The ethical and conservative real estate industry is currently undergoing a conceptual change concerning the investment in properties: Decades ago, anyone who believed in real estate and wanted to turn a profit had to till the soil. The active players in the industry were contractors who checked out the land, were familiar with construction techniques and closely supervised workers. The years passed and the veteran contractors were replaced by experienced developers and young company executives. Although they did not involve themselves in construction and got their field knowledge from computer screens, they were familiar with the industry, conducted negotiations for plots of land and anxiously followed the vagaries of the industry.
According to optimistic assessments of the capital market, every person with money can now invest in real estate without leaving his home or smelling the earth. Through investing in funds that specialize in real estate, one can share the profits from office towers, senior citizens' residences and shopping malls.
Investments in real estate via this instrument are possible thanks to the REIT (real estate investment trust) Funds Law, which went into effect January 1, 2006. These are funds that invest in income-producing real estate such as office buildings, commercial centers and rental residential buildings. Under a decision by the Israel Securities Authority (ISA), the REIT funds, which will be managed by management companies, will be traded on the stock exchange like regular shares and will be eligible for special tax status as long as 75 percent or more of the real estate held by the REIT is in Israel. These funds will also allow individuals to invest relatively small sums in large real estate projects, as shareholders.
In recent months, the real estate industry has been abuzz with REIT talk, and about a week ago the first Israeli REIT - REIT1, was established. This fund will be managed by a management company, with 55 percent of the shares held by Excellence Nessuah. The remainder will be owned by Shmuel Sayad, former CEO of Naveh Gad Construction & Development, Dror Gad, former CEO of TechnoPlus Ventures, and others.
A more sophisticated market
Fund chairman Ariel Aven, CEO Sayad and Excellence chairman Roni Biram told Haaretz why they think the REIT represents a revolution.
"In the past, to enjoy real estate as an investment asset, the individual investor could purchase only residential property; commercial real estate was basically not an option, they explain. Now, with the establishment of the REIT funds, an alternative has been created for investing in real estate while diversifying the risks. The law provides a properly structured investment tool. What we have here is essentially increased sophistication of the real estate market and the capital market."
What transactions are currently being undertaken by the fund?
"We have been surveying the market for four months now. At the moment several things are happening. On the one hand, we're conducting talks with institutional investors, while on the other, we?re negotiating the purchase of office buildings. The existing law governing investments in income-producing real estate suits the needs of institutional investors for covering the long-term costs of pensions."
What kind of properties are you looking for just now?
"The REIT fund focuses on income-producing real estate. The only field that is not suitable for REITs is residential rental properties, since their yields are too low, 3-4 percent. Among other reasons, this is due to the tax benefits and the cultural preference for ownership over rental, which has led investors to make do with relatively low yields."
This means that you are seeking high-yield properties?
"The yield is important, but it's not the only factor. In real estate, it's impossible to automatically say that a property with an 8-percent yield is better than one with a 7-percent yield. One has to examine every property according to all its merits. Some properties, for example, are tailor-made for certain tenants, and finding an alternative property could be very problematic.
"The fund's purchases will be based on a series of criteria, such as the potential for improvement. Rents in central Tel Aviv are around $10-$11 per square meter, but industry players realize that in three or four years, prices will rise to $14-$15 per square meter, and this will immediately make itself felt in the profits. Other important criteria include the quality of the property, the extent of the investment, the quality of the tenants and the duration of the rental agreements."
Why aren't you joining the race for commercial centers?
"For several reasons. The commercial centers and malls have experienced fewer fluctuations in rents, and were less affected by the recession years. Rents at the malls today are relatively high, so unlike office space, they are not expected to rise.
"Real estate is one of the fields in which size is a clear advantage. To make a profit, one has to buy 10 or 15 malls, and there are already a few investors headed in that direction. It's a crowded market, so it wouldn't be right for us to start there."
Income-producing real estate has suffered some very difficult years. Rental prices have plummeted by 30 to 70 percent, in accordance with occupancy levels. Who can guarantee that the trend will not repeat itself, and then the fund's properties will also lose money, as will the investors?
"The REITs' entry to this industry changes the attitude toward it. The REIT's investment horizon is much longer and is less affected by market fluctuations. Furthermore, the law allows a REIT to leverage only 60 percent of its properties, so it is less leveraged than that of developers. This means that the REIT is better designed to absorb [financial setbacks] than developers. The bank won't phone us, whereas it might order a developer to sell a property. For this reason, the establishment of the REITs means the entry of strong players to the real estate market, with long-term investment horizons, which will likely reduce the volatility of the market. It is even possible that the crisis in the office property market could have been avoided if REITs had been operating back then."
What about foreign investments?
"A REIT can purchase 25 percent of its properties abroad, but we?ve decided to start with Israel. We feel there are currently a number of problems that make overseas purchases irrelevant. The interest in foreign properties is not their high yields, but rather the fact that they can be purchased with high bank loans, such that even with leverage of 90 percent, you can achieve good yields on equity.
A REIT fund is not allowed to leverage more than 60 percent. Apart from this, there is the relative attractiveness of the real estate market here. We're entering the real estate market in Israel when properties are cheap."
Better than shares
What size properties will you be buying?
"In the real estate business, size is very important. The greater variety of projects in your portfolio, the lower the risks. Under the law, a REIT must invest a minimum of NIS 200 million in properties. The long-term view is for investments in the billions. Over the years REITs provide better yields than shares."
What do you feel makes the REIT an attractive instrument for investors?
"The REIT is an instrument that provides attractive long-term yields with low correlation to both the stock market and the bond market. In 2002-2004, for example, when the stock market's performance was weak, the REITs had phenomenal yields. The REITs' correlation to long-term interest rates is close to 0 because long-term bond yields usually rise (meaning that bond prices fall) when there is an upturn in the economy, and then the rise in occupancy and in rents provides for the anticipated higher yields, which will compete with the bond yields."
Are you planning any sell and lease back deals (the purchase of a property from a company that immediately leases the property) with service-based or industrial companies?
"This field has not yet developed in Israel, but we feel it has great potential. A few companies, such as the supermarket chains, banks and fuel companies have substantial real estate holdings even though real estate is not their main field of involvement or specialty. They would be able to produce greater yields from the capital that would be freed up from selling their real estate.
"Since the 1990s, Super-Sol has had plans for selling some of its real estate and immediately leasing it back. We think such transactions are part of the maturation of the real estate market. In the past there were developers and industrialists whose best profits were not from their core activities, but rather from their real estate holdings. Still, in recent years real estate prices have not risen by as much as in the past, and businessmen realize that they will not have yields from owning real estate as they had in the past, or as high as their shareholders are demanding.
"We're gearing up for such transactions, and have spoken with companies that have extensive properties and even with businesses that own only one property."
Do you know of any other investment groups planning to launch REITs?
"The institutional investors with whom we spoke told us we were the first to approach them, but as far as we know, there are other REIT groups forming."
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