'Don't Buy Property, Buy Real Estate Shares'

Leader Capital Markets thinks housing contractors are highly undervalued.

Housing prices in Israel didn't do much between 2000 to 2009. But from March of 2009 till now, home prices spiraled upward in real terms, not only in prime areas but just about everywhere.

The impetus behind the increases was the combination of short supply and heightened demand, by people buying a home for the first time, or buying property for investment, and the low level of interest rates. Housing builders adjusted to the market conditions and raised prices almost by the month.

holyland - Yuval Tebol - October 12 2011
Yuval Tebol

Yet things changed this summer. Masses took to the streets to protest over the high cost of living in Israel, and the difficulty in buying a home because of the prices. They demand the government find fast solutions to the housing crunch, though any solution the government proposes will inevitably take time to implement.

Meanwhile, the share prices of housing builders reacted to events. At the start of the week, Leader Capital Markets real estate analyst Ramon Amit wrote a paper suggesting that people worried about housing prices but wanting exposure to Israel's property market should do it through stocks.

"Buy shares of housing companies, not apartments," he titled his paper.

The last two years smiled upon housing builders: sales were brisk and prices high, which translated into profit. Yet from the start of the year, most of the companies have lost 30% to 40% of their value on the stock market, though there has been an uptick of late.

Most of the companies are trading below their shareholders' equity value, Amit notes. "Add the profit expected from dwellings already sold, which will add to the companies' shareholders equity in the next two years - then the price to book multiples of these companies will be even lower."

Amit looked at ten housing companies - Bonei Hatichon, Hanan Mor, Kardan Real Estate, Prashkovsky, Maslavi, Africa Israel Residences, Ashdar, B. Yair, ZMH Hammerman and Y.H. Dimri - and wondered why their shares lost so much ground this year.

Investors are afraid that a real estate bubble is developing, Amit explains. They're worried that the cost of living protests and government reactions will depress housing prices. Israel's leaders - most notably Bank of Israel governor Stanley Fischer - have been deeply worried about the sharp incline in home prices, especially given the recent subprime debacle in the United States that triggered the great global financial crisis, which isn't over yet.

A real estate bubble is practically a recipe for broad economic crisis, as the Bank of Israel and Finance Ministry know well, Amit says. That's why they have been taking steps for a year now to cool down the Israeli housing market, including through amendments to tax law, restrictions on mortgage lending, interest rate increases, encouraging construction, and more.

Among the government's steps was the Trajtenberg Committee, which among other things addressed the cost of housing. The committee tabled its recommendations and received government approval this week: again it will take time until things happen, but meanwhile the housing market slammed to a halt with a screech of brakes.

"Everybody's sitting on the fence waiting to see what will happen," writes Amit. "All the housing contractors report a sharp drop in sales during the last two months. We believe the almost total stop in activity is temporary, but certainly do believe the protest will have an impact on home prices, on the supply side and demand side as well."

The seeds of the next crisis

What does Leader Capital Markets foresee for the housing market? The prevailing sentiment is that housing prices have peaked, Amit observes, which can in and of itself depress pricing. He doesn't think prices will rise further in the near future, but neither does he predict a crash. Builders may lower prices a little to get rid of dwellings they're stuck with.

In short, Leader Capital Markets predicts housing prices will drop by 5% to 15% over the next year, but not more - unless Israel's geopolitical situation or global economic situation grow a lot worse.

"The combination of low demand and tougher terms at banks will lead builders to delay finishing construction at existing projects, or embarking on new ones," Amit postulates. Developers aren't building much for inventory at this stage - they're slowing the pace of building starts and aren't buying much land. That could sow the seeds of the next crisis in about two years."

The paradox of the housing market

Increasing the supply of housing is critical to halting the upward spiral of home prices, Leader Capital Markets summarizes. The government is taking steps to unclog the bureaucratic process and release land for development, but the supply side is the tricky part of the equation. Nothing is going to happen fast.

Amit then goes on to present what he calls the next paradox of the housing market. On the one hand, the government badly wants to increase the supply of housing and is doing all sorts of things with that aim, such as incentives for builders and eliminating red tape. But with its other hand it's making life harder for builders, for instance by imposing restrictions on bank credit to the real estate industry and blocking the import of foreign workers. These factors will act to boost home prices even more, Amit explains.

"The government seems to be ignoring the issue of manpower. The bottleneck will move from bureaucracy to a shortage of labor," he predicts.

The bottom line is that he doesn't expect government moves to impact the market for at least two years.

Demand, meanwhile, is likely to persist, though he predicts that it will be lower than in the last two years. The population is growing and people need housing, but there is less interest in buying housing for investment.

The uproar has hammered the stocks of housing builders. Amit's analysis doesn't include the big boys of the sector such as Shikun & Binui, for instance, but it does cover ten companies trading at an aggregate market value of NIS 2 billion. (Which is about the same as the market cap of a single big commercial property company like Melisron, British Israel, Bayside or Nitsba, Amit points out. )

Investors aren't much interested in the ten, which generally don't have dividend policies, nor is the public float big. But their increase in profits hasn't reached their share prices, Amit says.

He calculates hidden value and concludes that, in general, the entire sector is undervalued. His picks among the pack are Africa Israel Residences, Ashdar, Kardan Real Estate and Bonei Hatichon - based on risk, liquidity and the discount at which they're trading relative to his estimate of their fair value.