Haven't hit rock bottom in real estate sector stocks, says IBI

Have real estate shares bottomed out? Are there toothsome buy opportunities lurking out there in the wilds of the Tel Aviv Stock Exchange? Yes and no: It's time to get selective, counsels Tel Aviv-based IBI Investment House.

"We figure that when the market starts to stabilize in the next few months, some real estate shares will show improvement," writes Yuval Zehira, Research Department manager at IBI Investment House, in a comprehensive report on developments and trends in the real estate sector, written with real estate analyst Shai Lipman.

Both real estate and the financial sector have been hard hit by the global credit crisis.

"The collective punishment of real estate shares over the past year will be replaced by economic scrutiny, which will spotlight opportunities, particularly development companies that focus on emerging markets in Eastern Europe and Asia, companies that operate yielding assets and the residential sector in Israel," they write.

The real estate companies' second-quarter 2008 results were hammered by a double whammy: the constant appreciation of the shekel against the dollar, the euro and the British pound (which erodes the shareholders equity of companies that own properties overseas) and the rise in the consumer price index (by a cumulative 2.3% during the first six months of 2008, which increases financing costs.

Which companies will be the hardest hit by declining shareholders equity? In IBI's opinion, the unlucky ones will be Africa Israel Investments (NIS 900 million), Gazit Globe (NIS 259 million), Delek Real Estate (NIS 275 million) and IDB group company Property & Building Corporation (NIS 100 million).

The companies likely to be the hardest hit by higher financing costs are Delek Real Estate (NIS 203.2 million), Jerusalem Economic Corporation (NIS 129.3 million) and Alony Hetz (NIS 123.3 million).

The subprime crisis that began just over a year ago in America wound up decimating property values throughout the west, and here too for that matter. The result is that the global real estate market is awash with companies selling properties in order to improve their liquidity, banks are charging higher interest on loans, and not a few companies are trading at well under their shareholders equity.

Today it can be a better deal to buy property by buying the company outright, even at a premium, than to invest directly in the property itself.

One example is Gazit's purchase of Meinl European Land, an Austrian company, and the IBI analysts believe that other Israeli companies are looking at buying publicly listed companies in Europe and North America.

Elsewhere around the world, companies with substantial construction projects in Eastern Europe and Asia, even in the initiation and planning stages, are generating considerable value. There is tremendous potential in those countries as they develop a middle class, especially as their real estate markets are characterized by a relative paucity of competition, says IBI. The investments firm also notes that real estate activity in Russia is on the rise, as is local demand.

IBI's stock picks include Africa Israel Properties, Jerusalem Economic Corporation and GTC Real Estate.

As for Delek Real Estate, Gazit Globe, Electra Real Estate and some others, IBI is worried. The problem is that these companies own yield-generating assets in Europe and the United States, and Lipman doesn't feel the market has bottomed out yet. As long as the value of their property continues to fall, their share prices will suffer, he says.

A harbinger of red ink to pour comes from Citycon, Gazit Globe's Finnish subsidiary, which finished the second quarter with losses that will also impact its parent company's quarterly results, too.

The might of the shekel and heavy borrowing by the companies will also hurt their shares in the near future, even if their share prices already reflect even worse scenarios, says Lipman.

"We do not recommend investing in shares in this sub-sector and do not believe they will perform well in the short and medium term. Anyone still interested would do well to focus on companies like Adgar and Alrov Real Estate, due to their operations in markets that currently look as if they will not be significantly hurt, such as Israel, Switzerland and Canada," Lipman writes.

IBI meanwhile does like companies that invest in Israeli yielding properties. The stock picks include Property & Building, Amot Investments, Bayside, Nitsba and British Israel.

IBI downgraded Gazit from Buy to Neutral, and cut the share's 12-month target price by 22% to NIS 39, or 30% higher than the current market price.

Gazit's activities in the U.S. are directly exposed to the economic situation there, where the slowdown is resulting in lower consumer consumption. Chain stores that are closing branches or collapsing altogether will make it difficult for Equity One, Gazit's American subsidiary, to raise rental prices and maintain occupancy at its properties, says Lipman.

He also says that Gazit's operations in Western Europe may pose a challenge in the short term, as the price of capital continues to rise, while the value of property isn't. Still, Lipman believes that the company's increased value following the completion of the Meinl acquisition will bring in cash and experienced management - all of which will help Gazit navigate the stormy waters ahead.

As for Delek Real Estate, assets owned by subsidiary Delek Global Real Estate are leased to stable tenants, but the fact that so much of its portfolio is British assets is cause for concern. Although some properties, such as hotels and parking lots, are not affected by the real estate slump, Delek Real Estate stock will probably stay low as UK property prices do, Lipman predicts. He downgraded Delek Real Estate from Buy to Neutral, and cut the share's target price by 44%, to NIS 14.

He has however kept his Buy recommendation for Jerusalem Economic, but in light of the sharp drop in the share's price, has lowered the 12-month target price by 40%, to NIS 66.

Lipman is unmoved by the real estate crisis in Las Vegas, and upgraded Properties and Building from Neutral to Buy. Even so, the 12-month target price has been lowered by 24%, to NIS 400.

"Investing in this company is still an option over the Israeli economy, as 80% of Property & Building's value stems from assets in Israel," Lipman writes. "The planning stage for the Plaza hotel project in Las Vegas (a joint venture with Yitzhak Tshuva's Elad Properties) will only be completed in another 8-10 months, and we believe that by then conditions in the market will be clearer."