearing market price, pressuring valuers to mark up the book value, as a result of “mamma and papa” retail taking a particular shine to the asset and deciding the income return is better than gilts.
Overall, the IPSX presents a viable investment/ divestment alternative for portfolio managers. Improved liquidity and increased transparency at asset level should help to inform incoming investors, with the knock-on effect being that real estate and IPSX share valuations should move together more consistently than we see with the current stock market valuations.
However, there are scenarios, including the current real estate climate, where this may not be the case, making it difficult to gauge what the impact of the IPSX will be – the introduction of greater liquidity or ultimately greater volatility?
Initial trading of the first assets listed on the exchange will be interesting viewing. Boards, shareholders and professionals alike need to carefully consider and monitor the governance issues that this new market dynamic could present.
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