Copyright: David Lawson - pubished in Property Week February 2006
Valuation Flaw Raises Doubts Over REITs
The property industry is in a ferment of excitement over the biggest revolution in its history. Real estate investment trusts [REITs], which were finally approved in the Chancellor’s pre-Budget statement, could fundamentally change the way the market works by moving from traditional big landlords mainly owned by big institutions to trusts in which even the smallest investor can hold a stake. But one potentially fatal flaw appears to have been overlooked. These new bodies will require frequent valuations to determine share values.
Pioneers like Quintain and Land Securities anticipated such demands by moving towards quarterly ‘snapshots’ but this may not be enough. Weekly or even daily valuation could be required. That exposes a huge problem in the software. Property management systems contain key data such as rents and lease lengths but transferring this into valuation programs is a major task. Rent income, for instance, may be changed by valuers because they know a review is coming up. That involves a lot of manual adjustments – the very thing computers were meant to avoid.
And every time a figure is altered the odds on making a mistake increase. It is bad enough when this has to be done annually. How will valuers cope when they may be required to work almost continuously? And who will pay? Fees have been slashed to win business. Valuers have little incentive to spend money improving the process.
Friction between property management and valuation software also creates confusion, as investors rely on one set of figures while valuers produce another. That, combined with inevitable errors from manual alterations, should be a concern even without the prospect of REITs. Data used by valuers and investors can differ by up to 40%, says Dean Grossmith, a director of software firm Affinity. This should be critical to other innovations such as property derivatives and statements in annual accounts about relative performance compared with indices. ‘It has the feel of a corporate governance disaster waiting to happen,’ he says. ‘This manually intensive, high data volume, repetitive activity urgently requires automation and it should be a matter of serious concern for those responsible for business operations that they know the level of their organisation’s exposure and are taking steps to improve this situation.’
Investors might be forgiven for believing the much-debated Property Information Systems Common Exchange Standard [PISCES] should have ironed out such problems, as it was brought in to ensure each program writes data in the same way. But that still leaves a problem. Property management systems stick to the original data, so even when this can be easily transferred to and from valuation programs, any changes are overwritten. That adds danger to confusion.
Investors are under pressure since the Enron scandal to provide more insight into accounts and financial processes. Because manual changes are not recorded, valuers are struggling to produce ‘audit trails’ recording exactly what they have changed and when, says Grossmith. Leading names such as CBRE, Knight Frank and DTZ are getting around the problem with iXchange, a PISCES program developed by Affinity. This uses a series of filters to flag up changes and report back to investors. Property management and valuation feeds are compared and differences identified for on-line viewing and output in a variety of formats. Users can view or suppress differences to focus on specific areas or types of mismatch and identify differences which have a material effect on the valuation. Areas include leases, tenants, rents and even size.
Grossman says there is a further problem, however. Big software names seem to have created different ‘dialects’ of PISCES, so each needs to be processed differently by programs like iXchange. This adds time and complexity. Fragmentation may be why PISCES has still not become universally accepted 10 years after it was launched. Many valuers still rely on spreadsheets. One software vendor says the system of ensuring every program complies with a common standard is flawed. Another, the PISCES founder member Kel, has withdrawn from membership of PISCES ‘until they get their act together.’
PISCES board director Chris Lees, of management consultancy Calvis, says the problems are understood but should be addressed by the release of PISCES version 2 standards in the residential market at the end of last year. The earlier version was never intended to audit and manage data changes, he says. Many property management systems provide adequate auditing, and while valuation programs are expected to follow suit soon.
‘There is a lot of scare-mongery around as vendors vie to position their technology solutions and exploit confusion and uncertainty in the market. We advise many valuation teams here and in the US, where REITs are well established, and many of these stories don’t give valuers credit for their own intelligence. ‘These are professionals who don’t have their heads in the sand and have efficient and, in most cases, well proven approaches that overcome many of these issues. These teams are rightly focussing on how to commercially exploit the likely increase in volume of valuations, rather than being introspective about often needless IT investment.’
Propex Web Portal
The internet saved retailers from despair in the runup to Christmas. Online shopping rose 50% to almost £5bn while the rest of the market subsided to the slowest growth rate for half a century. This will bring a wry smile to those who have faced ridicule about predictions that the internet will fundamentally change the property industry. When the dotcom bubble burst, online trading was consigned to the fate of other science fiction like hover cars and robot housemaids. Yet fiction is rapidly becoming fact.
Questions are being asked whether shopping centres are really worth the ludicrous prices being paid by investors. Ironically, those same investors never lost faith in the idea of working online. Propex is one of the unsung successes of the internet. The web ‘portal’ listed around £800bn of commercial property last year. Multiple entries of the same premises might exaggerate real aggregate value but that does not apply to the 70% of all UK property investment estimated to have flowed through the portal.
These figures are all the more astounding when the service has existed for less than five years. This is far more of a revolution than a few thousand people swapping pre-Christmas crowds for a PC in their sitting rooms. It has not been an easy transition, however. The worldwide web was aptly named, as it snared almost everybody in confusion around the turn of the millennium. A slew of pioneers competed for the highly specialised market and just as they were beginning to make progress, the dotcom bubble burst, miring them all in its sticky residue.
Somehow the idea survived. Perhaps it was because investors are used to working off a computer, which has become the norm in giant dealing floors handling equities, commodities and currencies. But the key factor for survival was persistence. Everyone knew there were too many sites competing for business. Listings don’t work unless they are comprehensive. The question was whether competitors would agree to join forces – and how quickly. It required a lot of faith from backers to bar the inevitable losses until one emerged with critical mass.
Propex is the end result of mergers by around half a dozen pioneers [see panel]. The last main rival, UKPiP was absorbed last September, not long after Shop Property was acquired from Churston Heard. Patience by the 50 or so blue-chip shareholders has been rewarded by a move into profit. With such a firm foundation, plans are now under way to fulfil some of the promises that would certainly have been dismissed as fiction a few years ago. Another revolution is looming, with derivatives and real estate investment trusts transforming the property industry from a crude accumulation of bricks and mortar into some semblance of parity with sophisticated financial markets. That won’t work, however, without up to date information on prices, much like shares and bonds.
Propex is aiming to plug that gap in a revamp which involves supplementing its property listings with pricing on all the leading derivatives contracts. That could grab a bigger slice of the investment market and dwarf even last year’s huge turnover. Evolution into a primary gateway to the investment market has been underlined by talks about the Investment Property Databank taking a major stake. This seems a natural alliance, as IPD carries the key indices used to gauge performance of the property that investors find online.
Commercial director Colin Barber prefers the term community to gateway. All the top agents are members, running the recently upgraded Propex Pro software. But most of the 150 or so agents around the UK have taken advantage of spending a few hundred pounds to list individual properties. Many realise they have to do so when a major buyer like the Prudential insists that all introductions come via the portal. Add casual visitors, which are soaring since commercial property became attractive to private investors, plus all the links off the web site, and the total number of people involved comes to around 50,000.
It is easy to lose track of one key fact behind such success: no-one actually deals on Propex. This is essentially a listings site. Buyers and sellers come here to find information and then contact each other to do deals. The much-touted idea of ‘disintermediation’ - that middlemen like agents would disappear as property traded online - was never considered. Only one portal, FProp, has made serious inroads into online trading. The movers behind Propex and its merged partners felt there were too many complexities involving leases, surveys and market knowledge. Barber does not write off the prospect that automated dealing may happen someday. Lawyers are making great progress with protocols like PISCES, which speed and automate deals, he says. ‘And who knows where technology may be in 10 years.’
KEY DATES
Propex Key Facts
Media Groups Buy Up Online Property Listings
The war between paper and pixels erupted again when the editor of the Financial Times departed late last year, claiming he would never again devote time to smearing ink on dead trees. Online is the future, he said. It was no shock to insiders, as he spent hundreds of millions of pounds migrating the business community’s bible onto the web site ft.com. More significant is the change of heart by mass media giants. Rupert Murdoch, a long-term sceptic of the internet, finally admitted underestimating the potential impact on advertising and joined owners of the Daily Mail and Daily Mirror in a scramble to buy property listing sites.
Agents who endured heavy setup costs are finally reaping rewards as values soar. Murdoch’s News International paid £15m for Propertyfinder, the pioneer UK listings site, in 2004. By last autumn firms like Knight Frank, Savills and Strutts were anticipating a share of £48m forked out by Daily Mail Group for Primelocation. Countrywide and Connells could see even more spectacular returns when top-rated site Rightmove makes its long-awaited float on the stock market – providing some media giant does not step in with an offer they can’t refuse.
It will have to be a very big one. City analysts have pumped up the potential value of the UK’s leading property portal to more than twice the £200m touted when the Primelocation deal hit the streets. But Murdoch dug deep to pay almost £350m for networking web site Myspace last year, purely to draw custom to his TV channels. It may seem worth adding Rightmove to Propertyfinder in support of the property-heavy Times and Sunday Times. The turnaround has been spectacular. Primelocation was worth a mere £11m when set up around 2001. Few expected it and the clutch of rival sites to be more than an adjunct to newspaper listings. Yet Rightmove now estimates that 78% of home buyers go online to find prospective property.
Why has the change been so swift? It hasn’t. Media groups have been playing a waiting game as they assessed the real threats to a rich stream of income from property advertising. Such threats are not new. Freesheets proliferated across the UK through the Eighties and Nineties, often supported by agents annoyed at the near-monopoly prices charged by news groups. Yet local papers held their ground. The crunch has come as recruitment sites began threatening their other main income. Something had to be done.
The spread of broadband is one factor. More than 60% of homes and three-quarters of offices are now linked to fast, reliable services. Property sites have also changed out of recognition, becoming far more user-friendly and sophisticated.First came online pictures, then virtual ‘tours’. Buyers can now filter property by area or price. Operators have also begun tapping into the Land Registry to give price benchmarks. Multimap launched maps which show not just addresses but local features such as schools, shopping and transport – all the factors that an average buyer uses to make a choice. Landmark introduced site maps of individual properties.
Rising popularity has helped claw back costs. Early business plans anticipated property being bought and sold online, with commission paid to operators rather than agents. That was never a real possibility. The alternative of free listings supported by advertising also crashed in flames. Instead, agents now pay fees. It took time for some sites to accumulate enough property to draw in buyers but as hit rates soared, fees have increased.
Online lists are still seen as a supplement to newspaper adverts but this is weakening as agents increasingly place property on several portals instead of a in local paper. Further takeovers from news groups seem inevitable. Will this mean transferring from one near-monopoly to another? That is unlikely, as most agents now have their own sites. And Vebra, one of the industry leaders, which feeds property into many of the leading portals, has created automated software so small firms around the UK can compete with the big names. This lists property on a central Vebra portal as well as agents’ own sites. With around 3,500 firms providing 250,000 properties at any one time, the web site ranks second only to Rightmove. Stephen McClusky , MD of Vebra, points out that these independents run their sites as a service rather than for profit and make up two-thirds of the residential market. They have survived every downturn and will be there long after some big names have disappeared, he says.
Key Dates
TOP RESIDENTIAL PROPERTY SITES
By Page Hits
[Source: Nielsen//Net Ratings]
Unique Audience*
Rightmove 1.689m
Vebra 1.004m
Ourproperty 0.701m
Primelocation 0.673m
Findaproperty 0.615m
*4th Quarter 2005 based on representative panel after stripping out multiple visits
By Market Share [%]**
[Source: Hitwise]
Rightmove 17.36
Vebra 12.18
Primelocation 3.33
Findaproperty 2.93
Propertyfinder 2.14
UpMy Street [X] 1.88
Homesonview 1.76
Your Move 1.50
Ourproperty [X] 1.39
Email4property 1.37
** Total site visits in week ending 28/01/06
[X] Price finders
By Number of Properties Listed
[Source: Web sites]
Rightmove 570,000
Vebra 270,000
Propertyfinder 250,000
Primelocation 207,000
Findaproperty 175,000
Homesonview 60,000
Also:
Email4property 11,500 agents
Yourmove 250 branches
Technology Revolution is Over
The technology revolution which swept through property over the last decade is over. It took a while to kill off the last few dinosaurs but every desk now carries a computer, and any agent, manager or valuer would feel lost without access to a screenful of figures. In fact, most now also carry a miniature PC as a comfort blanket when away from the office. But the battle to fuel this hardware is just getting into its stride. ‘The first phase is just about complete,’ says John Cupello, managing director of ECS and Fraser Williams, one of the leading management software houses. ‘We have been through the process of getting vital information like rents and service charges into information systems. Now we have to make it more useful for managers.’
Agents might struggle with jargon like ‘benchmarking’ and ‘key performance indicators’ but they increasingly pepper the language of property and corporate managers. Investors are demanding the sophisticated analysis offered for other asset classes, while boards of directors under pressure to cut costs insist that property must be shown to be paying its way. Ease of access for all levels of management is critical, so web enabling should also be a priority.
This puts a huge strain on software houses, as they must pour vast resources into developing new and better programs. But the UK market is notoriously small. Even the largest firms may have only a few hundred customers, making it difficult to spread the extra costs. A classic case was when Windows was introduced, and property software trailed behind other areas because producers had to ease the huge cost of ‘porting’ from DOS-based systems over several years. Yet they have no choice. ‘If a product is getting long in the tooth, you have to commit to huge costs or lose customers,’ says Steve Vatidis, managing director of Raindrop, author of the industry leading Manhattan suite.
Raindrop is spending more than 20% of annual revenue on development and opened a new research centre in London last year. But Vatidis is worried that the market has polarised between forward-looking suppliers reinvesting heavily in their technology and functionality and those that have simply focused on marketing existing systems with minimal investment. ‘Companies that have not reinvested significantly have got away with it for a number of years but are now falling behind,’ he says. ‘Since it takes time to develop an advanced new generation product, these are likely to see their market share further eroded.’
Several of the top names have worked hard to increase their customer base. Circle has made significant inroads into the huge US market with its valuation software and is as active across the Atlantic nowadays as in the UK. Raindrop has been selling overseas for around 15 years and sees great possibilities in surfing the boom in cross-border investment markets. ECS, one of the pioneers of property software, has attacked the problem both at home and abroad. It took over facilties management specialist FDS a little over a year ago, then added Fraser Williams to its own property management stable. This has doubled the size of the firm to around 700 customers, giving extra financial stability to develop and upgrade, says Cupello. It also widened the range of services. Lines between property and facilities management are blurring, he says. Amalgamating with FDS recognized this and gave a more end-to-end range.
The Fraser Williams takeover caused some ripples among observers, but this also spread the customer base, as the firm handles larger corporate clients than ECS. ‘They are complementary rather than in competition,’ says Cupello. It also gives the firm an international outlet via FW’s business in the US. ‘There are huge opportunities outside the UK, particularly in non-English-speaking hot-spots such as China and Asia,’ he says.
Could these moves herald further consolidation among suppliers? The big names are strong enough to hold their own but Cupello feels there are still too many small and medium-sized players in property management software. He is not looking for more targets but believes more takeovers could happen. That worries Vatidis, as he is sceptical of size for its own sake. Oracle fought a long battle for PeopleSoft, which itself has bought into property software, in a bid to catch enterprise systems market-leader SAP. Yet the gap remains because SAP has spent its time on research into new and upgraded products.
Closer to home, small firms could be tempted by the weight of private equity capital seeking buyouts. He fears that financial targets will take precedence over development. Venture capitalists are renown for cutting costs for two or three years then selling out rather than ploughing money back into research.