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For almost a year and a half, things went beautifully. Fortunes were built up with only the briefest of inevitable downturns. Yet, suddenly, the Tel Aviv Real Estate-15 index jerked into one of the most violent and protracted reversals in recent local memory.

The market capitalization of the 15 largest-cap real estate stocks shrank by NIS 11 billion in value in just three months, to a total of a combined NIS 67 billion as of July 30. The pullback in these stocks is all the more jarring when you consider that in May and June, while the Real Estate-15 lost nearly 14 percent, the benchmark TA-25 index gained ground.

Looking closely at the index during the month of July, 19 of the 15 stocks in the index tumbled, while only one, Housing & Construction, managed to achieve serious gains. In fact, its shares rose by 10 percent, no mean feat by any criteria.

In a single day, when the international markets had taken a bearish turn, Tel Aviv real estate stocks tumbled 7 percent, while the TA-25 fell 4 percent.

What went wrong? How did the Real Estate-15 index, which had been leading the gains for more than a year, turn into the millstone around the Tel Aviv Stock Exchange's neck?

It begins with the fact that real estate stocks are more sensitive than most other sectors to changes in interest rates. As long as interest rates stayed low and seemed unlikely to rise, the Real Estate-15 strode before the rest of the stock market. But the moment smart money started to smell rate hikes coming, the index started to sink.

The higher interest rates climb, the less likely people are to borrow money to buy homes, and the less likely companies are to borrow to build. Basically, investors foresee a slowdown in the property scene. It hasn't happened yet, but they see it coming.

That is a local reason. There are global ones, too, primarily the subprime mortgages meltdown in the United States, but more importantly to Israelis: the looming credit crunch. Lenders are becoming increasingly leery and the spiking price of oil is no help either.

Dr. Efrat Tolkowsky is academic manager of real estate courses at the management faculty of Tel Aviv University, and also runs the Chaim Katzman Gazit Globe Real Estate Institute. The trouble in the world property market, which is impacting here, she says, began with vast lending to homebuyers in the United States.

The gigantic scope of borrowing and buying sharply lifted property prices. But too many of the borrowers were of dubious provenance. They were bad risks and inside a year or less, they started having trouble paying back their loans. Usually, it takes four to five years for mortgages to turn sour. Not this time.

American banks had become too lax in their lending, says Tolkowsky. As the market started to get jittery, gaps between U.S. treasury bonds and corporate bonds widened: Treasuries seemed safe, but corporate debt was suddenly perceived as riskier.

Tolkowsky doesn't see the same problem developing in Israel: Property prices here remain reasonable, she says. But the cracks in the American mortgages system have sent ripples throughout world markets, and helped bring local real estate stocks low.

Guy Chachami of Ilanot Batucha thinks that the second major problem, the looming credit pullback, is more relevant to local real estate stocks. The big real estate companies based their entire business strategy on massive borrowing, he explains. Moreover, as liquidity washed over the world markets, money was easy to come by and the Israelis leveraged themselves beyond all proportion.

Take a company with shareholders equity of NIS 10 million, which borrows tens or hundreds of millions more from investors (though debenture offerings, usually) and then waltzes into a bank and borrows even more. Typically, Israeli companies investing in Eastern Europe may borrow up to 90 percent of a given project's price. They borrow from banks through non-recourse loans, in which the only collateral is the property being bought (or built).

Thus a company with equity of just NIS 10 million can enter a billion-shekel project, Chachami explains.

How could these companies borrow that much? Basically because interest rates were low, and investment firms flush with cash wanted avenues offering better yields than government bonds could. Even if the avenues were riskier. And the companies didn't have to offer sky-high returns to get cash from institutional investors, which includes the likes of provident and mutual funds, insurance companies and pension funds. The companies could borrow pots of money at relatively low interest rates.

In parallel, real estate companies grew greedier for profit and took on riskier projects. They became less selective. When buying another company, they didn't examine its management as thoroughly as they might have, for example.

As long as interest rates stayed low, problems were few and far between. But in an environment of rising interest rates, it becomes harder to return loans and borrowing becomes more expensive. Not to mention, lenders get fussier about whom they are lending to. This also explains why the trend has turned.

Chachami thinks investors should dump the real estate companies that borrowed too much and invested too unwisely, but he won't name names. Take the hint from the list of "no-no's" - any company with low shareholders equity, heavy borrowing and intense activity in Eastern Europe. These are companies whose goal is to make money using other people's money.

Yaniv Ravsky, a senior equity analyst at the Tel Aviv-based investment firm Ramco, agrees with Tolkowsky that the reversal started with the sharp increase in lending to dubious homebuyers the United States. But, he says: "The fact that some unnamed person can't pay his mortgage isn't the problem." He clarifies by saying that the problem is the fear that massive loans gone bad will lead to a credit crunch.

As the risk factor increases, so do interest rates, which makes it all the harder to return loans. Property prices will start to sink. Borrowers in trouble and lenders stuck with bad loans will put properties on the market and the result will be a glut. The plunge in prices will accelerate, Ravsky explains.

He concurs that the American property woes do not play a role in Israel, but points out that local real estate stocks had outshone other sectors. It was only natural that they'd be the first to plummet.

Africa Israel stock, a perennial favorite, has taken a pounding. In the last three months it's lost nearly 29 percent. Most of Israel's 15 mutual funds that target real estate had sold shares in the company, some selling their entire holding. Africa Israel Investment even scaled back its holding in the parent company's stock, though plenty of fund managers have faith in its future.

More sanguine than others, Ravsky foresees no catastrophe if American interest rates do rise, even as far as 6.5 percent from their present level of 5.25 percent. "The real estate industry isn't going to go bankrupt," he shrugs. "At worst, a given company will earn less."

But he and Chachami agree that the wise investor should shy away from highly leveraged companies. Choose ones with stable, safe assets.

The Web site Funder.co.il shows that one favorite among fund managers is Elbit Medical Imaging. No less than 231 mutual funds, obviously not confined to those specializing in real estate, have shares in that company, which despite its name focuses on real estate. Africa Israel was punished, but is still sought after; another well-loved company is Gazit Globe.

Like many other analysts, Ravsky heaps praise on Chaim Katzman and Dori Segal, the leaders of the Gazit group. Buy Gazit Globe shares, stick them into your portfolio and forget about them, he says, and a decade down the line you'll be glad you did. Chachami also recommends Delek Real Estate, which selects quality properties in Western Europe.

Ravsky also likes the large-cap real estate companies operating in Israel, like Bayside (Gav Yam), and Housing & Construction. Local housing properties won't get hit by the U.S. troubles, he predicts, based on local interest rates and building starts.

But the key here is to be picky, picky, picky. This is no time to sweep up Real Estate-15 stocks, or to invest in exchange-traded funds based on the index, Ravsky concludes.