Equity Shares - A Solution to the Credit Crash
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  • Full Name Full Name Comment goes here.
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  • interesting...
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  • @nbtgm1

    Actually I'm not assuming that at all.

    Investors can sell Units at any time: it makes no difference whatever to the occupiers.

    So any stakeholder in the property development cycle who receives Units in payment can keep them as an investment for the income, or sell them to another long term investor, or to an occupier.

    It's essentially a Real Estate Investment Trust (REIT) with the additional attraction for investors that if they can't sell them to other investors, they can certainly sell them to occupiers, who could then use them against rental.
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  • Well, interesting, but you are assuming that all these interested parties will want to hold on to this assumingly riskfree investment. However, someone will obviously want cash for their services and not only equity, and this is where the banks used to come in. So, not so sure if this is the panacea to our current ills. As a friend observed once, all would be so much better if we all accepted to live in tents! But, housing requires committment of long term capital and maturity transformation, and by that the potential for banking crisis. So no easy way out.
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Equity Shares - A Solution to the Credit Crash Presentation Transcript

  • 1. Equity Shares A Debt Free Solution to the Property Crash Chris Cook FEASTA Annual Lecture 2008 5 November 2008
  • 2. We live in Interesting Times….. 06/06/09
  • 3. … .some say, “the end of the financial system as we know it” 06/06/09
  • 4. Most people have now heard of Peak Oil.... 06/06/09
  • 5. … .but last year we reached the point of Peak Credit.... 06/06/09
  • 6. ...when the Irresistible Force of economic growth…. 06/06/09
  • 7. ...met the Immovable Object of finite resources... 06/06/09
  • 8. ...and Peak Oil 06/06/09
  • 9. Where did it all go wrong? 06/06/09
  • 10. To find out, we need to understand what banks actually do.... 06/06/09
  • 11. A Bank is a Credit Institution which creates credit as interest-bearing loans.... 06/06/09
  • 12. ... a Pyramid of Credit, on a base of “Regulatory Capital”... Bank Credit Bank Equity 06/06/09
  • 13. ...and this Credit constitutes >97% of the money we use.... £ 06/06/09
  • 14. ..but a Bank does not lend pre-existing money…. 06/06/09
  • 15. … .it creates new money as interest–bearing credit…. 06/06/09
  • 16. … .which is then deposited back into the system 06/06/09
  • 17. But a Bank’s true economic function…. 06/06/09
  • 18. ...is as a Credit intermediary or middleman... Lender £ 06/06/09 Borrower
  • 19. ...stepping between borrower and lender... Bank Lender ( Depositor ) £ £ 06/06/09 Borrower
  • 20. … and guaranteeing that the borrowers’ credit is good… 06/06/09
  • 21. Interest is charged for the use of the guarantee Bank Interest Borrowers 06/06/09
  • 22. ..from which Interest is paid to Depositors.. Bank Interest Borrowers Depositors Interest 06/06/09
  • 23. ..Default and Operating costs deducted... Bank Interest Borrowers Depositors Interest Costs 06/06/09
  • 24. ..and a profit to Investors normally results Bank Interest Borrowers Depositors Interest Costs Investors 06/06/09
  • 25. Demand for Credit has been so high… 06/06/09
  • 26. … .that Banks began to “outsource” their guarantee to rid themselves of risk. 06/06/09
  • 27. … and thus allow Equity to support more credit creation 06/06/09
  • 28. Banks outsourced risk totally – through “securitising” debt and sale to investors…. 06/06/09
  • 29. … temporarily – with “Credit Derivatives” (a time-limited guarantee)…. 06/06/09
  • 30. … and partially – using credit insurance from insurers such as AIG 06/06/09
  • 31. The Result is a bigger Credit Pyramid than Banks alone could sustain… Investor Equity Credit Bank Equity 06/06/09
  • 32. … and a “shadow banking system” of Investors with “sliced and diced” risk… Investor Equity Credit Bank Equity 06/06/09
  • 33. This extended Pyramid of Credit funded the “Mother of all Bubbles” in US property prices…. 06/06/09
  • 34. … and servicing this credit finally exceeded the financial capacity of the US population... 06/06/09
  • 35. … to the point of Peak Credit .... 06/06/09
  • 36. In August 2007, the Bubble started to deflate and attention turned at last to defaults … 06/06/09
  • 37. ..but by now no-one knew where the Risk lay… Investor Equity Credit Bank Equity 06/06/09
  • 38. Banks started to think, “if this is what our balance sheet looks like…..” 06/06/09
  • 39. “… what does everyone else’s look like…..?” 06/06/09
  • 40. ...and Banks stopped lending to each other ... 06/06/09
  • 41. The problem is not shortage of money - liquidity – Central Banks can handle that 06/06/09
  • 42. … ..it is shortage of Equity - Solvency – which Central Banks cannot handle….. 06/06/09
  • 43. Bank Equity is being eaten away by defaults…. 06/06/09
  • 44. … and Investors will not recapitalise the shadow banking system... 06/06/09
  • 45. The Result? Equity Credit 06/06/09
  • 46. So, Credit is becoming both scarce and expensive…. 06/06/09
  • 47. … Central Banks are irrelevant…. 06/06/09
  • 48. … and further defaults in the shadow banking system….. 06/06/09
  • 49. … .continue to drain money out of the system in a “deflationary spiral”.... 06/06/09
  • 50. … .leading inevitably to a Depression.... 06/06/09
  • 51. So much for the Credit Crunch problem 06/06/09
  • 52. Clearly the solution cannot lie in creating more credit 06/06/09
  • 53. So why not take a new approach to “Equity” investment instead? 06/06/09
  • 54. Conventional Equity consists of shares in a Limited Company or “Corporation”…. 06/06/09
  • 55. Ownership by a Corporation is what makes the “Private Sector” Private 06/06/09
  • 56. While the Corporation may be conventional, it is not the only enterprise model there is 06/06/09
  • 57. While all eyes have been on Credit innovation… 06/06/09
  • 58. …” Asset-based” finance has been developing “under the radar”…. 06/06/09
  • 59. Canadian “Income Trusts” use a Trust law framework to “unitise” gross Corporate revenues…. 06/06/09
  • 60. Income Trust Income Trust Corporation Gross Revenues Unit Investors % % Units Costs Dividends? 06/06/09
  • 61. Units are sold to risk averse investors such as pension funds… 06/06/09
  • 62. … who consider investment less risky if they access corporate revenues… 06/06/09
  • 63. … . before the management does…. 06/06/09
  • 64. We are also seeing new asset classes such as Exchange Traded Funds (“ETF’s”)…. 06/06/09
  • 65. … Real Estate Investment Trusts (“REIT’s”)… 06/06/09
  • 66. … Hedge Funds using Limited Partnerships… 06/06/09
  • 67. … and Islamic finance ”Sukuks” 06/06/09
  • 68. In 2001 the UK introduced the Limited Liability Partnership (“LLP”)...... 06/06/09
  • 69. ....confusingly, an LLP is not legally a partnership... 06/06/09
  • 70. … but a corporate entity with a legal personality independent of its members..... 06/06/09
  • 71. … and limited liability, so members cannot lose more than they put in..... 06/06/09
  • 72. … and...errr...that’s it ...there isn’t even a requirement for a written LLP agreement... 06/06/09
  • 73. … which is why I call it an “Open” Corporate.. 06/06/09
  • 74. … and it is being put to some very interesting uses... 06/06/09
  • 75. Capital Partnership - Hilton Deal 2002 Capital Partnership LLP 10 UK Hotels Gross Revenues Hilton Group Capital User Consortium LLP Capital Provider Bank Property Developer Hotel Specialist % % % % % 06/06/09
  • 76. The Hilton Deal was the first example I have seen of a “Capital Partnership”... 06/06/09
  • 77. ...which I believe may perhaps be an optimal enterprise model - as follows.. 06/06/09
  • 78. Firstly, ownership of productive assets is transferred to a “Custodian”.... Assets Custodian Ownership 06/06/09
  • 79. … then Investors put in Financial Capital in money, or “money’s worth”… 06/06/09 Assets Investors Custodian Ownership Financial Capital
  • 80. … Managers put in Human Capital of time, expertise and experience.... Assets Investors Managers Custodian Ownership Human Capital Financial Capital 06/06/09
  • 81. … and Users pay for the use of this Capital… Assets Investors Users Payment Managers % % Custodian Use 06/06/09
  • 82. … resulting in a “Capital Partnership” Assets Investors Users Managers Custodian 06/06/09
  • 83. A “Capital Partnership” enables new forms of Equity… 06/06/09
  • 84. (a) Equity Shares - proportional (%age) ”n’ths” such as billionths..... 06/06/09
  • 85. … ..which may be bought and sold, but never redeemed, because there must always be 100% 06/06/09
  • 86. (b) Redeemable Units – eg Kilo Watt Hours; 06/06/09
  • 87. ...with a value in exchange, but with no continuing rights to production 06/06/09
  • 88. Units hold their value because they are asset-based on value provided by the issuer … 06/06/09
  • 89. … .rather than being deficit-based upon a claim over value issued by a Bank 06/06/09
  • 90. € nergy investment is for another time... 06/06/09
  • 91. ..today we are looking at the potential of Land Partnerships.... 06/06/09
  • 92. ...to solve the current Credit Crash. 06/06/09
  • 93. Imagine a developer has unsold homes.... 06/06/09
  • 94. ....and a Bank on his tail .... 06/06/09
  • 95. ...who in turn has a Central Bank on their tail.... 06/06/09
  • 96. First, we transfer the houses to a Custodian Houses Custodian 06/06/09
  • 97. Then we rent the houses affordably but at an index-linked rental.... Houses Occupiers Custodian Rental 06/06/09
  • 98. ....noting that because rents are affordable, failure to pay is by definition unlikely... 06/06/09
  • 99. Then we appoint a Manager and give him a proportional share in the rentals.... Houses Occupiers Custodian % Rental 06/06/09 Manager
  • 100. ....so that with a stake in the outcome he has an interest in doing a good job... 06/06/09
  • 101. ....and the Investors complete the picture Houses Investors Occupiers Custodian % % Rental 06/06/09 Managers
  • 102. Occupiers may “Rent to Buy” - simply by paying rent early, they become Investors... 06/06/09
  • 103. ...and end mortgage slavery as rental may then be paid in Equity Shares, not cash... 06/06/09
  • 104. ...while maintaining the property themselves will give them “Sweat Equity”.... 06/06/09
  • 105. For Investors it’s an index-linked, property-based investment... 06/06/09
  • 106. ..with low risk, since affordability=certainty.. 06/06/09
  • 107. ...giving a perfect match for the liabilities of the pension funds... 06/06/09
  • 108. ...who will buy from distressed developers their Equity Shares in the Rental Pool.... 06/06/09
  • 109. ...so that they can repay distressed Banks... 06/06/09
  • 110. ...and make the Central Bank happy 06/06/09
  • 111. Lets have a quick look at the numbers 06/06/09
  • 112. Imagine a Pool of a thousand homes with outstanding debt of €200 million
    • Conventional Mortgage Finance
      • 25 year loan at 6% gives repayments of €15,600 pa per home and €15.6m pa in total
    06/06/09
  • 113. Imagine a Pool of 1,000 homes with outstanding debt of €200 million
    • Land Partnership
      • Step 1 - Create the Pool
        • Set an affordable rent (say) €6000 in the first year
        • Rental Pool is then €6m in the first year
      • Step 2 – Unitise
        • One million Equity Shares each with the right to €6 initially
      • Step 3 – Sell Equity Shares to Investors
        • @ 3% initially €200 million is raised– repaying all debt
        • @ 4% we raise €150m – and repay 75% of debt
        • And so on
    06/06/09
  • 114. Let’s have a look at undeveloped land... 06/06/09
  • 115. Conventional development is based on transactions – the “Four B’s”..... 06/06/09
  • 116. Borrow, Buy, Build and B...er Off... 06/06/09
  • 117. First, the land is transferred to a Custodian Land Custodian 06/06/09
  • 118. ...and the Land Owner becomes an Investor Land Land Owner Custodian Land Value 06/06/09
  • 119. ...as does the Council, in return for planning permission... Land Council Custodian Value of Planning permission 06/06/09
  • 120. ...and so do the Contractors at least for their profit margin... Land Contractors Custodian Profit Margin 06/06/09
  • 121. ...and Risk-Takers provide € to pay Contractors’ agreed costs... Land Risk-Takers Custodian € 06/06/09
  • 122. ....while the Developer invests “Intellectual Capital” of concept and services... Land Investors Land-owner, Council, Contractors, Risk Takers Developer Custodian Value Value 06/06/09
  • 123. When the development is occupied... Houses Investors Occupiers Custodian % % Rental 06/06/09 Managers
  • 124. ...the Development Investors have a choice of selling their Equity Shares.... 06/06/09
  • 125. ...or keeping them for their pension 06/06/09
  • 126. Everyone has a stake in the outcome.... 06/06/09
  • 127. ....with an interest in high quality, energy efficient housing .... 06/06/09
  • 128. ....because this lowers the cost of occupation over time .... 06/06/09
  • 129. ....which makes the Rental value higher and makes Equity Shares more valuable 06/06/09
  • 130. So we go from a transaction model... Developer Property Buyer £ £ Property Buyer £ 06/06/09 Land Owner
  • 131. ...to a service provider model where property is never sold again... 06/06/09
  • 132. ...but service providers bring together Occupiers with properties... 06/06/09
  • 133. ...and property Investors with property investment 06/06/09
  • 134. A Land Partnership is not an Organisation ... 06/06/09
  • 135. ...it does not own anything, do anything, employ anyone, or contract with anyone... 06/06/09
  • 136. ...it is simply a framework within which the stakeholders self organise ... 06/06/09
  • 137. ...with a mutual interest in developing land sustainably. 06/06/09
  • 138. So let’s replace conventional secured debt with a new form of Community Equity... 06/06/09
  • 139. ...simply by Unitising pools of Rentals 06/06/09
  • 140. … and turn the Risk Pyramid the right way up! Management Equity Investor Units Community Equity 06/06/09
  • 141. It’s not Rocket Science 06/06/09
  • 142. Thank You 06/06/09