Capital Partnerships A Debt Free Solutionnet051108 2 1226050260740418 8

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Capital Partnerships A Debt Free Solutionnet051108 2 1226050260740418 8

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

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